China Shift to service sector sends global ripples, weakens imports

Hong Kong (Nov 28)  The debate over whether the service sector is replacing manufacturing as the growth engine for China's economy has global implications given the country's huge appetite for imports.

 Premier Li Keqiang stoked the controversy recently with his commentary in The Economist magazine, titled "China's economic blueprint." In the Nov. 2 article, he argued that China's economy is moving to a "sustainable growth model markedly more driven by innovation and consumption." Accordingly, he wrote, "One by-product is a fall in the relevance of indicators such as power consumption, rail-cargo volume and new bank credit in gauging economic performance."

These indicators are components of what has come to be known as the "Li Keqiang index," an alternative benchmark allegedly used in 2007 by Li, then party chief in Liaoning Province, to evaluate the local economy. But he now argues that this index has become irrelevant when applied to the country's economy.

     China's gross domestic product totaled 48.7 trillion yuan ($7.62 trillion) for the January-September period, with the service sector accounting for 51.4% compared with 40.6% for manufacturing. Back in 2007, when the Li Keqiang index was gaining currency, the manufacturing sector was China's economic engine with a 46.7% share of GDP, nearly 4 percentage points above services.

     Now the benchmark paints a bleak picture. The Li Keqiang index, published monthly by QUICK, a Nikkei group company, dropped 1.2 points on the year for September, its first decline since 2010. The index dropped 1.1 points in October.

     "Employment, income levels and the environment are all high on our list of priorities," Li wrote in The Economist article. These indicators, dubbed the "new Li Keqiang index," suggest China's government is shifting its economic focus to consumption and services while aiming to improve the quality of life, Mizuho Securities Asia says.

     The stable growth model in which manufacturing declines are offset by the rising service industry may be ideal for China, but trading partners may get fewer benefits. Mark Spiegel, vice president of the U.S. Federal Reserve Bank of San Francisco, argues in his report published Monday that growth in China's service industry can mitigate the impact of a manufacturing slowdown but cannot support imports. Little correlation exists between imports and service sector growth, unlike the link between manufacturing and imports.

     "Accordingly, service sector growth is unlikely to offset the adverse implications of a slowing China for global trade," he concludes.

     China's transition to a service economy, Spiegel said, "should have more benign medium-term implications for its trade partners." In the short run, however, the decline in its manufacturing prowess is rippling worldwide.