The China Bubble?

Crowded car inventory lot

As business in the United States has lagged and debt crises and austerity measures have hindered the economies of Europe, China has been touted as the world’s next economic giant, still expanding rapidly during a period of global uncertainty.

But recent observations of the Chinese economy are revealing a downward shift away from the booming growth of the previous decades. Waning worldwide demand for Chinese goods has led the country’s leaders to push for greater consumption of domestic products at home, yet this has been met with low demand. Reports of inventory surpluses and overproduction point to a future where China’s staggering economic growth rate may no longer be a sure thing.

What does this mean for American businesses? China has the world’s second largest economy behind the United States. As factors threatening its sustained growth arise, new risks to the global economy rise with them. A world in which China’s dwindling appetite for the world’s raw materials and importing goods could have a direct impact on American companies.

The potential risks and outcomes to U.S. business are some of the questions explored by Sellinger School faculty members in this month’s feature. John Burger, Ph.D., professor of economics, and Nancy Williams, Ph.D., associate professor of economics, study macroeconomic trends and analyze the potential effects and risks China’s recent economic ebb could have on the U.S. economy.

The Chinese government’s most recent statistics point to economic growth of mid-seven-percent range this year. That still seems strong. Where’s the concern?

JB: It is important to remember that China had been growing at a rate of about 10 percent per year for many years, so this is a slowdown. The 10 percent pace was not sustainable in the long run, so some slowdown was inevitable. The question now is how severe is the slowdown. Will they achieve a “soft landing”?

If China does slow substantially, it will have a significant impact on global economic growth. China has been an increasingly important source of demand for a wide range of products from commodities such as oil and copper to luxury automobiles. Combined with the very uncertain outlook in Europe a China slowdown could mean serious trouble for the global economy.

NW: China is the second largest economy in the world, and if Chinese growth slows, the world’s economy will definitely slow with it. Economies which supply products to China will suffer directly, except perhaps oil.

Recent Chinese policy has been to promote economic stability by increasing domestic consumption of goods rather than exporting them, but the Chinese domestic marketplace for consumer goods such as household items and automobiles appears to be saturated. Yet, manufacturers have been unwilling to cut production. How does this affect China domestically and will this continue to translate into a weaker economy for China?

NW: Historically, the Chinese economy has been driven by export-oriented policies fostered by the central government, which has driven the real estate boom as workers flock to the cities and the government builds the associated infrastructure needed to support the enormous migration from the rural areas to urban centers. So, I think they have been linked, but whether they remain linked in the future is another question.

For products with strong demand, however, production has not slowed and these strong brands are protecting the overall production totals in some industries. Quotas on new car licenses in a number of Chinese cities create a decrease in in quantity demanded that is artificially induced. Hence, changes in government policy play a large role in the demand for domestically consumed goods.

JB: Infrastructure spending is typically driven by government decisions and was particularly boosted by a stimulus plan during the recent global recession. Exports have certainly been a success story, but, as the domestic economy grows, exports will become a smaller fraction of GDP. Finally, China did experience a huge real estate boom and is now experiencing falling property prices. The real estate boom was fueled in part by speculation from wealthy individuals looking for a place to park their savings. There are very limited financial instruments available to the typical Chinese saver.

Eventually production will have to slow, but I wonder how wide-spread this phenomenon of overproduction really is. I certainly did not see evidence of it last summer during a field study tour of China with Loyola MBA students.

China is the U.S.’s third largest market for exporting its products. What does a glut of unsold Chinese goods mean for American exports?

JB: It might not matter all that much. I suspect the goods that the U.S. produces and exports to China are very different than the goods produced in China that are stockpiling. It would only have a big effect on U.S. exporters if this inventory accumulation was a sign of a severe slowdown in the Chinese economy.

NW: The slowdown does impact American markets for products such cotton and wool, both of which are produced in America and used in China for apparel. As the demand for apparel falls there, American producers of these and other inputs to production there are finding it harder to export their products. They are seeking out other markets abroad.

With an American economy slow to recover from recession, the ongoing European debt crisis, and a Chinese economy seemingly not growing as fast as it had been projected to, do we have a perfect storm of economic malaise brewing or are circumstances not as somber as they seem?

JB: “Perfect storm” is a bit strong, but some pessimism is certainly merited. It’s important to keep in mind that these economies are heavily interdependent. One of the reasons for a slowdown in China is precisely because of the trouble in Europe and the slow growth in U.S. It is possible that Europe figures out a solution that at least takes the worst-case scenarios off the table and that boosts growth for China and the U.S.

NW: We are inextricably linked by international trade, and the ongoing issues with the European debt crisis and our slow turnaround create an uncertain outlook.  But as our economy comes out of the recession, as it has shown signs of doing, China will benefit, and in the meantime, China is looking to other markets abroad in Asia, Africa and the Middle East for growth opportunities.

What adjustments can and should China make to its policy?

JB: A year and a half ago Chinese policymakers were worried about the economy overheating, inflation on the rise, and a housing bubble forming. They responded with a contractionary policy. That policy has had its intended effects. The question is whether they overdid it. Again, will they have a soft landing? Policy has more recently swung toward being somewhat expansionary again.

NW: I recently returned from a study tour in China with a Loyola MBA class. While in China we heard several speakers talk about tax incentives for Chinese buyers to spend more on durable goods. On the other hand, China is setting quotas on the number of new cars (licenses) in several major cities to curb gridlock on the overcrowded roads. So, mixed signals are coming from government policies there. 

One speaker mentioned that increasing the percentage of foreign investment allowed in joint ventures would increase joint venture activity in China. Another speaker mentioned that the Chinese need to engage in foreign direct investment themselves (FDI) in the United States and around the world. Given the intellectual property rights problems U.S. firms have with China, FDI in the U.S. is not likely to happen in many industries at this point in time.

Are there any silver linings—for American businesses or otherwise—to a slowdown of Chinese economic growth?

JB: The silver lining is for China itself. As I mentioned, the Chinese government wanted somewhat of a slowdown in order to stave off inflation and stop the housing bubble from getting out of control.  Perhaps they have achieved that. Hopefully they didn’t overdo it and they will avoid a steep fall in growth.

NW: As our economy comes out of recession, Americans who have been putting off purchases will kick-start the Chinese export machine. Let’s remember too that 7.5 percent growth is still high by any standard, and it is a lucrative growth market for our agricultural exports.  

What should American businesses keep in mind or be prepared to do in the wake of a Chinese economic slowdown?

NW: Be flexible and allow for making adjustments nimbly. Look for new opportunities. Our MBA students noted, for example, that few stores had swipe technology for credit card purchases, so there may be any number of avenues for American businesses to travel with success. American businesses should also keep in mind that China is a country of about 1.3 billion people, all of whom want to move into the middle class if they are not already there. It is a huge market, one that is difficult for us to comprehend when 300 million Americans is our reference figure.