China's problem? It's still outperforming everyone else

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Germans are alarmed. Jörg Wuttke, the man chairing the E.U. Chamber of Commerce in Beijing, said last week that China's "Wirtschaftswunder (economic miracle) is gone." And he should know. He represents thousands of European companies operating in China, which, one might suspect, provide him with valuable economic insights.

Herr Wuttke also says that China's "golden age [presumably economic golden age] is a distant memory." In his opinion, the "low-hanging fruit" of growth driven by infrastructure projects has been harvested.

So, what's left? Nothing, according to him, because China's household consumption and service industries are unable to compensate for weakening investments and export sales.

In his view, this dire situation is beyond repair. The economy is too closed and unreformed, he says. Beijing is also accused of excessive fears for "national security." And then the punch-line: "While China is renovating its house, the question for European companies is whether they will be in or out."

Sour grapes

I believe Herr Wuttke's assessment of the actual state, and prospects, of the Chinese economy is erroneous. He is also complaining too much.

To begin with, he should give some credit to the Chinese. In less than 40 years they built the second-largest economy in the world from a crumbling, famine-ridden and deeply impoverished subsistence economy the size of The Netherlands.

To claim that there is no structural change is absurd in view of that remarkable trajectory of the Chinese economy. Private consumption is the main driver of economic growth; it currently accounts for one-half of China's GDP, and it generates nearly two-thirds of the country's annual gains in demand and output.

That is roughly comparable to the case of Japan, where household consumption represents about 60 percent of GDP. The big difference is that Japanese private consumption has been falling at an annual rate of 2.3 percent in the year to the second quarter, while China's consumer spending is booming.

Retail sales in China grew 10.5 percent in July (year-on-year) – with online sales soaring 37 percent in the first seven months of 2015. It is estimated that there are currently half a billion smartphone owners in China who are sophisticated enough to use them to hail a taxi, order takeouts and splurge online through the largest Internet shopping services in the world.

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It therefore sounds odd to hear the German suggestion that China needs European expertise to digitize its banking and insurance businesses. The Chinese have that expertise already, as the Germans and the rest of Europe are now discovering, with China's top quality communications hardware and software coming to their markets at unbeatable prices.

Which brings us to China's service industries. That sector now represents more than 48 percent of the economy. In the first half of this year, the Chinese service sector industries attracted 63.5 percent of the country's inbound foreign direct investment (FDI). These investment inflows – a total of $68.4 billion – rose 8 percent from the year earlier, with the share of funds going to the service sector surging 23.6 percent.

The German observer might wish to note that along with pharmaceuticals, communications and electronics industries were the main recipients of inbound FDIs. Clearly, these are not unreformed, state-owned smokestacks.

Competing at home and abroad

And then think of those 350 million people expected to join urban lifestyles over the next four years. That, along with the rapidly growing "upper middle class" – millions of wealthy Chinese traveling in style around the world (the French have set up special services to cater to these Chinese visitors) – will carry the wave of rising consumption and an unrelenting growth of service industries.

China, of course, has a long way to go in modernizing its economy and industry. But it would be naïve to expect China to follow an imaginary blueprint of a totally open market economy with perfectly malleable and instantly adjusting labor and product markets. It is probably even too much to expect that China will copy the German and French models of (decaying) social market economies. China wants a social order "with Chinese characteristics" – whatever that means.

Here is perhaps a hint of what that could be. Beijing has just set up a 60 billion yuan fund to assist the functioning and the creation of small- and medium-sized companies - a sort of Chinese Mittelstand. Also, an astounding 10,000 privately-owned companies are reportedly being registered in China every day (sic). And a large number of the seven million college graduates entering the job market every year are becoming start-up entrepreneurs.

These are the features of dynamic, innovative and competitive new segments of Chinese markets. They perhaps partly explain why the Chinese have been so good at developing powerful import-competing industries. How else can one account for China's steadily declining import numbers?

A steep 14.6 percent drop of the country's imports in the first eight months of this year could only be consistent with a deeply depressed economy. But that is not the case; the Chinese economy continues to grow at a steady rate of 7 percent. A 13.7 percent drop of China's imports from the E.U. is part of the same story. The only plausible answer is this: China is now producing at home an increasing amount of goods and services it used to import.

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Particularly grating to Germans must be the fact that China is taking their Central European markets – traditionally the German economic and industrial hinterland. That's where China's much-maligned state-owned conglomerates are building bridges, high-speed trains, modern highways and power plants. During the annual summits that China holds in that region, the Central European governments are falling over each other to submit to the Chinese investment projects they complain the E.U. does not even want to look at.

And the Chinese are just warming up for their big 'Belt and Road' onslaught. In the first half of this year, China invested $7 billion – a 22.2 percent increase – in 48 countries that are part of this giant multinational project. Again, the job leaders here are large Chinese publicly-owned firms.

One of them, the China State Construction Engineering, just signed up last week a mega-project to build Egypt's $45 billion new administrative capital east of Cairo over the next seven years. Where is Europe here?

Investment thoughts

It is time for Germans to realize that China is not their captive E.U. market, where German companies consider it their "birthright" to act as exclusive product and service suppliers.

China needs no European advice on how to run its economy. Its reforms are difficult, but they will proceed – slowly and deliberately - in the way the Chinese have brought their economy from virtually nothing to the powerhouse it is today.

The financial sector – and the capital account, in particular – will be the most difficult project of economic reform that Beijing has had to deal with so far. The mistake of allowing a huge equity market bubble is an example of the painful learning process in managing China's increasingly complex financial system. Recent events have also shown that the exchange rate administration is another problem; if mismanaged, it can completely destabilize the Chinese economy.

Meanwhile, as mentioned in my earlier columns, China will fine-tune its economic growth with a more balanced mix of monetary and fiscal policies. Some of that stimulus is already under way. Public spending in the first seven months of this year rose 13.4 percent. An additional 1.2-1.5 trillion yuan ($190 billion to $240 billion) in public spending is also in the pipelines to support growth through already approved investment projects.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.