By Kenneth Rogoff
former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.
While virtually every country in the world is trying to boost growth, China's government is trying to slow it down to a sustainable level. As China shifts to a more domestic-demand driven, services-oriented economy, a transition to slower trend growth is both inevitable and desirable. But the challenges are immense, and no one should take a soft landing for granted.
As China's economy grows relative to the economies of its trading partners, the efficacy of its export-led growth model must inevitably fade. As a corollary, the returns on massive infrastructure investment, much of which is directed toward supporting export growth, must also fade.
Consumption and quality of life need to rise, even as China's air pollution and water shortages become more acute in many areas. But, in an economy where debt has exploded to more than 200% of GDP, it is not easy to rein in growth gradually without triggering widespread failure of ambitious investment projects. Even in China, where the government has deep pockets to cushion the fall, one Lehman Brothers-size bankruptcy could lead to a major panic.
Think of how hard it is to engineer a soft landing in market-based economies. Many a recession has been catalyzed or amplified by monetary-tightening cycles; former US Federal Reserve Chairman Alan Greenspan was christened the "maestro" in the 1990s, because he managed to slow inflation and maintain strong growth simultaneously. The idea that controlled tightening is easier in a more centrally planned economy, where policymakers must rely on far noisier market signals, is highly questionable.
If one were to judge by official and market growth forecasts, one would think that the risks were modest. China's official target growth rate is 7.5%. Anyone forecasting 7% is considered a "China bear," and predicting a downshift to 6.5% makes one a downright fanatic.
For most countries, such small differences would be splitting hairs. In the United States, quarterly GDP growth has fluctuated between -2.1% and 4.6% in the first half of 2014. Of course, Chinese growth almost surely fluctuates far more than the official numbers reveal, in part because local officials have incentives to smooth the data that they report to the central authorities.
So where is China's economy now? Most evidence suggests that the economy has slowed significantly. One striking fact is that annual growth in electricity demand has fallen sharply, to below 4% for the first eight months of 2014, a level recorded previously only in the depths of the global financial crisis that erupted in 2008. For most of China's modernization drive, electricity consumption has grown faster than output, not slower.
Weakening electricity demand has tipped China's coal industry into severe distress, with many mines effectively bankrupt. Falling house prices are another classic indicator of a vulnerable economy, though the exact pace of decline is difficult to assess. The main house-price indices measure only asking prices and not actual sales prices. (Data in many other countries - for example, Spain - suffer from the same deficiency.)
Of course, exports have also slowed, given sluggish growth in the rest of the world. Commodity exporters such as Australia, Indonesia, and Brazil have already felt the effects of slowing Chinese growth, as have countries, such as Germany and Switzerland, that depend on satisfying China's voracious demand for capital-intensive goods.
Unfortunately, China's data are not nearly as reliable as those measuring a developed economy, which makes it difficult for anyone to be sure of what is happening. Electricity usage is typically one of the most reliable measures of growth; but, with the economy shifting toward services, and with many energy-intensive industries such as cement and steel production slowing down, it is perfectly possible that slow electricity growth is simply a symptom of rebalancing.
Likewise, the softening of housing prices follows a short period in which prices more than doubled, which makes it difficult to tell whether China is facing a modest and healthy correction or outright collapse. And if continental Europe eventually recovers, as the US and the United Kingdom are, export growth could pick up again.
What seems clear is that China's leadership is intent on pursuing many of the market-oriented reforms approved by the Third Plenary in 2013. President Xi Jinping's aggressive anti-corruption campaign might be seen as preparation for political resistance to further economic liberalization. On the other hand, one can argue that, until now, Chinese corruption was more of a tax than a paralyzing force, and that dramatically changing the rules of the game could by itself catalyze a sharp drop in output.
Can China's government engineer a soft landing while weeding out corruption, reducing pollution, and liberalizing markets to ensure long-term growth? The stakes are high. If Chinese growth collapses, the global fallout could be far worse than that caused by a normal US recession.
China's growth rate remains perched at a very high level, so there is a great deal of room to fall. The potential vulnerability of Western exports and equity prices is massive. Of the two major instances of policy tightening occurring in the world today, the US Fed's may be the easier one to understand, but it is not necessarily more consequential for the world than what is happening in China.