2.2 Cyclical aspects of China's growth

China's rate of economic growth has varied between 4% and 15% per annum over the past thirty years, averaging 10% per annum over that period. In the first half of this period, growth rates were more variable and high growth tended to lead to high inflation. The late 1980s were an example of this: inflation reached more than 18% in 1988 and 1989 following economic growth of 15% earlier in the decade; and again in the early 1990s annual inflation reached 24% in 1994 following economic growth of 14% in the previous two years (Figure 7.1).[39]

Figure 7 - China's macroeconomic performance

Source: IMF (2013) (Figure 7.1)

Source: Haver Analytics (Figure 7.2)

The late 1980s were a period of high inflation worldwide, but most countries were starting to bring their inflation under control by the early 1990s and so high inflation in China at that time seems to have been largely owing to domestic factors, although large devaluations of the currency would also have contributed. The response of authorities to the high inflation was to tighten monetary conditions to slow growth and reduce resource constraints and price pressures (Figure 7.2). Porter (2010) estimates that on various measures of potential growth, China had a positive output gap in the late 1980s with a rapid reduction in the gap in the early 1990s.[40]

China's real GDP growth dipped below 5% in the late 1980s following the monetary tightening in response to the period of high inflation. However, growth picked up again in the mid-1990s to average 10% per annum over the decade, the same as the 30-year average. Inflation also picked up again and peaked at 27.5% during 1994; the People's Bank of China (PBoC) tightened monetary policy again with the prime lending rate reaching 12.1% in the second half of 1995. The PBoC also uses quantity-based tools and administrative guidance to control credit growth (Conway et al., 2010). Growth dipped below 10% per annum during the Asian financial crisis (although China was not directly involved in it) and the subsequent period of slower world growth following the bursting of the "tech bubble" in the US. Inflation was negative in the late 1990s and early 2000s, but appears to have been on a rising trend since then, with wide fluctuations including a period of falling prices in 2009 when commodity prices fell.

There is some evidence that GDP growth rates were less variable in the second half of the past three decades than in the first half and that inflation was lower and less variable in the second half of the period (Table 3). Average GDP growth rates from 1980 - 1995 were similar to the period since 1997 (10.2% vs. 9.7%), but the standard deviation of growth almost halved from 3.5% in the earlier period to 1.8% in the later period. The change is more marked with inflation: the average inflation rate fell from 8.9% in the first period to 1.9% in the later period and the standard deviation fell from 7.0% to 2.3%.[41] The greater stability in macroeconomic performance in the second half of the period suggests that growth has become more sustainable.[42]

Source: IMF (2013)

There could be several reasons for China's more stable macroeconomic performance in the second half of the three decades since liberalisation. In general, it reflects a renewed emphasis on economic growth in the past decade and better macroeconomic management on the part of the Chinese authorities as they become more adept at running a large and rapidly expanding economy, for example the adoption of a managed float exchange rate regime in 2005. The period from the mid-1980s to the mid-2000s coincided with the "Great Moderation", the period of relatively stable growth and low inflation in the developed economies; China may have benefited from this (as well as contributed to it) as a result of its closer integration with the rest of the world economy, especially after its accession to the WTO in 2001.

Chinese authorities use both monetary and fiscal policy to control aggregate demand and inflation. Fiscal policy was used extensively to buffer the economy from the effects of the GFC (discussed further in Bowman and Conway, 2013), although much of the expansion was achieved via credit growth through the banking system rather than direct spending or central government borrowing. Credit growth was above 30% per annum for most of 2009 and was 20% in 2010 as part of the response to the GFC, but fell to 16% in 2011 and 15% in 2012. After late 2010, the authorities used monetary policy (interest rates, banks' reserve requirement ratios and quantitative controls) to slow credit growth and thereby economic growth and inflation. However, inflation increased sharply in the first half of 2011 chiefly as a result of rapidly increasing food prices and rising housing costs, peaking at 6.5% in July 2011, and the PBoC responded by tightening monetary policy. A year later annual inflation stood at 1.8% and the PBoC had relaxed monetary policy on three occasions.[43]

In this section we have shown that investment accounts for a larger share of China's GDP than at its peak in other emerging Asian economies. China's heavy dependence on investment and exports for economic growth has contributed to imbalances in its own economy, with the accumulation of large foreign exchange reserves and consumption's low share of GDP, and in the global economy, with large trade and savings imbalances between countries. China alone is not responsible for the latter development. Despite consumption's low share of GDP, household disposable income and consumption expenditure have grown rapidly and the level of consumption may be understated.

We have also suggested that China's growth has become more stable in the second half of the past three decades and inflation has been lower; this may reflect an emphasis on growth and better macroeconomic management on the part of Chinese authorities, as well as a more stable external economic environment. The nature of China's development, which is heavily dependent on investment and export growth and which has also resulted in rising incomes, has influenced its impact on the rest of the world. In the following section we will trace the impact of these features of China's growth on the New Zealand economy. In the accompanying paper (Bowman and Conway, 2013) we discuss the medium-term outlook for China's growth and its likely impact on the New Zealand economy, including the main risks.