China's Third Quarter Growth: Transition on a Steady Pace
China’s third quarter GDP growth of 6.9 percent is the slowest since the height of the global financial crisis. It is not, however, the harbinger of a coming economic meltdown. Rather, the third quarter continues trends evident since the beginning of 2010. First, a massive deceleration in investment in housing has led to a marked slowdown in the demand for steel and other building materials, slowing overall industrial growth by about three-fifths over the past five years. Second, China’s services sector has slowed by far less, holding up GDP growth. Put another way, if the service sector had slowed proportionately with industry, China's current pace of expansion would be about 4 percent.
Why have services become the most important driver of China’s economic growth in recent years? In a word: rising private consumption. Several factors are responsible. First, wage growth has been running well ahead of GDP growth for several years, in part because of demographic factors. The growth of the working age population first slowed and more recently began to fall slightly. All other things being equal, when wages rise, increased consumption growth follows. Second, the increased reach of the social safety net, particularly the marked progress in providing health insurance to over 90 percent of the population, has reduced the precautionary demand for savings. The corollary of a lower savings rate of households, of course, is stronger consumption. Third, the World Bank now classifies China as an upper-level middle-income country. This is a level of per capital income at which basic needs of food, clothing, and so forth for the vast majority of China’s population are reasonably well met, and the share of consumption that is on services, rather than goods, increases. The most obvious examples are rapidly rising outlays on entertainment, travel, and education. Fourth, since the production of services is about twice as labor intensive as industry, increased demand for services leads to more rapid growth of urban employment, which reinforces the underlying trend of rising wages.
Each of these factors reflects fundamental changes that are likely to be sustained, leading to an expansion of services that is more rapid than GDP and thus a rising share of services in China’s GDP. Services already account for half of GDP, as compared to a combined share of industry and construction of 40 percent.
Bottom line—if you want to understand the likely trajectory of the Chinese economy over the medium term, spend as much time analyzing the factors contributing to the growth of consumption and services as the factors contributing to the growth of investment and industry.