China reduces GDP growth goal to 7.5%

The Chinese government announced this morning that it was lowering the economic growth target for the country from 8% down to 7.5% a year. Prime Minister Wen Jiabao called for a rebalancing of the economy to a more sustainable, consumer based system. 

that’s a complicated way of saying: China has been one of the fastest growing economies in the world for the past several decades. Economists argue over why the high growth rate has been sustainable for so long. Undoubtedly two factors have played a significant role. First, the government has liberalized many different aspects of the economy and encouraged rural farmers to begin working in new industries. This has fostered competition and increased the labor supply for companies who operate within China’s borders. Less government control of markets usually leads to greater business innovation. Second, there have been, and continues to be, large infusions of investment by the Chinese government and companies. New machinery, building factories, and improving infrastructure (airports, roads, ports, railroads, electrical grids, etc), as well as acquiring new technologies to improve efficiency all contribute to higher economic growth.

Why would China want to grow at a slower pace? At some point the rate of growth for China will slow. A country can not grow at elevated levels forever. China may be tamping down the engine of growth in anticipation of the fact that they are closing in on an economic output that is ideal. Growing any larger would be very costly. Producing new buildings or universities would just be a waste of money and effort. No individuals would have the capacity to utilize the tools.

How can the Chinese government slow growth? The government can slow growth by using both fiscal and monetary policies. Fiscal policy would mean less government expenditures. “Expenditures” is construed broadly to include government subsidized research and development, less funding to repave roads or build new bridges, and reducing the number of government employees. Monetary policy might mean increasing the bank reserve requirements for banks or allowing higher inflation. The goal of either fiscal or monetary policy is to reduce the amount of money flowing into the economy from the government.

What repercussions will the decision to slow growth have for the United States and Eurozone? Lower growth in the Chinese economy almost certainly means less demand for developed world products. Companies that specialize in producing machinery used to build factories and roads will be hurt. For example, Caterpillar exports many heavy duty machines around the world. With lower Chinese growth expectations it is likely CAT will find it more difficult to export their goods to China. Companies that are trying to gain a foothold in the Chinese market will have to work harder to find Chinese customers. This means that those companies will need to find demand in other countries which will not be easy to do. If they can not find replacement customers, they will have hard times meeting payroll and revenue targets.

Will the Chinese be successful in lowering the growth rate to 7.5%? Most likely no. While the government will use various monetary and fiscal policies to reduce the amount of growth, other factors that go into the GDP figure will continue to grow rapidly. However, the lower growth target will negatively impact the world economies. Psychologically investors will think there is less opportunity in China. Ultimately, when China reports their actual growth numbers, I predict world markets will rise.