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Interview

Is China recession proof?

A panel of leading Chinese economists explains how the world’s fastest-growing economy keeps expanding despite the global downturn.

May 2009

China’s economy has demonstrated remarkable resilience in the midst of a worldwide slump. How has the country coped with the financial crisis? Is China finally emerging as an engine of global demand? Can its economy generate enough new jobs to maintain social stability? What will drive future growth? How should foreign firms in China adapt? In this interview, conducted by McKinsey’s Janamitra Devan in March 2009 in Beijing, four distinguished members of the McKinsey Council on China Business Economists explore these questions. Watch the video, or read the transcript below.

Video

Is China recession proof?

A panel discussion with leading Chinese economists.

Janamitra Devan: What is your view about China’s GDP in 2009?

David Li: My view is very, very simple. That for 2009, the Chinese GDP most likely will grow between 8 and 9 percent. And most likely it will move toward 9 percent rather than 8 percent. The reason’s very simple. Two things are going up to compensate for the diminishing export. One thing is consumption: the retail [sector] has been growing very, very fast in China. The other thing is investment. Lots of investment projects are being started right now as we speak. So, these two things are growing very fast, compensating for lost exports.

Tang Min: I’m less optimistic than David. My projections are 7 to 8 [percent].

Chi Wei: Well, I’m optimistic about the Chinese economy. But I’ll say 7 to 8 percent is about the range. But in the long term, China is going to grow at a considerable rate.

Xiao Geng: I think 7 percent would be great. Eight percent would be quite difficult. I’m a little concerned about the export sector and also how fast those investment projects can create value-added employment, wages, and profit.

Janamitra Devan: Is China in a recession? And if so, how do you define “recession” for a country like China?

David Li: I wouldn’t say “recession.” I would characterize it as an expanded time-out [of the growth of the economy]. The Chinese urbanization rate has been slower than the industrialization rate. And right now, China is making up for its slow pace of urbanization. And urbanization is the major engine for the economy of the world. As we speak, in Beijing, there are three or four subway lines being built underground. We don’t see them; they are very busy working on this. And Beijing is not exceptional. There are many, many other cities in which these [types of] things are happening.

Also, China is in a stage where households are massively, aggressively upgrading their consumption. We are not talking about their first watches. We’re not talking about their first microwaves. We’re talking about their first automobiles—the first automobiles in their lifetime. And the first commercially developed apartments.

In this kind of environment, it’s very difficult to expect the Chinese economy to grow very slowly. Anything below 8 percent would be, by Chinese standard, considered a recession.

Tang Min: By international standards, 7, 8 percent, that’s excellent—the best—performance for many, many countries. But standards in China for the past 30 years have averaged 9.7, 9.8 percent. So a 7 to 8 percent [growth in GDP], from a Chinese point of view, is a little bit disappointing.

Janamitra Devan: What is wrong or right about China’s growth? Or rather, what is wrong or right about China’s composition of GDP?

David Li: What is appropriate and what is not appropriate depends on the time horizon. In the long run, the current structure of GDP definitely is crazy, right? It’s inappropriate, because we are having only about 50 percent—actually, 49.5 percent—of GDP each year absorbed by consumption. That’s too low a ratio of consumption. That’s the long-term point of view.

However, facing the impact of the financial crisis, there’s no other choice but to increase the proportion of investment. If consumption cannot be boosted in the short run, the only answer is investment. Investment typically, in the past few years, accounted for 45 percent of GDP. This year, I would predict that investment would even go up as high as 60 percent of GDP.

So, that’s the only thing to do, right? Because otherwise, there’s no way to provide enough jobs. If you cannot provide enough jobs for the young kids and the college graduates, they are going to complain. The social pressure will be so high. So, to me 8 percent is the minimum [needed] to provide enough jobs.

Tang Min: I think China needs a major structural change. And that structural change, mainly, is domestic demand and more job creation and less dependence on the global market. And this pattern can only be achieved if the government invests more in the service sector, if the policy is more favorable to the service sector—to small and medium-size enterprises, to private-sector development.

David Li: In the short run, there are very few options but to keep a reasonably fast pace of GDP growth through heavy investments. In the long run, after the financial crisis, sure, we definitely will work hard, improving the structure of the economy.

Chi Wei: I’m concerned about this huge investment infrastructure in such a short period of time. Is there any way you can guarantee that this investment will be effective? Once you put the railway there or highway there, if it’s not going to be productive, it’s redundant. It’s a waste of resources at the expense of the high growth.

Xiao Geng: I think infrastructure investment actually is very useful and important. But the government also needs reform to help increase productivity in the service sector. And I don’t think the government has done enough.

They already have a plan to build the subway, build the highway and railway. So, you just speed up those processes. But we have to think about who’s going to use them and how to encourage the service sector’s development, tax reform—those kind of second-wave reforms—to encourage a more productive market.

Janamitra Devan: Chi Wei, a question to you as a labor economist. What is your view on job losses so far?

Chi Wei: Well, in terms of total numbers, it’s striking. And in terms of structure, most of the losses have been in the manufacturing and exporting industries. And the group of people who have been hit most by the financial crisis and the downturn is migrant workers. They don’t really show up in official statistics, because they go back home. They’re not counted as a base of the total labor force. But their welfare has to be considered. And there should be more policy to help them.

Janamitra Devan: Is that a major concern of the Chinese government right now?

