IPCS Special Commentary
China and Likonomics: Li Keqiang’s Emerging Economic Strategy
22 Jul, 2013 · 4045
Narayani Basu analyses what the policy signifies for the changing economic strategy under Li Keqiang
Eponyms for new policies instigated under the aegis of political leaders nearly always become a catchphrase. Recently, the global community saw the emergence of Abenomics in Japan, under the leadership of Shinzo Abe. Now, China appears to be joining the fray with the advent of what is being called ‘Likonomics’. What is Likonomics? What does it signify for the changing economic strategy under Li Keqiang?
Behind the Semantics of Economics
On 27 June 2013, in a China Daily editorial, three Chinese economists at Barclays Capital: Yiping Huang, Jian Chang, and Joey Chew coined the term, which refers to the emerging economic doctrine of Li Keqiang, China’s prime minister, who has been overseeing the country’s economy since March this year.
According to these three economists, Li Keqiang’s economic policy comprises of three parts.
The first part calls for no fiscal or monetary stimulus. After a 4 trillion RMB injection last year led to an unexpected slowdown in economic growth, characterized by increasing inflation, a housing bubble and industrial overcapacity, the current argument is that China has little room to rely on stimulus policies, or government-led investment for growth. The main driver, then, must be market forces and mechanisms.
Secondly, there is a need, according to Li, for banks to make better use of existing credit as part of their efforts to curb growing financial risks. On the heels of the implementation of the previous stimulus package in 2008, China’s total credit increased from USD 9 trillionto USD 23 trillion by early 2013. This has pushed the credit gap (the difference between credit rates and rates of nominal GDP) into double digit figures, so that the gap now stands at 14% - a trend that has proven to be economically dangerous. So the recent move by the People’s Bank of China to curtail the credit bubble in the interbank market underlines the Chinese leadership’s desire to deleverage (by reducing the growth of money supply and bad lending) and reduce the possibility of future financial risks.
Thirdly, and lastly, Li Keqiang has also spoken a great deal about the need for structural reform. At a May meeting of the State Council, he outlined many initiatives in this regard, from liberalizing interest rates to raising utility prices. The current hope is that these words will not remain pure rhetoric. However, China’s economy-watchers will have to wait until the Third Plenum of the Central Committee of the Chinese Communist Party, which is meeting later this year, for a more specific fleshing out of economic policies.
Likonomics, then, stands for the new Chinese administration’s attempts to push the Chinese economy towards what is being called a ‘temporary hard-landing’, in which quarterly economic growth will drop to 3 percent within the next three years, after which the economy is expected to bounce back to normal.
Short-term Pain for Long-term Gain?
There are still questions on whether Li Keqiang’s new economic policies are the tonic that the Chinese economy needs. The economic doctrine of the previous Wen Jiabao government is regarded as having been strong on economic growth but weak on economic reforms. Monetary stimulus was regarded as the shortcut out of the knots that the Chinese economy was tying itself into.
Currently, and perhaps as a result of these policies, the Chinese economy is riddled with problems like reckless government borrowing, skyrocketing rates of inflation, asset bubbles, and the threat of bad debts following the massive credit expansion. An example of the consequences this may have on the economy can already be seen with the case of Rongsheng, China’s largest private shipyard, which recently laid off thousands of workers and is now lobbying local governments for a sorely required bailout.
China’s economic growth during the second quarter of this year continued its downward trend – registering 7.7 percent in the first quarter and 7.9 percent in the months prior to that. In June, China faced its worst cash crunch in years, with several banks taking short-term loads at extremely high rates in order to stay afloat. The liquidity squeeze comes in the wake of a severe crackdown on shadow banking and the government’s decision of not bailing out banks by infusing additional funds. While the outlook is not exactly bleak, the release of the trade data for the month of June showed that the country has lost some of its economic vigour. Export figures fell 3.1 percent from the same period a year ago, while import figures have decreased by 0.7 percent. The weak import growth, in particular, reflects a low rate of domestic demand, while low export rates are an indicator of rising wages and a steady increase in the value of the renminbi which means China, while still doing fairly well, is no longer quite as highly competitive as before.
