A report in The Wall Street Journal on July 15, 2019, pinpointed the Sino-US trade war as the main reason behind China's growth decelerating to 6.2 percent in the second quarter of the year, but to what extent has the trade war been a drag on China's economy?
China's dependence on foreign trade has gradually been reduced, starting with the outbreak of the global financial crisis. And the declining share of trade in goods as a percentage of GDP - from its peak of 28.7 percent in 2006 as a result of its rapid integration into the world market to 18.2 percent in 2018 - indicates China's growing reliance on its domestic market. In this sense, China has a rising position in the world market, which can be seen in the share of China's exports of goods as a share of global total, which rose to 12.7 percent in 2018 from a mere 3.8 percent in 2000.
So what is behind China's slowing growth? The answer lies in the declining growth in domestic demand, which is reflected in the shrinking contribution of gross capital formation to growth and the rising share of consumption expenditure, with the latter overtaking that of the former. This indicatesChina's transition from a lower-middle-income country to an upper-middle-income one, with the focus now on high-quality growth rather than high-speed growth as before.
While the main growth engine was investment in the past, the Chinese economy is now mainly driven by consumption, household consumption in particular, a change that is consistent with the general course of development of all economies. In other words, with China's growth slowing to between 6 percent and 7 percent from around 10 percent, the impact of the trade war on the Chinese economy will be limited. There will be a dip but it will not be definitive, chronic or a fundamental shock.
If we look at things from the perspective of economic growth, we can see changes in at least three key factors.
First, the growth of the labor force has stalled and shrank. During the period of the 11th Five-Year Plan (2006-10), the labor force in China grew at a rate of 0.49 percent per year on average. Growth declined in the five-year period that followed, to 0.35 percent, with the labor force peaking at 776,640,000 in 2017, before declining by 540,000 to 775, 860,000 in 2018, with the agricultural sector losing 6.86 million jobs and the industrial sector, 4.34 million - 11.2 million in total, surpassing for the first time the number of jobs gained in the service sector (10.66 million), which has had an overall negative impact on economic growth.
Second, there is continued decline in the growth of gross fixed capital formation, from 15.2 percent in 2014 to single-digit growth of 9.8 percent in 2015 before dropping to 5.8 percent in the first half of 2019, the second lowest since it slumped to 5.1 percent in 1999. The decline reflects the effect of the investment growth rate on the economic growth rate; in other words, a slowdown of the former leads, inevitably, to a decline in the latter. Let's look at previous five-year periods. During the period of the 11th Five-Year Plan, gross fixed capital formation grew at 25.5 percent per annum, and nominal GDP growth grew at 17.1 percent. Elasticity of investment growth stood at 1.49. In other words, investment needed to grow by 1.49 percentage points for the economy to expand by 1 percent, which reflects high investment growth elasticity. During the period of the 12th Five-Year Plan (2011-15), gross fixed capital formation continued to show robust growth at 19.3 percent per annum, with nominal GDP growing at 10.7 percent, and elasticity of investment growing at 1.80 percent. In other words, investment needed to grow by 1.80 percentage points for the economy to expand by 1 percent, which showed ultrahigh elasticity. Between 2016 and 2018, gross fixed capital formation grew at 4.7 percent per annum, and nominal GDP growth expanded at a rate of 9.5 percent. The elasticity of investment growth was 0.49 of a percentage point. In other words, investment had to grow by 0.49 of a percentage point for the economy to expand by 1 percent, which is low elasticity.
Third, science and technology are playing an ever larger role. During the period of the 13th Five-Year Plan (2016-20), China adopted for the first time an indicator to measure the contribution of scientific and technological progress to growth, with a target of 60 percent by 2020.With the sustained decline in the growth of labor and capital inputs and continuous development of innovation capacity, the contribution of science and technology to growth has risen from 55.1 percent in 2015 to 58.5 percent in 2018. Science and technology are playing an increasingly important role in China's economic growth, marking an important change in the country's transition from a lower-middle income economy to a higher-income one, and from a model of high-speed growth to one of medium-high-speed quality growth.
Overall, China's economy is still on a path of steady, robust and vibrant growth, and is likely to sustain only limited damage as a result of the Sino-US trade war. This is because China has a huge market, abundant human resources, enabling conditions for its industries and is rapidly developing new growth drivers, which means the Chinese economy is resilient, with bright prospects and plenty of space to achieve its objectives through macro-control measures. Even if the Sino-US trade conflict evolves into an all-out trade war, China will still be able to accomplish its first centenary goal of building a well-off society on schedule by 2020 and it will continue to be an economic powerhouse and engine of global growth.