Xiao Geng: We probably have 200 million migrant workers. And then also, you know, these migrant workers, they are supposed to have a piece of land in their village so they have a kind of safety net that they can go back to. And also the food price in China is quite low, you know. So it’s not like in the US, where if you lose your job, you’re in trouble, you have to pay mortgage, everything, you have to pay. So, this is a group of people who don’t have any mortgage, you know. As long as they can have enough to eat, basically, they are largely fine. I think it’s manageable.

Tang Min: This misunderstands the current new migrants. In fact, we did some surveys in the rural areas. The majority of those who go back—the migrants who lose their jobs—are young people. They may have a piece of land, but, when they graduate from high school, right away they move to the city. They have never done farm work. So for them, it’s very difficult to go back and stay in the farm area. And the income in farm areas is maybe only one-tenth of what they are getting in the cities. Also, once people lose their job it means the whole family loses out, because there are many families in the rural areas that are very low income and depend on the money that’s sent back. Now, when people lose money, the whole family is forced back into poverty. So, it is actually quite serious.

David Li: I think the migrant workers losing jobs, relatively speaking, is less of a social problem [than] college graduates who are looking for jobs but cannot get jobs. After all, these migrant workers are scattered in the countryside. They are not so well organized. In contrast, we have college graduates. They are concentrated in large cities. And if a significant proportion of these people cannot get jobs—say, ten percent—these students, they are together, they are in cities, they are communicating with each other. So it is not unimaginable for these kids to organize something, organize some kind of protests in urban areas. So, in my mind, the college graduates’ employment is a much, much bigger problem than the migrant workers losing jobs.

Janamitra Devan: What does all this mean if you’re a foreign business looking into China right now?

David Li: Well, I think there are two kinds of business opportunities in China for foreign business. One is that we are actually doing a lot of infrastructure projects. And the government is really enhancing environmental standards. So, in this regard, a lot of advanced technologies, advanced equipment, will be imported from overseas.

So, for those large corporations, I think they will see a great businesses opportunity. And second, the Chinese government is now eager to promote GDP growth for all the various reasons we have discussed. So, therefore, the government is much more open-minded in talking about various reforms. Arguably for the past few years, the GDP growth rate, the economy, was doing too well to do reform. The government was busy controlling the overheating of the macroeconomy. Now, the opposite is true. So there are a lot of discussions of reform. And in these discussions, foreign corporations are not only observers. Actually in many cases, they are participants.

Why not form some kind of collaboration with local partners and participate in the reform process and tell the government what kind of things, what kind of regulations, can be relaxed? Therefore, more investment can come in, more businesses opportunities can be there.

Janamitra Devan: Can China really be the new growth engine for the world? Is that realistic?

Tang Min: I do not overestimate China’s capacity. China is a developing country. Per capita GDP is only $3,000—less than one-tenth of United States, Japan, or Germany.

The engine for growth is maybe overestimated. Maybe the Chinese share will be higher. But in the next one or two years, I don’t think we can count on China to play such an important role. Yes, if you take a look at China, GDP grows a bit—at 7, 8 percent, it’s the highest in the world. But if you take a look at the past few months, imports actually dropped even faster than exports.

So for an engine to grow, you have to have a lot of imports, and then people can sell and then stimulate the economy. But in fact, at this moment China cannot play such a role. So I will say to the world: do not put too much of your hope on China.

Chi Wei: China’s population accounts for, like, one-fourth of the total population in the world, right? If you can keep this one-fourth of people growing and happy and getting wealthier, that’s a big contribution already.

David Li: China perhaps is a co-engine of growth, a co-engine of international collaboration in many, many regards. And in this regard, the world needs to learn how to better accommodate China. And China has to learn how to acquire various kinds of skills to better play this role.

Xiao Geng: I think that China actually is a leading engine right now—probably the first one to come out of the recession, or however you want to name it. And that’s because China actually is probably the only economy that is functioning normally now, without much debt problems to the credit system, like overspending.

And so, it is really important as a case to show confidence to the global economy. You know, we can show how [a country] can return to normal [levels of growth]. If you look at the US, Europe, Japan—they are still in panic and they don’t know how to get to normal situations. China, I think, has already started getting to a normal situation.

Janamitra Devan: When do you expect recovery? Second quarter, third quarter, fourth quarter, or early 2010 for China?

David Li: Second quarter.

Tang Min: Third, fourth quarter.

Janamitra Devan: Third, fourth.

Chi Wei: Yeah, third, fourth quarter.

Xiao Geng: Yeah, I would probably say third quarter.

Chi Wei: I expect a good change in the sense that, you know, the government is putting more attention on social welfare. But the concern I have is that most of the 4 trillion yuan investment [stimulus], most of the investment will be on the state sector, you know, the big share, will go to state corporations and government spending deficits.

Xiao Geng: I think China actually is at a crossroads right now. And which direction it will go depends really on what China will do in the next few months and few years. If China really starts to reform, it can take this opportunity to really become a modernized market economy.

If China does not reform enough, then there’s a danger that China will actually expand the role of the government in regulation, in social service. And I’m not sure China has found a good model of social service, social security.

Janamitra Devan: How would you advise local players, local businesses and so on, in terms of responding to the crisis?

David Li: Very simple: stay in the game. Keep being alert. And try to be very, very active in this game, in this time. This is a time not only of tremendous opportunities, but, also, the rules of the game are changing. And they are changing in a rapid way, in a dramatic way. So this is actually a time of golden opportunity.

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