In the past, whenever the economy slowed down, the government has been swift with monetary injections to revive the sagging economy. Further, China has relied on heavy manufacturing and state-sponsored investments and exports to power growth. This is a model of economic growth that is now proving to have its pitfalls. The new leadership, under Xi Jinping and Li Keqiang, appear to be aware of the limits of these growth drivers. However, this time, the new leadership has been reluctant to travel down the same path. The central bank has followed the government’s lead by refusing to cut reserve ratio requirements. Indeed, since taking control, China’s new leadership has talked repeatedly about the need to overhaul the economy, and focus more on increasing domestic demand and productivity.
With otherwise profitable heavy industries like steel and cement struggling with overcapacity, the engines for economic growth now need to shift to the private sector, and to household consumption. The challenge is now the phase of transition that the Chinese economy will face as it moves from a state-driven one, to one balanced more by domestic consumption. This may imply lower and slower rates of growth, rather than the astonishing levels of double-digit growth that the economy has been maintaining over the recent years. As Huang Yiping said in his editorial in China Daily, ‘the growth potential is now around 6-8 percent’.
This is one of the costs of the plan to overhaul the economy – which was aptly summed up by a Global Times editorial as ‘short term pain for long-term gain’. To this end, the new leadership’s economic endgame is to turn China away from policies that are heavily dependent on exports and investment, towards those that are tilted towards domestic household consumption. This may just be easier said than done. China’s political elite has a stake in many of the state-owned enterprises that are currently weighing the economy down. More importantly, rising figures of unemployment may trigger off social unrest which is the last thing that the Party needs. Indeed, demographic changes brought about the country’s infamous One-Child Policy means that the figures of manpower resources have not only peaked, but are beginning to shrink. This would certainly mean that a lower rate of economic growth is needed to support the creation of new jobs, but it would also mean that the millions of young Chinese already in the pool of employable labour could face the possibility of a steadily tightening job market.
Given these facts, as long as unemployment rates do not rise by startling levels, the government is unlikely to put in place new stimulus measures to boost growth. This being said, a worrisome trend emerging in the Chinese economy is the divergence in growth rates between credit (above 20 percent) and GDP rates (below 10 percent) in the most recent financial quarters.
This cannot, however, be the only criteria driving Likonomics. China can easily change the composition of its spending, while maintaining a healthy growth in spending and size. An example from its recent economic history proves this. China is no longer as overly dependent on exports as it used to be, having cut back from a 38 percent share of exports in GDP to less than 26 percent in the last five years. All this was done while maintaining an overall economic growth rate of over 9 percent a year. As far as the credit ratio to GDP is concerned, there are two sides to this as well. A blog in the Economist has put forth the theory that the credit gap (the gap between credit rates and nominal GDP) has historically proven to be dangerous only when it is bigger than 10 percent. With China’s credit gap touching 14 percent, it is clear that this is one warning signal that should be paid attention to by Chinese policymakers.
Keeping these indicators in mind, then, it must be remembered that the Chinese economy has not, by any means, gone past the point of no return. The country’s current account surplus is still sizeable – China is still spending less than it is earning, and consumer price inflation rates are still low. Keeping these factors in mind, it would be safe to say, perhaps, that while certain warning signals must be heeded, China must just adjust its spending. The complexity of economic factors and economic conditions has been oft acknowledged the government. Structural reforms remain vital to the success of Li’s plans for the domestic economy, as these will channel the energies of the private sector into the economy, which could ensure that the full economic potential of the country is achieved. In a May 24 statement, the State Council approved a list of measures such as changes in the household registration (hukou) system, boosting social welfare and taxing products that are heavily resource intensive.
These appear to be just the tip of the iceberg as far as indicators for reform go. So far, China’s new leadership seems set on cutting short-term losses in favour of rectifying long-term problems. The emphasis is on keeping economic activity within reasonable bounds, so that whatever impact economic reforms may have on the social fabric of the country does not result in widespread social anxiety. However, just how extensively the Party leadership will look into reorienting the economy towards a more stable, less environmentally antagonistic model remains to be seen.