China Requires a Shift in Economic Policy

The effects of the bombshell at the start of 2016 spread from China and had an impact on investors around the world. Within the space of a few days, the Chinese stock exchange fell by 15 per cent. Negative assessments of China's economic development have accumulated. Prior to 2008, the Chinese economy expanded at a rate of between 8 and 14 per cent. During the crisis, China showed itself to be astoundingly robust. Since 2011, however, the rate of growth has plummeted. In 2014, growth was seven per cent. This year, it could fall to five or six per cent. This is still a considerable rate of growth. The question remains, however, whether these rates are really achievable.

China has become a key market, in particular, for Germany. In 2014, German exports to China had a total value of 75 billion euros. China was therefore the fourth largest export market for Germany. What’s more, the customers of German companies throughout East Asia would also be hit by the end of the Chinese boom.

What's the outlook for the coming years? The biggest challenge is eliminating China’s excessive and inefficient investments without triggering an economic slump. The government in Beijing responded to the global economic crisis that began in 2008 with a massive investment programme. The rate of investment before 2008 was, at 42 per cent of GDP, already very high. During the crisis, this rate increased to over 48 per cent. It is now at 43 per cent. In other developing countries such as India or Indonesia, the rate of investment is around 33 per cent; in Western industrialised nations, it is around 20 per cent. High levels of investment are welcome, as long as they are productive. But there are many signs that China has invested poorly on a massive scale.

A significant portion of investment has landed in mostly unproductive construction projects. In addition, current studies show that state-owned enterprises in China frequently make investment decisions on the basis of political, and not economic criteria. Drastically cutting these investments could precipitate an economic downturn. But cuts are urgently needed to provide room for personal consumption and investments by small and medium-sized private companies.

In the medium term, China needs to overcome its reliance on technology and expertise from the US and Europe to achieve growth through its own innovation. China has been pouring significant amounts of money into research and development and the expansion of universities. As a result, current innovation indicators, such as the number of patent registrations, show a steep upward trend. Recent studies by ZEW, however, have found that the quality of patents is sinking: While China is producing large quantities of knowledge, the quality is all too often poor.

China requires a shift in economic policy. It must concentrate on improving the framework for innovation and entrepreneurship and abandon short-term growth targets that are only obtainable via government-sponsored economic stimulus plans. If China succeeds in implementing such reforms, it will continue to serve as a global economic engine in the future.