China’s poised for slower economic growth, but it’s not all bad news
As a fast-maturing economy, China is rebalancing to a consumption- and services-led economy.
This will naturally translate into a lower long-term economic growth performance.
To overcome some of these obstacles and escape the middle-income trap, China will need to boost productivity growth by promoting innovation, making technological advances, achieving higher education rates and making steady progress in addressing institutional and resource-allocation issues.
The numerous structural factors affecting the country will see it transition to a structurally-lower long-term economic growth path that will likely be below 5%.
While China’s GDP performance slowed sharply in the first half of 2020 as a direct result of the COVID-19 outbreak, the economy was able to fully recover very quickly, with GDP reaching a record high towards the end of 2020. However, Chinese growth momentum has subsequently dissipated, as GDP slowed to a growth rate of 4.9% year-on-year in the third quarter of 2021, the slowest annual rate of growth in more than a year. The moderation in economic growth appears most likely to continue into 2022 as the country faces a number of challenges that are both short term as well as structural in nature.
Short-term headwinds stalling China’s economic recovery
The Chinese economy is facing three shocks to its economic recovery as we near the end of 2021.
Firstly, owing to the government’s zero-COVID strategy, the resurgence of infections (driven by the Delta variant) in many parts of China has resulted in the reintroduction of strict social distancing measures.
This has affected domestic consumption activity, particularly travel, accommodation, catering and entertainment. Unfortunately, this is happening at a time when the consumption side of the economy was expected to drive growth in the second half of the year.
The resurgence of infections globally and ongoing supply disruptions are putting downward pressure on China’s production and export performance. This means that the demand side of the Chinese economy is recovering at a slower pace than was expected, at a time when production activity is moderating.
Secondly, the Chinese economy has been hit by significant electricity shortages related to energy restrictions that are meant to control carbon emissions. This has forced factories to curb output or shut down completely, particularly in energy intensive sectors such as the production of steel, aluminium and cement.
Lastly, ongoing regulatory tightening in the property sector, in an effort to limit financial risk, has curbed construction activity and squeezed financing of the sector. Historically, China has relied heavily on the property market for economic development and it remains an important driver of economic growth, so these restrictions are likely to dampen economic activity in the short term. In addition, this crackdown means that Chinese authorities can no longer use the real estate market as a policy tool to stimulate the economy during times of slowing economic activity.
Structural factors affecting China’s long-term economic development trajectory
Beyond the short-term factors hampering China’s economic recovery from the pandemic, longer-term economic activity in China is also set to be slow, affected by a number of structural economic headwinds. As a fast-maturing economy, China is rebalancing to a consumption- and services-led economy, thereby moving away from an investment expenditure-driven economy. This will naturally translate into lower long-term economic growth performance.
Importantly, China’s “common prosperity” initiative, which is aimed at addressing some of the important socio-economic challenges facing the country, is also likely to drive longterm economic growth lower. This initiative means that China’s policy focus is shifting from a significant emphasis on economic growth towards trying to address social issues, including income inequality and climate change.
The range of regulatory tightening and cultural reforms recently in the technology, property and education sectors could be seen as the first steps by government to achieve the common prosperity goals.
Additionally, Chinese authorities are committed to reducing inequality in outcomes and access through changes in:
- Establishing a comprehensive social safety net;
- Realising a significant green transformation;
- Enhancing the quality of employment, healthcare and education and;
- Income transfers.
Chinese authorities aim to reduce the cost of basic needs like education, housing and medical care and address the extremely high levels of inequality in the country.
The authorities also acknowledge the need to address other longer-term challenges, particularly by reining in private and household sector debt (and addressing financial stability risks) and reducing technological dependence on the US.
This drive to steer the economy onto a greener, more resilient, and inclusive development path will inevitably lead to lower, but “higher-quality” growth for China.
Another characteristic of a maturing economy is a stabilising population, which is translating into unfavourable demographic changes in China. China is experiencing declining fertility rates and a significant rise in the old-age dependency ratio.
The rapidly-aging population trend is likely to shrink the labour pool, threatening China’s natural advantage in human resources, and putting pressure on its long-term economic growth prospects. Positively, however, one of the expected benefits of the common prosperity agenda is to reduce the cost of raising children, increasing the incentive to have more children and potentially slowing this demographic trend.
Despite the slowdown in economic activity in the second half of 2021, the strong recovery in the first half of 2021 – along with base effects – means that China’s economy will still post strong growth in 2021. Currently, GDP growth is projected to reach 8.1% this year, rebounding from 2.3% in 2020. This forecast has, however, been recently revised down from 8.4% as ongoing issues with energy shortages, COVID-19 outbreaks, tighter regulations and supply chain bottlenecks continue to affect China’s economic growth for the rest of the year.
Overall, given the headwinds that China is facing, such as limits to the growth of its export-dependent manufacturing industry, the need for structural reforms, and its aging population, the country is transitioning to a structurally-lower long-term economic growth path that that is likely to be below 5%.
To overcome some of these obstacles and escape the middle income trap, China will need to boost productivity growth by promoting innovation, making technological advances, achieving higher education rates, and making steady progress in addressing institutional and resource allocation issues. If done right, the common prosperity agenda could address some of these requirements, but it is unlikely that China will be able to achieve the level of economic growth that it did in the past.