October 25, 2016. By Mark Barry:

Our Global Spotlight series takes a dive into foreign economies and their big-picture impacts. This edition will include commentary and analysis covering the economic state of China, and will be posted in three issues: 1.The Great Rebalance  2.Economic Transition and Reform  3.Risk of the Consumer.  

Part 1: The Great Rebalance

When Deng Xiaoping, the leader of China from 1978 to 1989, was questioned on his “unorthodox” economic ideas by more fervent members of the Communist Party, he often replied with “It doesn’t matter if a cat is black or white, so long as it catches mice.” Fast forward 35 years to today, and there is no question – Deng Xiaoping’s decision to open up the economy and embark on a path of economic reform has been a resounding success. Since reforms were first implemented in 1980, the pace of China’s growth has been incredible, with GDP growth averaging about 10% a year. This has transformed China into the world’s second largest economy, lifting hundreds of millions of Chinese out of poverty along the way. China’s economic rise also positively impacted the rest of the world, as it supplied cheap labor to produce goods for consumers in more developed economies and was a steady source of demand for commodities and other input materials.

Now, China’s growth has begun to slow. Officially, China’s annual GDP growth target is 6.5% for the next 5 years (their economy is currently growing around 7% per government statistics). While there is some debate over the accuracy of China’s official GDP statistics, the fact remains that China has been growing much faster than more developed economies for a long time, and while this relative outperformance may continue, China’s rate of economic growth is likely to decline moving forward. This decline is only natural, as a 10% growth rate in the long run is clearly unsustainable. However, China’s policymakers face a number of challenges in managing this slowdown in a way that maintains domestic economic and political stability.

How does this impact the United States? For one, China now plays an integral part in the global economy, and thus a prolonged economic slowdown (which we haven’t seen from China in the 35 years since it opened up) has the potential to disrupt growth in developed economies precisely at a time when they are suffering from a lack of it. Secondly, major US multinationals now derive a material proportion of revenues and profits from China, as it is after all the world’s most populous country. The importance of China to both the US economy and financial markets has been apparent over the past year; indeed, Chinese economic data and/or policy was the main driver of stock market volatility in both August 2015 and January 2016, and the US Federal Reserve mentioned economic conditions in China as having been a consideration in coming to their decision to hold off on any interest rate hikes.

So, if China’s economy is slowing and this slowdown will have a meaningful effect on the rest of the world, this means bad news ahead right? Not necessarily. As noted earlier, China’s rate of economic growth over the past 35 years is unsustainable in the long run – growth had to decline at some point. It is the manner in which this transition to a more mature economy with lower but more sustainable growth takes place that will determine what path China takes and the ultimate impact on the rest of the world. Managing this transition is not an easy task for China’s policymakers, and there are a number of necessary economic reforms that will be challenging to implement along the way. However, China’s rapid economic growth has resulted in a number of positive developments that should aid in the transition, most notably a large middle class and an innovative private sector. Where China goes from here remains to be seen, as there exist both challenges and opportunities for the economy.

In part two of this Global Spotlight, “Economic Transition and Reform”,  you will find additional detail on some of the most pressing challenges and reform, including rising wages, as well as an overview of China’s ‘new economy’ and the way forward.