The meeting of the Chinese Communist Party’s Politburo decided upon a number of priorities and set out guidelines for economic policy directions for the second half of 2023. Of particular interest to the market, were the directives related to boosting consumption, supporting private enterprise and stabilizing real estate, employment, local debt, capital markets and exchange rates, among other issues.
The meeting effectively acknowleged the various challenges and difficulties facing China’s economy, including a lack of domestic demand, the operational difficulties facing some enterprises, growing risks in key sectors and a complex and severe external enviornment.
But while the economic recovery after the relaxation of pandemic restrictions in late 2022 has been up-and-down, China’s economy still has great developmental resilience and potential, and the fundamentals for its long-term improvement have not changed.
On July 17, 2023, the National Bureau of Statistics (NBS) released a series of economic data for the first half of the year, showing that Gross Domestic Product (GDP) grew at a rate of 5.5% year-on-year. The GDP growth for the first quarter was 4.5% and 6.3% for the second quarter. On a quarter-over-quarter basis, GDP grew by 0.8% in the second quarter.
The release of the data attracted global attention, and various domestic and foreign analysts interpreted the data in differing ways, with one viewpoint suggesting that China’s economy is now showing signs of weakness. This is evidenced by the 0.8% sequential GDP growth rate in the second quarter, compared to the 2.2% sequential growth rate of the first quarter’s GDP.
There are always “short-sellers” and “long-sellers,” who pay attention to different indicators and consequently come to different conclusions. And even if the indicators are the same, interpretations will be different, so it is not surprising that there are different or even opposing views in the markets.
However, it should be noted that most of the current analysis of the economy focuses on short-term economic growth, such as whether the government’s growth target can be achieved this year, and whether China should further drive economic growth by further boosting infrastructure investment.
All of these discussions are very important, but focusing too much on short-term issues will cause us to overlook more important long-term issues and could cause us to lose sight of our future goals. Therefore, this article will provide an initial view of the short-term issues in order to shape the more important analysis of the long-term potential of the Chinese economy.
Let’s look at the short-term problems first. There are at least three pressing issues that threaten China’s short-term economic future: a decline in economic growth rate, a lack of confidence in economic growth and a low rate of domestic consumption.
Firstly, looking at the decline in economic growth, World Bank figures show that China’s year-on-year GDP growth rate in 2022 is only 3.0% in constant 2015 dollars, with inflation and exchange rate changes accounted for.
As far back as 2007, China’s year-on-year GDP growth rate managed highs of 14.2%, and even just 10 years ago in 2013, China’s GDP growth rate was 7.8% year-on-year. It is therefore fair to say that China’s economic growth rate has declined rapidly, and while all countries face some level of slowing growth eventually, in China it is proving to be unusually quick.
Secondly, there are various data and examples that show that people’s confidence in the prospect of future economic growth is low. For example, in the past two years, few people are leveraging to buy a house, and many are deleveraging to pay off their loans early.
Lack of confidence in economic growth and weakened expectations of income growth have led people to start arranging their personal financial allocations with the goal of minimizing debt. A direct consequence of this is lower aggregate demand.
In addition to the consumers’ lack of confidence in economic growth, private companies’ expectations for the future are not as optimistic as in the past. In this context, their willingness to invest has also declined.
According to the NBS, in the first half of 2023, the year-on-year growth rate of the country’s fixed-asset investment—excluding farm households—was 3.8%, but the year-on-year growth rate of private investment instead slipped 0.2% to 0.7%.
Thirdly, the rate of consumer spending is too low. China’s economy has many structural problems, but the core problem is the low ratio of consumption to GDP.
The purpose of our economic development is to enable people to lead a more affluent life, and this is reflected in economic indicators by the level of consumer spending. The causes of low spending are complex, and the structural problems will not be resolved overnight. I will not go into details here, but in brief, this is still effectively a short-term problem.
China’s economic potential
After 1949, China established a planned economic system modeled on that of the Soviet Union, but this system failed, and China’s economy stagnated throughout a long period of weak growth. After 1978, China shifted its entire focus to economic development, beginning a process of reform and opening up, and gradually implementing a market economy.
