China’s economic slowdown: Good or bad news for Europe and Central Asia?

By Maurizio Bussolo, Europe and Central Asia Chief Economist Office, The World Bank Group

China’s economy looms large in global markets. After decades of sustained economic growth, the country became the world’s largest exporter in 2007 and today sells abroad 60% more goods and services than the United States and 75% more than Germany – the second and third largest exporters, respectively. In addition, China is the second largest importer of goods and services in the world, after the United States.

Because of China’s importance in the global economy, news of its economic slowdown and financial sector turmoil have caused many observers to worry. In fact, at the beginning of 2016, some were explaining the plummeting of stock markets as anticipating a growth collapse in China (also reflected in very low oil prices).

I would caution that, while there are real uncertainties about short-term developments in China’s financial sector, the jitters in global financial markets have less to do with China and more to do with a range of other factors. For instance, we currently see a trend in tightening of monetary policy, accompanied by uncertainty fueled by post-“Brexit” scenarios and other, non-economic factors such as violence and instability.

Overall, the fundamentals of the Chinese economy have not changed that much, and the current moderation in the pace of growth should not come as a big surprise. We know that China’s GDP growth slowdown is related more to a decrease in the expansion of production capacity than by a sudden, cyclical fall of domestic demand.

So, my argument – taking a longer term view – is that the economic transitions in China (not only its growth moderation, but also the changing pattern of its growth) should be seen as a reason less for concerns and more for potential opportunities. But, you may ask, how can slower GDP growth in China be good for anyone?

First, look at supply versus demand. The slowing of China’s GDP growth over the past few years does not appear to be caused by faltering domestic demand. Rather, it is linked to a structural slowdown – essentially, sluggish productivity growth. A cyclical, demand-side, growth reduction implies decreasing imports, while the current structural, supply-side slowdown implies that both imports and exports will decrease. The slowing down of GDP growth, therefore, could potentially be associated with an increase in net demand for the rest of the world. This is a source for opportunities.

After decades of struggling with Chinese firms that gained ever-greater market share, European firms, especially those along the “Silk Road,” are finally improving their competitive positions both at home and in the global market. For the first time since 2003, export growth of the countries in the Euro area has been higher than global export growth.

And other opportunities exist too. The rebalancing of the Chinese economy that is accompanying its slowdown will have profound impacts on the economies of Europe and Central Asia in the future. We will see a shift towards more domestic consumption and less investment. The investment to GDP ratio, currently standing at more than 40%, is expected to decrease to below 30%. The share of tertiary-educated workers in employment will almost double, thanks to 100 million skilled workers entering the labor market in the next ten years. And, we will see a strong expansion of outward foreign direct investment.

All of which means that China’s demand for domestically produced and imported high-skill goods will decrease, while that for low-skill goods will go up. This trend will be magnified by the skilling-up of the labor force. The large increase in tertiary workers will improve China’s comparative advantage in high-skill products and again alter its trade with Europe, Central Asia and the rest of the world.

This will bring significant opportunities for countries especially in Central Asia, which, with their still-abundant unskilled workers, will likely experience increases in their exports to China. Kazakhstan, for example, could become an important supplier of food products to China and world markets.

One particularly important effect of China’s economic rebalancing is a potential reduction in inequality within countries. For instance, a surge in demand for goods produced by unskilled workers will likely increase their wages relative to the wages of skilled (and generally higher income) workers. In addition, because of an increased demand for agricultural products, the urban premium, or the gap between the wages of unskilled workers employed in manufacturing and services versus the wages of those employed in agriculture, may decline.

These opportunities are genuine, but they can slip away if economic policies do not actively support certain adjustments. For one, resources will need to shift away from non-tradables – or out of resource sectors for some countries – into tradables. Also key is facilitating mobility in labor markets and flexibility in domestic banking. To take effect, however, these adjustments will need to overcome the rigidities and vested interests that emerged in several countries during the long “prosperous” period of high oil prices.

But, I believe we have reason for optimism. When we look back 20 or 30 years from now, the gyrations of the Chinese market hopefully will appear as minor glitches in the economic story of Europe and Central Asia.

Read the latest World Bank report
here on the impact of China on Europe and Central Asia, and see a longer version of this article (in Chinese) here in Boao Review.