China's Economy

As mentioned in my introduction I am going to share what I read and experience. Well most of my reading nowadays is from some interesting books I have collected related to economics and my subscription to "The Economist".

I read an article in 'The Economist' ( issue of January 25th 2014, pg 59), under the Finance and Economics section. The title of the article is "China's economy - In three parts". The author of the article says that to understand China's economy, it would be helpful to think in threes. Three forms of growth: in supply, demand and credit.

The part that interested me the most was the one about how credit is spent. According to Richard Werner of Southampton University, credit spending can be divided into three categories.

1. Credit can be spent fruitfully on new capital and infrastructure which increases the economy's productive capacity. Lending of this kind adds to both demand and supply which results in higher economic growth without higher inflation.

2. Credit can also be spent wastefully, either on consumption or on misconceived projects such as coal mines without markets. These loans add nothing to the economy's productive capacity, but they do add to the demand. They make a claim on the economy's goods and services, without adding to its ability to provide them. Credit of this kind results in higher inflation, increasing nominal GDP but not real GDP.

3. The third kind of credit is speculative kind. It is spent on existing assets, real or financial, in the hope that these will rise in value. Because these assets exist, they can be purchased (and repurchased) without adding directly to GDP or straining the economy's capacity to produce new goods and services. Credit and asset prices then chase each other, even as consumer prices remain flat.

The author states that the lack of inflation suggests that growth in credit should be of the third kind (Speculative). The article considers the data as of 2013. Then if the author has eliminated the first kind of credit spending, then it means that China has failed to add much in terms of productive capacity. We ( Indians ) have not been known to spend credit the way China has. This leaves me the question: What kind of credit expenditure are our financial authorities doing? With inflation rising and growth slowing are we spending credit wastefully?

Also, credit expenditure expands the banks balance-sheets. The author mentions that Chinese financial authorities have accepted that the bank (especially mid-tier banks) balance-sheets are overstretched and they will carry out the necessary measures to encourage the flow of credit to 'real economy'.

Other than the above part there are certain statistics that have been mentioned about China that I find fascinating.

1. The working age population of China shrank by 2.44m in 2013, having already fallen by several million the year before. This is a demographic turning-point dubbed 'peak toil' ( interesting use of words ).

2. Last year China's output of services contributed 46% of GDP, finally overtaking the output of its industry which stood at 44%. In China Services are known as tertiary sector whereas agriculture and industry are considered primary and secondary respectively.