By: Our Correspondent

Even with the outlook
for the world economy rapidly worsening, many economists are still
relatively optimistic about the prospects for the Chinese economy
next year.  While the International Monetary Fund recently
lowered its forecast for 2009 real GDP growth to 5 percent, the World
Bank is expecting 7.5 percent. This was also the consensus estimate
of professional forecasters surveyed earlier this month by
Frankfurt-based Dekabank.  Wang Tong-san, a spokesperson for the
Chinese Academy of Social Sciences, was even more  upbeat at a
recent press conference, telling reporters he expected 9 percent, or
even a bit more, and putting the likelihood of this prediction at "better than 70 percent."

Speaking at the opening
of the fifth US-China Strategic Economic Dialogue on December 4,
China’s central bank governor Zhou Xiao-chuan sounded a more
pessimistic note, however, warning that China must prepare for the
“worst case scenario.”  While he didn’t
elaborate, it’s easy to see what he’s worried about. 
If the sharp slowdown in exports and investment that is now showing
up in the monthly statistics continues next year, the 8 percent
growth believed to be necessary to keep unemployment under control
will be difficult to achieve.

To answer the question
of how bad things could get in 2009 we might start by considering a
repeat of the net exports crash and fiscal stimulus that followed the
1997 Asia crisis as a base case.  In this scenario, real gross
domestic product growth could slow to as little as 4.5 percent. 
While in 1999, the worst Asia crisis year for China, growth only fell
to 7.8 percent, the drop in net exports experienced 10 years ago
would have much more severe consequences today because of the Chinese
economy’s increased reliance on foreign trade. 

The question then
becomes how much the recently announced Rmb4 trillion fiscal stimulus
package could boost GDP above this base-case level, which already
includes the 1-2 percentage points such policies are believed to have
contributed in 1999.  National Development and Reform Commission
Minister Zhang Ping has put the contribution from this stimulus at
only 1 percentage point per year, implying no increase over our base
case at all.  And even the 2 percentage-point impact that many
private-sector economists are looking for would at most raise this
base-case forecast by only 1 percentage point.  Thus 5.5 percent
growth would seem to be about all that could be hoped for.

The problem, of course,
is that now, unlike in 1999, the whole world is in crisis.  Even
5.5 percent growth looks like more of a best case than a worst case
scenario.  In the worst case scenario, growth will be close to
zero or even negative, which would have serious implications for
employment and social stability.


Zero percent

In 1998, consumption
accounted for 60 percent of nominal GDP (as calculated by the
expenditure method); investment, 36 percent; and net exports, 4
percent.  In 1999, these three components grew at 8 percent, 5
percent, and -35 percent, respectively, resulting in nominal GDP
growth of 5.2 percent.  (Real GDP growth was higher that year
due to deflation.)

A rerun of those 1999
growth rates, but starting from the current GDP component shares—with
consumption now accounting for 49 percent of GDP; investment, 42
percent; and net exports, 9 percent—would result in nominal GDP
growth of only 2.9 percent.  (The effects of a fiscal stimulus
equivalent to the one in 1999 are captured in the ’99
consumption and investment growth rates as both include government
spending.)  Even if we also assume a repeat of the 1-2 percent
deflation of the late 1990s, so that next year’s base case real
GDP grew at, say, 4.5 percent, allowing for an additional one
percentage point fiscal stimulus only gets you to 5.5 percent.

To expect something
more than this, you’d have to believe that either the fiscal
stimulus would contribute a lot more to growth than the NDRC says it
will or that there will be a big turnaround in the world economy next
year.  As there is no reason to doubt the NDRC’s analysis
of the stimulus package and all the evidence we have so far suggests
that the global slowdown is worsening rather than abating, neither of
these possibilities seems particularly likely.

On the other hand,
plenty of downside is possible.  Private sector investment, for
example, could easily fall next year in response to the ongoing
contraction in real estate and manufacturing and the excess capacity
that has been evident for some time in sectors such as steel, cement,
and auto manufacturing.  (In 2007, Hebei Province alone produced
107 million tons of steel, more than any country except Japan.) 
Government investment will presumably grow rapidly as a result of the
stimulus plan, but there is no guarantee that this can entirely
compensate for a slowdown in the private sector. 

Zero percent investment
growth is certainly not out of the question and this would imply only
0.8 percent nominal GDP growth in our base case scenario.  And
if the GDP deflator next year were in the range of October’s 4
percent CPI inflation, real GDP would shrink for the first time since
the beginning of the ‘reform and opening’ period in
1978.  (The GDP deflator is a measure of inflation used to
adjust nominal GDP growth for the effects of price changes.)

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Bankruptcy free-for-all
Recent news from
Guangdong, which, because of its dependence on foreign trade has seen
the most severe downturn so far, paints a grim picture of what this
worst case scenario might be like.   The province, long one
of China’s most prosperous, is now experiencing a property
crash, widespread bankruptcies, and massive job losses. 

