Why China's Economy Will Grow Strongly in 2012

By JOHN ROSS

THE start of 2012 is a suitable moment to look at China's economic prospects for the New Year. The overall outlook is clear – China's economy will continue to grow strongly, remaining the world's fastest growing major economy and outperforming Western pessimists' predictions. This is the same prediction I have made for the last two years and results have shown me to be correct. Given accurate or inaccurate predictions depend on different fundamental analyses rather than the personal characteristics of those making them, what is it that leads to repeated projections of China's economy that are consistently correct or incorrect?

The central issue is simple but difficult for many non-Chinese analysts to admit, despite constant confirmation by reality and repeated debunked predictions of a serious slowdown. The fact is that statements by Chinese analysts that China has a stronger economic structure than the U.S. and Europe, and that this produces a stronger economic performance, are not a boast but actually tell the truth. As many Western analysts do not understand the strength of China's economic structure, they systematically underestimate China's economic growth potential every year. A difficulty for non-Chinese analysts is that sometimes explanations of this economic strength are posed solely in terms of specifically "Chinese characteristics," so it is worth spelling out why China has a stronger economic structure than the U.S. and Europe more generally, along with how this relates to economic issues that will be faced in 2012.

China defines its system as a "socialist market economy." This means that it differs fundamentally from the economy that existed prior to its 1978 economic reforms, which was modeled on that of the former USSR, in that now the main guiding force of the economy is market forces rather than administration. China has a large and vibrant private sector that is growing more rapidly than that in any other country worldwide. However, where China essentially differs from the U.S. and Europe is that it has a sufficiently large state sector, and a nationalized core banking system, which allow it to directly set the economy's overall investment level. The state sector is too small in the U.S. or Europe to do so. This combination of market system and state sector is what gives China greater economic strength than the U.S. or Europe.

To illustrate this, take a key contemporary economic problem – the current situation in the U.S. The Financial Times on December 15 accurately described the situation of the U.S. economy. It noted that the share of wages in U.S. GDP had fallen to its lowest level since records began, and concluded: "The decline in the labor share, along with a shift of labor income towards higher earners, may be an important part of why the U.S. economic recovery is so sluggish. Workers on lower wages consume much of their income, while higher wage earners and those with capital income are more likely to save. That will not affect total demand if savers lend to those who want to consume or invest in buildings and start-ups – but investment has been slow to recover in the wake of the recession."

In short, the U.S. economy is growing slowly not because there is a shortage of funds for investment (on the contrary – profits are at a record high), but because investment is very low. Indeed, the entire decline in U.S. GDP in the current "Great Recession" is accounted for by the fall in investment. The problem is that in the U.S. there is no mechanism that ensures that the huge funds available for investment are actually invested.

In China no such problem exists. If funds are not directly invested by companies, then the state owned banking system and state sector can invest them. Therefore no shortfall of demand occurs of the type analyzed by the Financial Times in the U.S. During the entire international financial crisis, China, unlike the U.S., suffered no decline in investment – on the contrary investment increased.  The problem of accumulation of unused funds like that currently seen in the U.S., which in Keynesian terms is a shortage of effective demand, does not arise in China. If, on the other hand, China's economy is booming, and companies are utilizing all funds for investment, the state steps back and reduces its own investment in order to avoid overheating. That is why China's macroeconomic policy is stronger than that in the U.S. – the extremes of either shortage of or excessive demand that plague the American and European economies are smoothed in China.

China still faces macroeconomic problems. No policymaker can judge absolutely accurately how strongly the world economy will grow, all of the inflationary or deflationary pressures that will be present, exactly how China's own economy will respond to a given measure, and so on. Issues like overheating, undershooting, inflation, and deflation can therefore always appear, but in China these fluctuations are smaller than those that occur in the U.S. or Europe.

The period since the onset of the international financial crisis showed the strength of China's economic structure clearly. Faced with the international financial crisis in 2008, China was able to launch a massive stimulus package, which meant its economy did not suffer a recession at all. The recovery of the world economy in 2010-2011 combined with the aftermath of the stimulus package to create some economic overheating and 2011 was therefore mainly spent damping inflation. In 2012, with negative trends dominating the world economy, China will loosen its economic policy.

The overall result is evident. In the four years leading up to the latest economic data, for the third quarter of 2011, the U.S. GDP grew by 0.5 percent, the EU shrank by 0.3 percent, and China grew by 42.2 percent. China's economy therefore suffered some fluctuations on its strong growth path, whereas the U.S. and Europe suffered overall economic stagnation. The stronger character of China's economic system was shown by these facts. Those predicting crisis for China on the same scale as the U.S. and Europe made the wrong predictions because they failed to analyze that strength.

It is this superior strength of China's economic structure that also makes it possible to predict for 2012 that China's economy will continue to grow strongly, remaining the fastest growing major economy in the world, and outperforming Western pessimists' predictions -- as in previous years the facts of 2012 will confirm that analysis. Not until they understand the greater structural strength of China's economy will current critics be able to make persistently accurate predictions such as this.