Economy at Risk of Long-Term ‘Downward Spiral,’ State Researcher Says

The head of an influential state-backed think tank has forecast that China’s economic expansion may be entering a long-term “downward spiral” as all three engines of growth — investment, exports and consumption — slow down.

The comments by Li Yang, head of the National Institution for Finance & Development (NIFD) and the former deputy head of the Chinese Academy of Social Sciences, come against the backdrop of increasing concern among the country’s top policymakers about the outlook for the world’s second-largest economy and the impact of the trade war with the U.S. Gross domestic product (GDP), a measure of all goods and services produced in an economy, rose by 6.5% year-on-year in the third quarter, the lowest in almost a decade.

“GDP (growth) is slowing, investment (growth) is slowing, export (growth) is slowing and consumption (growth) is slowing” and the growth rates are slowing at the same pace or faster than GDP growth, Li said in a speech at the Chinese Institutional Investors Summit on Saturday in Beijing.

“There’s a lot of musing about what’s really going on with the numbers, but in short, we need to pay extremely close attention because it might mean that the economy is in a kind of downward spiral,” Li said. “The recent meeting between the central authorities and private enterprises also suggests that the situation (of the private sector) is quite serious.”

President Xi Jinping held a seminar with private entrepreneurs on Thursday in Beijing to assure them of the government’s and the Communist Party’s support for the private sector as the entrepreneurs struggle amid a cooling economy and an unfavorable financing environment. The event followed a meeting of the Politburo, a committee of the Party’s top 25 officials chaired by Xi, which also emphasized support for the private sector.

Employment worries

In addition to his academic roles, Li is a delegate to the National People’s Congress — the country’s legislature — and a member of its financial and economic committee. He also advises a number of provincial and municipal governments, according to his biography on the NIFD website.

Li’s speech touched on several economic challenges facing China, including job creation; monetary policy and the changing dynamics of credit creation; the relationship between the country’s financial system and the real economy; and the potential impact of the trade war between China and the U.S. and its geopolitical significance.

Although government data show that the target for job creation this year was met ahead of schedule in October, evidence is starting to emerge that the employment situation could become more challenging in 2019 or 2020, compounded by the U.S.-China trade friction, Li said.

“As the economy cools, it’s possible new job creation will soften, companies who are in difficulty will cut wages, the growth rate of salaries will decline, and we will see an absolute fall in pay,” Li said. “We may even see people lose their jobs. This is the impact of Sino-U.S. trade friction passing through into the labor market.”

Li also highlighted weak credit creation by financial institutions and how the credit impulse, which is the change in new lending by banks as a percentage of GDP, has weakened significantly. Although the People’s Bank of China can influence the money supply and can add more money to the financial system by cutting banks’ reserve requirement ratio, for example, financial institutions also influence money supply by increasing their lending.

But the process of money creation has stalled or contracted because demand for loans from companies is insufficient and profitable investment opportunities are limited, Li said. This has become a prominent problem and a sign of economic contraction, he said.

Although the PBOC has adjusted the way it calculates total social financing (TSF) — the broadest measure of credit in the economy that includes bank loans, “shadow banking,” and bond and equity issuance — growth in TSF has lost steam and continues to slow, Li said, adding that the Chinese Academy of Social Sciences estimates the increase in the measure will be “even worse” next year, he said.

Economic aggression

Li also raised the alarm about the economic slowdown in Guangdong, Jiangsu, Shandong and Zhejiang provinces in the first half of 2018. These are China’s most developed regions, and they showed a slide in growth that was higher than the national average, he said.

Turning to the deterioration in relations between China and the U.S., Li said this is not a short-term problem that can be solved anytime soon. Washington’s China policy has undergone a fundamental change from one of engagement and negotiation to one of containment.

China’s call for its relationship with the U.S. to be based on a new model of great power relations, which in effect signals China does not acknowledge the U.S. as the world’s No. 1 superpower, somehow crossed a red line with Washington, he said. The U.S.’s aim is now to stifle China’s ability to develop its technological strength, and this is a form of economic aggression, Li said.

China should not give in to the U.S., and while it should not go on the attack, neither should it be afraid of a fight, Li said. Beijing should stick to its position but also seek to reduce friction by offering reasonable solutions.

Li also called for the government to take a market-oriented approach to managing the economy, such as abandoning the policy of handing out massive subsidies to encourage innovation, and to expand reforms.

“There are important reforms such as property rights, especially the issue of non-state ownership, intellectual property rights,” as well as accelerating fiscal reform, Li said.

Contact reporter Leng Cheng (chengleng@caixin.com)