Investment opportunities, official incentives offer path for speedier growth

Editor's Note:

China's GDP grew at 7 percent year-on-year in the first quarter, its slowest pace in six years. March retail sales, industrial output and fixed-assets investment all missed analyst expectations. The across-the-board decline in economic indicators has raised questions about whether China's economy has bottomed out. Is the economy heading for a hard landing or a welcome rebalancing? At a forum held Saturday, Justin Lin Yifu, former chief economist and senior vice president of the World Bank, and Li Daokui, director of Center for China in the World Economy (CCWE) at the School of Economics and Management of Tsinghua University, shared their insight to what caused the current slowdown in China's economic growth.

Justin Lin Yifu:

China's economic growth has slowed since the first quarter of 2010. In the first quarter of 2015, the economy only grew 7 percent. This is the longest slowdown since the reform and opening-up and the 7 percent growth is the slowest pace in 25 years. The economy remains under great pressure.

To answer the question whether China's economy will continue to slow and what tools we still have to stabilize the economy, we have to figure out whether the economic slowdown since 2010 was caused by the internal factors of China's institutions or external cyclical factors. As a country in economic transition and a developing nation, China certainly has a lot of institutional issues, which we need to address. But personally I believe the prolonged economic slowdown in China since 2010 was cyclical and mainly caused by external factors.

A nation's economy is powered by three pillars - exports, investment and consumption. In terms of China's exports, the average annual growth of exports had been 17 percent until 2013. However, export growth slowed to 3.4 percent in 2014. The main reason for the sharp decline is that the economy of developed countries has not fully recovered to the pre-financial crisis level. An economic recovery in Europe is not on the horizon and Japan's economy only grew 0.2 percent last year from a year ago. Meanwhile, the US economy, though it performed better, expanded by 2.2 percent last year, still slower than its average 3 percent pace. When the economy of developed countries such as the US and Japan, as well as those in Europe, whose GDP account for half of the world's total, do not fare well, China's exports will slow.

Investment is the second pillar. Since the financial crisis in 2008, each nation had taken some proactive fiscal policies to support domestic investment. These investment projects have been basically completed over the past five to six years. Without new projects, investment growth is bound to slow.

That brings us to the third pillar - consumption. Consumption in China has grown fairly well. Over the past few years, consumption had maintained an annual growth rate of more than 7 percent, despite the drag of external factors. But because the impact of external and cyclical factors has not diminished, ordinary households are pessimistic about the future, so consumption growth will also slow.

To look ahead, we can expect developed economies such as the US, Europe and Japan to remain in an economic slump for quite a while because their structural reforms have not yet taken place. Hence, China's exports are unlikely to grow by 10 percent, which has been the average since the reform and opening-up. Whether China's economic growth stabilizes depends a lot on the growth of domestic demand.

Investment in China has more room to expand, despite overcapacity in many industries such as building materials, cement, glass and aluminum. Because the majority of China's industries remain as middle- and low-end and have potentials to move to middle- and high-end, they can create vast investment opportunities with high economic returns and social benefits.

To answer the question whether China's economy will continue to slid or bottom out is simple. It depends on whether we make good use of our investment opportunities. Good investment opportunities can create jobs, and with jobs, consumption will grow, as will investment. The economy will eventually grow at a faster pace.

Li Daokui:

It is too early to say that China's economy has reached a trough. It will take (at least) another quarter for the economy to hit bottom and start to recover. The main reason is that the two factors that drag on China's economy - exports and real estates - cannot improve immediately. The economy in the second quarter of the year is likely to continue to grow by 7 percent. If favorable factors emerge, the economy could recover in the second half and grow by 7.1 percent on an annual basis.

Undoubtedly, the factor that bolsters the new round of China's economic growth is retail sales, a proxy for consumption. If one excludes the factors of fuel prices and automotive consumption, consumer goods spending grew robustly around 12 percent year-on-year in the first three months. So the bright spot in the new round of China's economic growth is the continuous rise of consumption.

The current economic slowdown poses the question of what needs to be done to stabilize the economy. First of all, stabilizing the economy means more than just stabilizing growth. Stabilizing growth focuses on the GDP growth rate, but stabilizing the economy requires maintaining the sound growth of the employment rate, preventing further weakness in the real estate market, avoiding wild fluctuations in the capital market and ensuring the stable growth of trade and the international balance of payments.

China is taking measures to stabilize the economy, including speeding up investment in large projects such as high-speed railway and subsidized housing as well as macroeconomic policies such as moderately flexible fiscal and monetary policy.

However, stabilizing China's economy involves not only the adjustment of monetary and fiscal policies, but also giving positive incentives to officials, especially local government officials, so they are driven to focus on stabilizing the economy and more importantly, promoting reforms.

Currently, some local officials slack at work, which prevents the pro-growth policies from being implemented and adds to the pressure on the economy.

As the ongoing anti-corruption campaign moves forward, officials should be given incentives for doing a good job in developing the economy. Along with promotion, rewards in cash or in kind could be given to those who perform well.

That said, it does not mean we will return to the old model where GDP growth is the key metric for judging a local official's success. There needs to be broader criteria for evaluating officials.

By providing incentives to officials who are committed to reform and innovation, government action can align with market behavior. Then the economy can bottom out in the third quarter, laying a solid foundation for economic growth in the coming two years.