Is the Chinese miracle over?

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By YAO YANG*

China's government is taking bold steps despite short-term costs

China's economic performance over the past year has been disappointing – so much so that some observers argue that growth has already peaked, and that it's all downhill from here. But it is too early to dismiss China's economic resilience.

As 2023 began, the lifting of draconian “zero-COVID” restrictions fueled a kind of domestic euphoria, reflected in increased consumption. But the picture soon darkened as the second quarter brought declining exports, stagnant retail sales, shrinking corporate profits, local government spending cuts and a weakened real estate sector. Chinese business confidence plummeted and foreign companies got scared. In November, China recorded its first quarterly deficit in foreign direct investment.

Still, China's economy will likely grow at least 5% this year – a respectable rate by international standards. More importantly, China's economy still has plenty of fuel left in the tank: a record savings rate means it still has plenty of cheap financing for investment and innovation.

China is already investing heavily in technologies – such as renewable energy, electric vehicles and artificial intelligence – that will shape the global economy in the coming decades. China is also rapidly developing its capabilities in emerging technologies such as nuclear fusion, quantum computing, quantum communication and photonic semiconductors. We know this strategy works: other successful economies, such as Japan in the 1970s and 1980s, have proven this.

But China faces headwinds to growth. Geopolitical tensions – in particular, the US-led effort to “decouple” economically from China – are discouraging foreign investment, just as they are encouraging companies to diversify their production away from China. But rather than leaving China altogether, many foreign companies are adopting a “China+1” strategy, opening new facilities in a third country while maintaining their Chinese operations.

The reason is simple: with 30% of the world's total manufacturing value added – an amount equal to the shares of Germany, Japan and the US combined – China still offers companies a huge cost advantage. Add in the existence of massive excess capacity, and you can see that China's manufacturing sector will continue to prosper. In fact, the only thing the U.S. decoupling effort will ultimately accomplish is to encourage China to accelerate the development of its own manufacturing capabilities abroad, just as Japan has done since the 1980s.

The likely impact of unfavorable demographic trends on long-term growth is similarly exaggerated. Yes, China's population is aging and shrinking rapidly. But as artificial intelligence enables the automation of an increasing number of tasks, productivity will rise and the demand for human labor will fall. Along with improved education, this should more than offset the shrinking workforce – possibly even creating the opposite problem: too few jobs.

So what explains China's slow recovery from the COVID-19 pandemic? The answer lies in government policy.

In recent years, the central government has been working to combat imbalances that threaten China's long-term growth prospects – starting with massive debts held by state-owned enterprises, private companies (such as real estate developers) and local governments. If China has learned anything from the US, it is that excessive financialization can destroy a country's manufacturing sector. This is why Chinese authorities are committed to deleveraging, that is, containing the advance of financialization.

Local governments are a top priority on this front. Since 2010, China has pursued two major rounds of fiscal and monetary expansion, each of which has led to an increase in local governments' commercial debts. After the first round in 2014-18, the central government allowed local governments to issue long-term bonds worth 8 trillion yen ($1,1 trillion) so they could pay off their commercial debts – a kind of debt exchange program. But local governments have again been forced to borrow heavily during the COVID-19 pandemic, accumulating even more debt that authorities are still working to resolve.

Another priority for the central government is to end the excessive commercialization of some sectors. Consider the tutoring industry: Families pay private education companies for after-school classes, hoping to give their children an edge over their peers. But these companies charge high prices, which parents struggle to pay, but offer few benefits to students, who are already working hard in school. So in 2021 – with the private tutoring industry having grown to $120 billion – authorities banned for-profit after-school tutoring in core subjects.

The third key imbalance that China's government is trying to reduce is in the real estate sector, which is simply too large, accounting for about a quarter of all fixed investment between 2013 and 2021. With some major developers now struggling to pay their debts, Stabilizing the sector has become a priority for policymakers.

Neither of these imbalances poses an imminent threat to Chinese growth. But reducing them will bolster China's long-term economic health. That's why China's government is taking bold action despite the short-term costs. For example, home sales have plummeted by about 40% since mid-2021, largely due to government efforts to control the sector.

The good news is that the government has set growth as its main goal for this year and has implemented new expansionary monetary and fiscal policies. Notably, with monetary authorities encouraging banks to resume lending to developers, the real estate sector is expected to return to normal this year.

*Yang Yao is a professor at the China Economic Research Center and the National Development School of Peking University.

Translation: Eleutério FS Prado.

Originally published on the portal Project syndicate.


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