Advancing sustainable growth in the United States and China

Voices: Why China’s Market Crash Won’t Kill the Economy

By Andrew Batson

The market decline will hurt plenty of little guys but may not have much impact on economic fundamentals

One of the peculiarities of China’s huge domestic stock-market boom has been that it has taken place even as the nation’s economic slowdown plumbed new depths. While the relationship between financial markets and the real economy is rarely straightforward, it certainly has not looked like the state of the economy was having much impact on the stock market. But what about the reverse relationship: could the stock market be having an impact on the real economy? That question has become even more urgent after the sharp reversal in Chinese stock markets over the past two weeks. If the rising stock market has been supporting the real economy, then that support could well be in the process of unraveling.

It’s difficult to find much strong evidence of such support. There could be a “wealth effect,” as the rising values of stock holdings makes people feel wealthier and more willing to spend. But this effect is unlikely to be very big in China, since less than 7% of the urban population actively trades stocks. Some commentators even argue that there has actually been a “negative wealth effect” in the recent boom, with people holding off on purchases so they can put even more money into stocks. In any case, the steady slowdown in retail-sales growth this year suggests that rising stocks have done little to boost consumer spending.

If households are not big beneficiaries, what about companies? The rising stock market has clearly allowed more companies to raise more money from IPOs and share sales than would otherwise have been the case. So if the market continues to decline, that source of funds could dry up. Yet the potential impact still does not look very large: the equity market has accounted for only about 5% of total private-sector fundraising in recent months; in China, borrowing from banks and bond markets is much more important. And it is hard to detect any big impact on actual spending from the extra funds: the growth of overall corporate investment spending has actually been in precipitous decline this year, a very worrying trend.

In the end, perhaps the simplest way to answer the question about the stock market’s impact on economic growth is just to remember that the financial sector is itself part of the real economy, and contributes directly to growth through its own output and employment. In fact this direct contribution has been surprisingly large: official statistics show that the financial services sector contributed about 1.4 percentage points of the 7% GDP growth in the first quarter of 2015. This was an unusually high rate, as financial services usually contribute around 0.6-0.8 percentage points.

The obvious implication is that the surge in stock trading and related activities (like margin lending), which created lots of new revenue for financial firms, added about half a percentage point or more to GDP growth in the quarter. It seems a straightforward conclusion that national GDP growth would have been below 7% without the stock-market boom. So while I have no idea if the recent correction will mean an end to the surge in stock trading, if trading volumes return to their historical levels then some of that growth boost will also disappear. It’s less clear, though, that there would be more wide-ranging economic effects.


Andrew Batson

Director of China Research, GaveKal Dragonomics

Andrew Batson

Andrew Batson is Director of China research at GaveKal Dragonomics, an independent economic and financial research firm. He is also a Nonresident Senior Fellow of the Paulson Institute’s small “virtual” Think Tank. He has lived and worked in China since 1998. Over the course of a long career as an award-winning journalist and analyst, Batson has written hundreds of articles on Chinese business, economics, government, and society. Before joining GaveKal in 2011, he covered the Chinese economy for The Wall Street Journal.

Topics: Economy