ECONOMIC events in China are inextricably linked to those in Britain, and in particular the current worries over inflation. Is the “China effect” — low-cost imports that have helped to keep prices down — coming to an end? You don’t have to look at the official statistics to know the Chinese economy is booming — some would say dangerously overheating. Visiting Beijing last week, I was struck by the forest of construction cranes, traffic jams at all hours, a permanent smog haze and non-stop bustle.
The figures, mind you, are pretty impressive. In the first half of this year China’s economy grew by 10.9% compared with a year earlier. That is hot but not necessarily untypical. Since 1978, growth has averaged 9.6% a year. Retail sales are rising by 13%, exports by 33%, imports by 25%, incomes by 11%-12%. Employment is growing by more than 1m a month.
The question is whether this boom has got to the point where it is doing the rest of the world more harm than good. The China effect has been crucially important in recent years. Without it, inflation and interest rates would have been significantly higher. Imports from China have transformed what would have been an environment of low inflation into one in which, until recently, prices were increasing at a snail’s pace or even falling in the case of many goods.
But now, if the China effect is coming to an end, it raises questions about the past decade. Was it all just a short-term party, giving us, on the back of low inflation and interest rates, a housing and consumer boom but not much to show for it in the long run? Have we sacrificed much of what remained of our manufacturing industry without gaining permanently lower prices? Add in China’s contribution to high oil and commodity prices, now thankfully easing back, and the doubts multiply.
One of the things I was doing in Beijing was attending the World Economic Forum’s (WEF) China Business Summit. Participants from multinationals and domestic firms expressed concern about wage inflation. That, coupled with booming property prices suggests a degree of overheating that may mean higher export prices. Anecdotal reports suggest that it is already happening.
I have touched on the puzzle of China’s export prices before, expressing scepticism about whether the China effect is ending. That scepticism still seems justified.
In the absence of data for the import prices into the UK from China, the best source is America’s official data. Figures from the Bureau of Labor Statistics show that US imports from China in July were 1.3% cheaper than a year earlier, and have continued to fall, month-on-month, in recent months.
That is supported by official data on consumer-price inflation within China, which has averaged 1.2% this year, with goods prices falling.
How can China be avoiding inflation? The investment boom has led, at the very least, to adequate capacity or, more likely, overcapacity. Productivity, partly as a result of this investment, is rising strongly.
Can the China effect continue? Yes, said every Communist party representative at the China Business Summit, including Zeng Peiyan, the vice-premier. He and others extolled the country’s 11th five-year plan (2006-10), with its emphasis on science, innovation and technology.
The aim is to extend China’s reach up the value chain in manufacturing and into services. The prospect, in other words, is of a further rise in China’s market share, exerting a disinflationary effect on Britain and other advanced economies.
Even if sock prices do not keep falling, the price of higher value-added goods will. Certainly there seems to be no let-up in China’s ability to gain market share. The trade surplus was a record $18.8 billion (£10 billion) last month.
The biggest risk to the China effect comes from another source. The WEF, in an attempt to peer into China’s future, has been working with 150 experts to flesh out prospects over the next two decades.
Its most optimistic scenario, which it calls “New Silk Road”, has China continuing to grow at a rapid rate, averaging 9% a year until 2025. China, on this view, pushes through economic and banking reforms and internal political dissent is contained. The middle class grows, individual rights are enhanced and action is taken to tackle inequality and environmental damage. Most importantly, China is seen as a positive partner by the rest of the world, both political — contributing to peacekeeping operations — and economically, as the world’s motor.
At the other end of the scale is what the WEF calls “Unfulfilled Promise”. In this scenario, growth is still strong by normal standards, averaging 6%, but it falls short of what China has achieved in the past quarter-century. The reform process grinds to a halt for fear of dissent. Export growth weakens as competitiveness declines. And China fails to become a major global player.
Perhaps most interesting, however, was what Professor Jean-Pierre Lehmann of the International Institute for Management Development described as the base case. This, called “Regional Ties”, sees China continuing to grow strongly, averaging 7.5%, but with the emphasis on trade with Asia.
Trade with the rest of the world is hit, first, by a sharp American slowdown and, second, by protectionism. Both look plausible. Protectionism is already evident in Peter Mandelson’s bra and shoe wars with China on behalf of the EU.
In Brussels and Washington protectionism is never far below the surface, particularly as far as China is concerned. If it increases, it will have the effect of depriving European and US consumers of the China effect of falling prices.
Protectionism is not, of course, a one-way traffic. China has just introduced media rules that discriminate against foreign businesses. The authorities have said they are examining controls on imports where local firms are subject to “unfair” competition. Many UK exporters will be shaking their heads at that.
So protectionism could be the biggest risk. Left to its own devices, the China effect has many years to run. Protectionism, if allowed to take hold — and the collapse of the Doha world trade round was a pointer — could cause this era of globalisation begin to run into the sand, and deprive the world of its contribution to low inflation. China would probably do pretty well, even in these circumstances. For the rest of us, things might not be so good.
PS: Pointed question. Has a Labour chancellor of the exchequer ever become a successful prime minister? Answer: No. This may be unfair on Gordon Brown, because the sample is only one. It may be unfair on the one, the late Jim Callaghan, who inherited an appalling economy from Harold Wilson (Callaghan had been chancellor some years earlier), improved things for a while but left office under the cloud of the 1978-79 winter of discontent.
Across all parties, some great prime ministers served at the Treasury, including Gladstone, Churchill (poor chancellor, good prime minister) and Lloyd George, who did both jobs pretty well. Harold Macmillan was another. Aside from Callaghan, the only recent holder of both posts is John Major. When chancellor, he coined the phrase, “if it isn’t hurting, it isn’t working”, then found life as PM painful.
So Brown has all to play for, assuming he enters No 10. But his chancellorship is drawing to an end on an unhappy note. The “misery index”, a measure of economic wellbeing arrived at by combining the unemployment and retail-price- inflation rates, stands at 9. It was last this high in March 1999 and higher in June 1998. Who said things could only get better?