The situation appears
to be worst in Dongguan, a manufacturing center in the Pearl River
Delta located about two hours north of Hong Kong.  Anywhere from
a quarter to a third of the city’s factories, which produce a
variety of labor-intensive products ranging from toys to computer
mice, are now believed to have closed—victims not only of the
global recession but also of rising costs, changes in export-tax
rebate policy, currency appreciation, and, in the case of the toy
factories, product-safety concerns.

The situation is
particularly chaotic due to the lack of any kind of orderly
bankruptcy procedure.  Typically owners simply abscond with
whatever is left of the company cash to homes in Hong Kong or Taiwan,
setting off a scramble among unpaid suppliers and employees to loot
whatever is left in the factory.  In some cases parts of factory
buildings have been dismantled and taken away, leaving banks with
practically worthless collateral.  According to a post from the
end of last month on the website of the pro-democracy magazine
Beijing Spring, some creditors have even recruited members of the
People’s Armed Police or the army to seize assets at gunpoint.

It is estimated that as
many as 800,000 jobs have been lost in Dongguan this year, resulting
in a massive reverse migration from the city back to the
countryside.  At the nearest rail hub in Guangzhou, the large
crowds typical of the Chinese New Year holiday can now be seen every
day as the newly unemployed make their way home.

Last month one group of
workers avoided the long lines at the train station and made the
front page of the Chongqing Evening News by travelling from Dongguan
to their hometown in Szechuan province on motorcycles, which they had
managed to salvage from their plastics factory after the owner
disappeared without paying them.  Converting the vehicles into
miniature mobile homes, they covered three thousand kilometers in ten
days—an odyssey strangely reminiscent of the Dust Bowl exodus
of the 1930’s, when bankrupt farmers made the (somewhat
shorter) trip from Oklahoma to California in broken-down Hudsons and
Model ‘T’ Fords.

Sudden flare-ups
Indeed the number of
such travelers nationwide could soon far exceed the 2.5 million
people that fled the Dust Bowl in the largest US precedent for this
kind of large-scale economic migration.  Some believe that as
much as 20 percent of China’s floating population of something
like 120 million workers could lose their jobs.  This implies a
staggering 24 million people out of work, far more than any
conceivable fiscal stimulus projects could possibly absorb. 
(Studies have shown that a one percentage point stimulus can create
about one million jobs.)

Like the ‘Okies’
of 70 years ago, the unemployed face a bleak future once they reach
their destinations.  There is hardly enough land in the
countryside to support even the existing rural population, let alone
large numbers of new arrivals, many of whom have in any case spent
their entire working lives in industry or construction and know
little about farming.  While the government has announced a plan
to stimulate rural spending with subsidies for electronic goods,
these people are more likely to need free food and clothing than
deals on mobile phones and washing machines.

Local officials will
have a critical role to play in responding to this crisis, but their
record even in the best of times inspires little confidence that
things will go smoothly.  Even the official weekly Observer
(Liao Wang), in an editorial on “mass incidents”
published at the end of last month, criticized “the Party
committees and grassroots level of government of some localities”
for “responding slowly, misjudging things and handling them
poorly, resulting in minor things being delayed, while major things
explode.”

It seems that the
central government is under no illusions about the potential for an
escalation of protests and riots as the economy worsens.  In an
effort to prepare for this eventuality, the Central Party School in
Beijing is even arranging a special seven-day course for two thousand
county-level party secretaries, who will be attending in groups of
five hundred.  Two topics will be covered: “maintaining
social stability” and “handling sudden flare-ups ”
(tufa shijian de chuli).

Winds of change
You might think a
global downturn that originated in the US would have relatively
little impact on China.  In fact, however, the historical record
suggests that events originating overseas can sometimes have
profoundly destabilizing effects on the Chinese political order. 

A study published in
the November 7 edition of the journal Science shows that climactic
change thousands of kilometers to the south may have led to the
overthrow of three of China’s greatest dynasties.  The
authors found that the final years of the Tang, Yuan, and Ming
dynasties all coincided with failures of the summer monsoon, which
normally brings rain from the Indian Ocean to the northern and
western provinces.  (Ominously, the monsoon began to weaken
again in the late twentieth century.) 

Could economic
headwinds from across the Pacific have a similar effect on the Middle
Kingdom today?

Consistently high
economic growth since 1978 might be thought of as confirming a
‘mandate of heaven’ for China’s present-day leaders
in much the same way as good harvests once did for imperial rulers. 
If the professional economists are right and GDP grows at 7.5 percent
or more next year, this mandate will be stronger than ever.  But
in the worst case scenario, a lot more than the economy will be at
stake.

Mark A DeWeaver,
PhD, worked as a research analyst in Shenzhen from 1991-1995, first
for W I Carr and later for Peregrine Brokerage. He manages
Quantrarian Asia Hedge, a fund that invests in Asian equities and
related index products (on the web at
www.quantrarian.com)
and can be reached at deweaver@quantrarian.com.

(Copyright
2008 Mark A DeWeaver. Used by permission.)