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January 14, 2013

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Home » Business » Finance Special

Urbanization boosts demand and efficiency

By Chang Jian, Huang Yiping and Steven Yang | January 14, 2013, Monday | Print Edition

NEW Year's Day saw China's December official manufacturing Purchasing Managers' Index come in unchanged from November, at 50.6, below our forecast of 50.9 and consensus of 51. Two consecutive months of downside surprises support our long-held view that, while growth is stabilizing, the recovery is still not on solid ground.

The output index fell to 52 from 52.5, pointing to balanced risks to our real GDP growth forecast of 7.8 percent year on year for the fourth quarter of 2012 (third-quarter growth: 7.4 percent). The new orders index was flat at 51.2, and new export orders dipped to 50 from 50.2, in line with the trend in the HSBC PMI reading.

This suggests that: 1) domestic demand continues to hold up, offsetting external weakness; and 2) soft external demand will continue to weigh on China's growth recovery into 2013.

For 2013, the latest developments on both the policy and economic fronts have been in line with our views in December.

While we expect improving consumption, new investment projects and stabilizing exports to sustain growth at its potential level of more than 8 percent, we maintain our slightly below-consensus 2013 GDP growth forecast of 7.9 percent, as we expect no big fiscal stimulus, cautious monetary policy, and gradual, rather than drastic, structural reforms under the new Chinese leadership.

In fact, shortly after the 18th Party Congress in mid-November, the new leaders have acted swiftly to make changes. Already, many senior officials, including several at the ministerial level, are under investigation for corruption. This has helped boost market sentiment and build credibility for the new government. Meanwhile, top leaders repeatedly articulate two key policy messages to the public: reform pays the greatest dividend, and urbanization is the next key theme of Chinese growth.

Driving force

In our view, urbanization will certainly be a key driving force for the Chinese economy in the coming decade or two. However, we should be realistic about how much progress can be made in this area in the short term. In addition, we feel urbanization should not be turned into a top-down movement; rather, it should be a gradual and natural, bottom-up development. This is especially important as a new growth driver is much needed at this critical stage of development, given China's diminishing dividends from demography and WTO membership, and as liquidity expansion in recent years has brought increasing financial and fiscal risks.

First, owing to demographic shifts (for example, slower growth in the working age population and an aging population), and rapid economic growth in the past decade, the potential for rural-urban migration may not be as much as many have expected. There is increasing evidence that not as many surplus workers remain in rural areas as had been thought.

Official statistics show the urban population (classified as those residing in the cities for six months or more in a year) exceeded 50 percent of the total in 2011, but only 35 percent of the total can be regarded as real urban residents based on the household survey. This means that China's urbanization should add more urban consumers, but not necessarily more urban workers.

Second, assuming the 160 million migrant workers settle in cities, that would add 400 million urban residents if we include their dependants. This obviously implies tremendous potential for consumption, as well as infrastructure and property investment. However, it will not be easy to integrate them smoothly into the urban communities. Even after local governments grant official urban residency to migrant workers and their families (to be announced in 2013), the integration would require at least the following: urban infrastructure, affordable housing, and education and other social welfare programs. It will take time and, more importantly, money and resources for these to be arranged properly.

Third, as we have argued before, a country's potential growth rate ultimately depends on the growth of labor, capital stock and total factor productivity. Given the shrinking labor force (estimated to be at -0.4 percent in 2020-2030 from 0.1 percent in 2010-2020) and slowing capital stock growth (estimated to be at 2.9 percent in 2010-2020 from 3.6 percent in 2000-2010), China's potential economic growth is slowing to about 8 percent now compared with 10 percent in the past decade, by our estimates, and the ultimate tipping factor will be productivity growth.

Productivity growth

In the past three decades, China's urbanization, climbing from a rate of 18 percent in 1978 to 51 percent in 2011, has clearly boosted productivity growth through the rural-urban migration and the shift from agricultural to manufacturing production.

Given the now aging population and the end of the era of surplus labor, further productivity growth will require the economy to move up the industrial ladder and enhance operational efficiency. All these demand further structural and institutional reforms. China's next stage of urbanization is likely to lead to better income distribution, improved public services, and greater demand.

But properly carried out reforms along the way, such as land reform, fiscal and financial reforms, are crucial to improve resource allocation and release the so called new "reform dividend".

Chang Jian, Huang Yiping and Steven Yang are economists with Barclays. The opinions expressed are their own.

Finance Special


 

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