Commentary on Political Economy

Thursday 7 September 2023


China is no longer sure to become the largest eco­nomy

Eco­nom­ists and Wall Street ana­lysts have been dis­ap­poin­ted in China’s eco­nomic per­form­ance, hold­ing out hope that this might prompt the gov­ern­ment into a stim­u­lus effort sim­ilar to the one seen in 2008.

This, in turn, would rein­vig­or­ate domestic growth and restore China as a key engine of global expan­sion.

However, the more likely scen­ario is con­tin­ued weak growth. The primary policy ques­tion now is how quickly the gov­ern­ment will shift away from stim­u­lus meas­ures to a faster fun­da­mental over­haul of its growth strategy.

China’s under­whelm­ing eco­nomic per­form­ance so far in 2023 can be attrib­uted to two major factors: a lacklustre recov­ery fol­low­ing the eas­ing of strin­gent zero-Covid restric­tions and more per­sist­ent and struc­tural growth chal­lenges. The lat­ter is the res­ult of an eco­nomic strategy that has his­tor­ic­ally over-relied on real estate, high local debt, inef­fi­cient state-owned enter­prises, lower-end man­u­fac­tur­ing and domestic con­sumer inter­net plat­forms.

This prob­lem has been exacer­bated by sev­eral factors, includ­ing reg­u­lat­ory over-reach, geo­pol­it­ical ten­sions and lower for­eign dir­ect invest­ment inflows.

There have also been con­cerns about a poten­tial Japan-style defla­tion­ary trap, espe­cially in light of declin­ing con­sumer and pro­du­cer prices. Some for­eign investors have asked whether “China is invest­ible”.

Beijing has announced over recent weeks a series of small mon­et­ary, fiscal and reg­u­lat­ory meas­ures to boost the eco­nomy and mar­kets. These meas­ures have thus far been per­ceived cor­rectly as piece­meal and lack­ing con­vic­tion.

Yet many still believe they will even­tu­ally accu­mu­late into an impact­ful crit­ical mass. There are prob­lems, however, with this view.

China faces not only growth chal­lenges but also sig­ni­fic­ant fin­an­cial issues, includ­ing pock­ets of high indebted­ness that could eas­ily trans­form into sys­temic risks. This lim­its the scope for old-fash­ioned stim­u­lus.

The heightened sens­it­iv­ity sur­round­ing the strug­gling prop­erty sec­tor, in par­tic­u­lar, makes house­holds more cau­tious on spend­ing, fur­ther dimin­ish­ing a growth driver. Con­cerns about youth unem­ploy­ment per­sist and are not being helped by the gov­ern­ment’s decision to halt the release of rel­ev­ant data.

The external trade and invest­ment out­look is equally prob­lem­atic. There is a grow­ing real­isa­tion that the eco­nomic and fin­an­cial decoup­ling between China and the US is likely to con­tinue. This could cut the con­tri­bu­tion of exports to growth, dis­rupt the import­a­tion of cru­cial indus­trial inputs, under­mine for­eign dir­ect invest­ment and make port­fo­lio investors even more skit­tish.

The will­ing­ness of the author­it­ies is also in ques­tion. A care­ful ana­lysis of the lead­er­ship’s state­ments points to wor­ries that heavy reli­ance on tra­di­tional stim­u­lus meas­ures would jeop­ard­ise China’s abil­ity to escape the com­mon devel­op­ment trap of get­ting stuck in middle-income levels.

This pit­fall has already hindered many devel­op­ing coun­tries in their quest to join the ranks of advanced eco­nom­ies. A big-bang stim­u­lus would also increase the risk of cor­rup­tion.

It is likely Beijing will con­tinue to only tinker with small stim­u­lus meas­ures while seek­ing to com­mu­nic­ate bet­ter an inten­tion to accel­er­ate the trans­ition to new growth sec­tors (such as higher value-added man­u­fac­tur­ing, green energy, health­care, arti­fi­cial intel­li­gence, super­com­put­ing and life sci­ences).

This revamped growth model takes time and involves cre­at­ive destruc­tion, espe­cially in the short term. Addi­tion­ally, Beijing will need to con­sider more force­ful debt restruc­tur­ing meas­ures that, ini­tially, also detract from growth.

It is time for the mar­kets to recog­nise that China is not revert­ing to its old eco­nomic and fin­an­cial play­book, and its return as a power­ful driver of global eco­nomic growth is unlikely in the near future. Eco­nomic per­form­ance is likely to remain lacklustre for the remainder of 2023 and the first half of 2024.

Look­ing bey­ond this period, the out­look is also far from reas­sur­ing. The chal­len­ging pro­cess of reori­ent­ing the Chinese eco­nomy in the face of ongo­ing geo­pol­it­ical ten­sions and the com­plex­ity of build­ing an altern­at­ive inter­na­tional order poses sig­ni­fic­ant hurdles.

Beijing will need to over­come its over­whelm­ing inclin­a­tion towards cent­ral­isa­tion and instead enable but not micro­man­age the emer­gence of power­ful private sec­tor growth engines. Des­pite what many may con­tinue to tell you, it is no longer a given that China will become the world’s largest eco­nomy.

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