beyondbrics

By Shen Minggao of Citigroup

China’s structural economic reform is overdue. The current indecisiveness on that reform is largely due to a lack of consensus among authorities about the urgency and direction of change.

Some triggers are needed to engineer a turning point in China’s growth model. The high-speed rail (HSR) tragedy last weekend could be one of those triggers.

China’s structural economic problems can be measured by the degree of decoupling of the Chinese economy from the developed world. The HSR was a product of a vast stimulus, needed to support artificially high growth.

The Wenzhou accident underscores the intensifying conflicts between the speed versus quality of growth. While China has focused on rapid growth in manufacturing and exports, services and quality have failed to keep pace. These things take not only investment, but also time, care, and attention to develop.

China’s GDP per capita has now exceeded US$4,000, and the demand for quality and respect for safety and lives is increasingly surpassing the need for speed. In the words of one blogger after the HSR incident, “China, please stop your flying pace, wait for your people, wait for your soul, wait for your morality, wait for your conscience!”

We believe Chinese authorities may choose intentionally to slow GDP growth in a gradual but firm manner to 7-8 per cent in coming years. At the same time, they are likely to focus more resources on fixing the problems created by seemingly unstoppable rapid growth.

Two problems tend to arise from slowing the growth rate below 8 per cent. Firstly, unemployment will rise. Secondly, with reduced industrial, infrastructure and construction investment, future growth may be impaired.

The solution likely lies in the service sector. Parts of the service economy could be privatised or securitised, providing proceeds to resolve the local government debt problem, creating investment and job opportunities in the private sector, and promoting consumption by removing supply bottlenecks in the service sector. China’s service sector is underdeveloped, and requires further investment – in particular healthcare, financial services, and also the transportation system.

Meanwhile, China’s investment in HSR will probably slow, but not stop. It’s true that the HSR is costly, but given China’s population, the cost per capita is still low. This is a technology and an industry that has a scale effect. Railway investment was 3.3 per cent of total fixed-asset investment in 2009; it has now dropped to 2.2 per cent in 1H11 (partly due to the rescaling of the statistics this year), and it could be further normalised to 1.5-2 per cent in the next few years, ushering in the twilight of infrastructure-supported growth.

Shen Minggao is head of China research at Citigroup.

Related reading:
Guest post: Has China over-invested in infrastructure?, beyondbrics
China railways: is setback terminal?, beyondbrics
Cautionary tale for China’s rail boom, FT