China’s services sector has been instrumental in maintaining its economic growth as its low quality manufacturing advantages erode. Even so, signs of mounting pressure on the sector are becoming apparent. As such, there is now reason to be skeptical of optimistic forecasts of China’s economy. Such forecasts focus largely on the services sector’s resilience.
China’s services sector is the linchpin of its economic development. Increasing growth in the sector might be necessary prerequisite to offset the erosion of China’s manufacturing growth and export competitiveness. The sector is to serve as a source of employment for workers exiting China’s sunset industries. Sector re-balancing also contributes to China’s pollution reduction targets. To be sure, China has enjoyed considerable success in bolstering its services sector. With a growth rate of 7.6 percent, it performed better than the rest of the economy and contributed to 59.7 percent of GDP growth in 2018. Even so, signs of mounting pressure on the sector are becoming apparent.
As such, there is now reason to be skeptical of optimistic forecasts of China’s economy. Such forecasts premise largely on the services sector’s resilience.
Dissipation of growth bubbles
According to data from the National Bureau of Statistics (NBS), China’s tertiary sector value added growth fell to 7% year-on-year. This was the case for the first quarter of 2019, falling from the 7.6% reported for 2018. Moreover, this amounts to the lowest growth the sector has experienced during since the turn of the millennium. One major source of this slowdown is the dissipation of asset bubbles in the financial and real estate sectors.
In the case of financial inter-mediation, value added grew at an average rate of 9.8% during the 2010-15 period. This was higher than the overall service sector average at 8.6%. Since then, however, average growth in the financial sector has almost halved and stands at 5.1%. This is likely due to the Chinese economic leadership’s crackdown on informal banking and measures taken to mitigate financial risks.
Despite attempts to stimulate the broader economy, China’s financial sector is unlikely to return to pre-2016 value addition levels. This is because policymakers intend to rely on fiscal measures to prop up growth and encourage moderation in the financial domain.
Real estate and finance
Similarly, real estate value added growth slipped to a low of 2.5% in the first quarter of 2019. The real estate sector has been reeling from the state’s measures to rein in a property bubble emerging in 2016. It had allowed value added growth to reach 8.6%. Moreover, much like the financial sector, growth in real estate is unlikely to witness a rapid resurgence, with policy makers opting for modest property policy easing such as lowering mortgage interest rates in a limited number of cities.
Slowdowns in these two sub sectors are especially impactful due to their size in the economy. As per 2018 data, real estate and finance combined accounted for 14.3 percent of China’s total nominal value addition. To be sure, insofar as the slowdown is reflective of the dissipation of asset bubbles, it improves China’s prospects of sustainable, less risky growth. Nevertheless, it will serve to subdue services value added numbers on paper. As a result, this will likely make it increasingly difficult for China to achieve her GDP growth targets.
Services and manufacturing are tied together
Another salient source of downward pressure on China’s services sector is the manufacturing slowdown itself. Certain important services sub sectors are dependent on the manufacturing sector for their business. The performance of wholesale and retail is a prime example of this. This is the single largest services sub-sector by value addition and accounted for 17.9% of the 2018 total. Growth, which prevailed at near double digit levels in the mid 2000s, reached a low of 5.8% in the first quarter of 2019.
Secondly, while transport and storage services have proven fairly resilient up to this point, these too face headwinds. Manufacturing supply chain migration out of China will likely intensify. This is due to the tariff dispute with the US, which will arguably affect the logistics sector as well. While much of China’s exports and, by extension, its logistics services industry, benefited from strong American growth and a depreciating Yuan, these tailwinds are slated to dwindle. China’s logistics companies will certainly derive benefits in the short-run from facilitating the migration of supply chains to Southeast Asia. In the long-run, however, it will be left to rely on local manufacturing, the outlook for which is not particularly optimistic at this point.
In addition to weakening output, the service sector’s capacity to preserve employment levels also appears to be under stress. As per NBS data, in 2018, growth in tertiary sector employment failed to offset drops in primary and secondary sector employment for the first time since 2000. Observing the Caixin services Purchasing Managers Index (PMI) also reveals subdued job creation throughout 2019, even as export orders grew, indicating lingering uncertainty.
Deft policy required to maintain growth
As such, while China’s services sector will continue to outperform the rest of the economy and engender a re-balancing away from manufacturing, it appears less easily capable of holding overall growth at high levels, given its current trajectory. Preserving services growth will arguably require continued stimulus measures aimed at the demand side, involving the maintenance of employment and income levels even as the effects of last year’s stimulus kicks in. It will also necessitate supply side incentives to the secondary sector insofar as it is a source of business for services.
Moreover, China’s policy makers will need to mitigate the crowding out of the services sector. In achieving this, they may simultaneously reduce the growth barriers it faces. This can be done through reforms, such as expanding input tax credits and opening up to the private sector. Allowing more foreign investment is another great alternative that can contribute to this process.
The tertiary industry is hardly insulated from the broader economy and presently lacks the momentum to stabilise growth adequately. The strength of China’s services sector and its role in preserving overall economic growth, thus, hinges greatly on the economic leadership’s ability to sequence stimulus policies and reforms optimally. In conclusion, it is hardly foregone that China’s economy will witness another high growth period simply due to its success at re-balancing.
