Mohamed A El-ErianIn assessing the complicated risks posed by the outbreak of the coronavirus to China and the global economy and markets, the main focus has rightly been on the effectiveness of containing its spread, treating those infected and preventing a recurrence. But a second longer-term dimension, which has attracted little attention so far, exposes risks to China’s historic and impressive economic development process.
Especially when compared with earlier similar outbreaks, including the SARS crisis 17 years ago, the Chinese government has moved quickly and forcefully to limit and counter the contagion. Vulnerable areas have been subject to lockdowns aimed at stopping the spread of the virus. And there’s been larger-than-usual information-sharing with other countries, at least by China’s standards.
Despite all this, worries persist. On Saturday, President Xi Jinping accentuated them by expressing public concern about risks to public health because of the “accelerating spread” of the illness.
The concern is not limited to China. Related cases have been reported in more than 10 countries so far, all of them taking action of varying intensity. The most pronounced so far also came on Saturday in Hong Kong, where the government declared a “virus emergency,” stopped official travel to the mainland and extended school closings.
What happens over the next days and weeks will prove critical to China and the world. Possible outcomes are difficult to predict, but in the short term they are based on a relatively low probability of a catastrophic global spread of a highly infectious deadly disease. That being said, a second longer-term risk will be equally tricky for policy makers and markets to get their arms around.
The coronavirus is yet another unanticipated shock to Chinese growth. Like the 2018-19 escalation of trade tensions with the US, it is not one that is easily countered by the deployment of available economic policy tools. Because of the government’s desire to avoid a marked slowdown in economic growth, it results in ill-suited short-term stimulus measures that produce limited benefits and considerable risks of collateral damage and unintended consequences. Moreover, several of these are inconsistent with the direction of the longer-term reforms that China needs and seeks to consistently pursue. The coronavirus adds a tricky dimension for trade. As illustrated by the shutdown of cities, leisure activities and many gatherings, it is limiting the movements of goods, services and people within China. Moreover, it undermines domestic economic activities that are key to the country’s well-being in two important ways.
In the short term, the slowdown in domestic economic activity eliminates an important counter to the negative impact of still-slowing and uncertain global trade notwithstanding the “phase one” agreement with the United States. This amplifies the already tricky stimulus versus reform question facing the government. It increases the likelihood of deepening household risk aversion, further undermining economic activity. And it increases the risks of pockets of financial instability associated with past periods of over-indebtedness and excessive leverage.
In the medium term, the hit to domestic sectors slows the needed reorientation of the economy — one that de-emphasizes external demand and state-owned enterprises in favor of more self-sustaining domestic private demand. It is a risk that is notably amplified by the fact that China’s historic development process is navigating the trickiest of all transitions — that involving the “middle-income trap,” in which a country’s economy becomes stuck and never shifts into higher gear. It is a phenomenon that has derailed many developing countries before China. It is still too early to say what will happen next, either in the immediate or longer term. What is clear at this stage is that, with the recent accumulation of headwinds to China’s impressive multidecade development process, the country is becoming more and more vulnerable to the vagaries of the middle-income transition. Courtesy: Bloomberg