Low growth, a real estate slump and grim trade figures are the most visible of China’s economic problems. They are symptomatic of China’s underlying and more fundamental issues.
During the summer, China’s central bank unveiled a package of measures to support the economy, including easing borrowing rules for first-time homebuyers and cutting interest rates. Around the same time, the government unveiled new tax relief measures for small businesses and some households.
This activity - and there was much more - was a reaction to some worrying economic indicators. In July, China’s Consumer Price Index (CPI) fell by 0.3%, making it the first G20 nation to record a decline in consumer prices since the height of the pandemic. Deflationary pressures, a symptom of economic weakness, have since eased, but China’s post-pandemic recovery is clearly weaker than expected.
That’s serious, because China’s economic growth has helped drive the global economy for a number of decades. In that time, the country has transitioned into the world’s factory and its second-largest economy, and millions of Chinese citizens have been lifted out of poverty.
A temporary blip?
But the country’s recent challenges might not be temporary blips before normal service resumes. The current slowdown is part of a long-term trend that started around 2010 and will continue for much longer. Some forecasts suggest we could see average Chinese GDP growth rates fall to as low as 2% within two or three decades from now.
Nobody can be certain whether that scenario will play out just yet, and much depends on the government’s response to the current problems. But economists worry that China has little room to manoeuvre and that a number of interconnected and systemic problems are now bubbling to the surface.
Is China caught in a middle-income trap?
It has been suggested that China is locked in a “middle-income trap”. This is the struggle to transition from a middle-income economy characterised by low-skilled, low-wage manufacturing and export-driven growth to a high-income economy characterised by higher-value activities, higher wages and consumption-driven growth.
This phase would likely be difficult anyway, but it may be particularly challenging for an economy hindered by high debt and low productivity.
In addition, China is undergoing a real estate crisis, born of decades of easy money and relaxed regulations. But demand has dried up, house prices have slumped and Chinese developers are in trouble. Huge sums in savings and investments are tied up in real estate, which means the crisis in the sector has serious repercussions for the wider economy.
That would be bad enough on its own, but China’s problems are multi-faceted. The population is ageing. Youth unemployment is high. Productivity growth is low. On top of it all, the state may be too indebted to simply pump money into the economy, as it has in the past.
Poor decisions, low returns
Public debt is not necessarily a hindrance to economic growth if it is spent wisely. “However, there are signs that the money is not being invested very productively,” says Bert Burger, Asia economist at Atradius.
“Local Government Finance Vehicles (LGFVs) have accumulated a lot of debt in recent years. However, the projects they financed show a relatively low average rate of return. Besides that, LGFV borrowing crowded out investment by more efficient domestic private firms.”
Investment in China, which for decades has been the largest contributor to China’s growth, is expected to slow because of these disappointingly low returns. They continue to fall, especially for state-owned enterprises. The Chinese government’s central control of the economy has become a drag on growth but relinquishing that control may be a step too far for the current political leadership.
Geopolitical tensions undermining economic growth
That is another compounding factor, because the Chinese government’s relationship with big business is creating tension with the West, which has become suspicious of Chinese technology and its potential uses.
“Trade tensions between the US and China started with the Trump administration in early 2018 and soon moved into technological containment, which has continued and has even been strengthened further under the Biden administration,” says Burger.
“Related to this, the Chinese government has chosen to make the economy more self-reliant or, to put that another way, it wants to be less dependent on the US and other Western economies. China gives priority to security above economic growth.”
Without Western technology, China is finding it hard to fully exploit new innovations like AI and quantum computing. At the same time, some multinational companies are decoupling from Chinese supply chains, preferring trading partners that are less controversial or closer to home.
The list of challenges goes on. Covid left a number of scars, including a youth unemployment rate that has risen to over 20%. That in turn escalates the real estate crisis, because young people without jobs don’t buy homes. Paradoxically, companies cannot find the right people for the jobs where they are needed – in advanced manufacturing. Part of the labour force is overeducated, while many workers are low-skilled. A human capital mismatch with serious consequences.
What does the future hold for the Chinese economy?
China recognises these issues, even if it has limited scope to act. One positive is increased spending for research and development (R&D) and higher education. The number of patents and innovations is rising as a result.
But too often, good ideas hit the bottleneck of excessive state control. Subsidies around innovation and R&D are often allocated to inefficient state-owned enterprises (SOEs), a policy which in turn reduces business dynamism in the private sector.
The challenge for China is that current problems have not occurred in isolation. These are symptoms of structural challenges for which quick fixes are not an option.
“The authorities try to drive innovation to raise total factor productivity, but are hindered by their own choices”, says Burger. “It will be difficult for China to develop into a high-income country on its own. It requires a more cooperative stance towards the rest of the world. Japan and South Korea did this in the past and have prosperous economies today. That seems a long way away for China right now.”