Beijing has been forced to intervene in the manufacturing sector
At the start of the year, forecasters were enthusiastic about a substantial economic recovery in China. The argument was simple enough: China would cast off the chains of its lockdown and the economy would take off like a rocket. Now, as the data emerges, the recovery seems at best to be two-speed.
The Chinese services sector is powering ahead. Services activity has been expanding for five straight months now, and it has even been surprising forecasters to the upside recently. So, the reopening narrative seems to be keeping some promises. But the manufacturing sector has remained stagnant. This has led many to question the viability of the Chinese recovery.
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But we are about to experience, once again, in real-time that the Chinese economy works differently from Western economies. In the West, capital investment is controlled by the private sector. Central banks exert some control over it by manipulating interest rates, but this control is wielded clumsily and can typically only produce either recession or recovery.
In China, capital investment is largely in the hands of the state. Through the influence exerted over the banking system, the large state-owned enterprise sector, and the housing market, the Chinese can juice the economy in a much more finessed way than is possible in the West. If the Chinese government is afraid that it will not meet its growth targets, it can simply instruct the state institutions to turn the economic knobs up a notch.
This appears to be happening now. Last week the Chinese government announced that it was considering introducing a package supporting the property market. Around the same time, we saw the first tentatively positive readings in the manufacturing sector. The Chinese government has set a GDP target of around 5% for 2023 and it looks like it is pulling out all the stops to hit it.
For some time now, the Chinese have been trying to wean their economy off its reliance on capital investment and rely more on consumption. While the recent consumption figures have been impressive, they are nowhere near high enough to put the gigantic economy on a different track. The recent interventions by the Chinese government suggest that this rebalancing is still some way off.
What do these developments mean for Western economies? If the Chinese recovery starts to take off in the second half of the year, as seems likely, this should lift Western exports somewhat. However, this will not be enough to make a meaningful difference to Western growth prospects which remain stagnant at best, recessionary or even depressionary at worst.
The most important impact that a Chinese recovery would have on the West is via its effect on energy prices. We have recently seen oil prices soften significantly, and OPEC+ has been forced to respond this week by once again announcing production cuts. But if the Chinese behemoth kicks back into gear, these prices should firm back up. Copper markets, a leading indicator, have already bounced back on talk of government intervention in the property market.
If the Chinese government succeeds in its goals and energy prices remain firm, this could be quite painful for the West should it enter a recession in early 2024. Typically in this scenario, energy prices crater, alleviating the cost burden on producers and consumers strained by the recession. But with a new two-speed multipolar economy emerging, where the developing markets can continue to grow as the Western economies sag, this pressure release valve may no longer function, and we may have to continue suffering high costs even in a recession.