We know that the market economy has unparalleled advantages over the planned economy in promoting economic growth, but at the time people were unsure of what impact this new new economic system would have on China.
It turned out that the market economy encouraged a tremendous economic vitality, moving the Chinese economy towards a period of massive growth. According to the World Bank, China’s GDP grew at an average annual year-on-year rate of up to 9.1% from 1978 to 2022 in constant 2015 dollars. Using the same measurements, China’s GDP was $364.4 billion in 1978, and this number saw a 45-fold increase to $16.3252 trillion in 2022.
A consistent level of economic growth this high was unprecedented in human history and something that took many people by surprise, so it is unrealistic to expect that China’s economy can continue to grow so fast for another two decades. While we have now reached a point where it is unclear what potential for growth still remains, China’s economic prospects are not what they used to be.
Gaining a clear understanding of this issue is a concern as the results will have a major impact on the formulation and implementation of economic policy over the coming years.
Looking at historical examples, many countries have shown that catching up to advanced economies is a possibility, with Japan being a prime example. According to the World Bank, in constant 2015 dollars, Japan’s per capita GDP in 1960 was just 32.7% of that of the US, at $6,261 and $19,135, respectively.
By 2022, the GDP per capita of Japan was $36,032, 57.3% of the United States figure.
Based on this, we can see that from 1960 to 2022, the average annual growth rate of GDP per capita in Japan was 2.9% and 1.9% in the United States.
Using this as a comparison, we know that China’s 2022 GDP per capita in constant 2015 dollars was $11,560, 18.4% of the US number and significantly lower than Japan’s 32.7% in 1960. Without considering demographic factors, if US GDP per capita continues to grow at the same average annual rate in the future, then in 20 years, in order for the ratio of China’s GDP per capita to reach even 30% of the US number it will require an average annual growth rate of at least 4.9%.
Taking this further, and without taking population into account, if the US GDP per capita continues to grow at an average annual rate of 1.9% in the future, then growing the ratio of China’s GDP per capita to the US’s GDP per capita from 18.4% to 57.3%—Japan’s level in 2022—would require China’s GDP per capita to grow at a compounded annual rate of 3.9% over the next 60 years.
Don’t underestimate the difficulty of hitting 3.9%, which is the compound growth rate after taking out inflation and exchange rate changes. Under CAGR, a difference of 2 percentage points in GDP per capita over 60 years—3.9% growth in China vs. 1.9% growth in the US—ends up making a huge difference.
Following the assumptions and calculations above, we can clearly see that even by 2042, China’s GDP per capita will be less than one-third that of the United States. And by 2082, this indicator will not even have passed 60%.
The Chinese government’s economic growth target for this year is 5%, which for emerging economies is still part of a gradual decline until it stabilizes at a lower level once it reaches a certain point of economic development.
Under these circumstances, either 3.9% or 4.9% means that China’s economy is well placed to maintain a relatively high rate of growth for a long time to come.
But at the same time, a 5% growth target implies a certain level of pessimism about current economic growth prospects given that China remains an emerging economy.
Fighting tough battles
The economic policies that China pursued prior to the reform era clearly struggled to overcome the laws of economics, but the considerable corrections to these policies subsequently allowed the country to reap the rewards of rapid development.
If we start counting from the first Opium War, China’s modernization process is less than 200 years old. During this period, we have traveled a very tortuous road, with many ups and downs.
In recent history, although China was penniless in the early days of the reform era, policymakers have generally pursued sound economic policies, allowing private enterprise to develop domestically, but rather opening to the international markets and actively integrating China’s economy into the global supply chain.
With this combination of policies, Chinese manufacturing began to expand, the Chinese economy grew rapidly, and hundreds of millions of people were lifted out of poverty. In a sense, China’s modernization has made it halfway down the road, but the road ahead is not a good one, or at least not as good as the first half.
The Chinese economy is now facing a series of headaches, at least in the short term. Perhaps we will have a weak economy or even a recession of some sort in the future, and are we ready to meet these challenges?
No economy is free of structural problems, and the emergence of crises is the norm, not the exception, and in this regard a look at the United States will provide a clear example.
Since the 1980s, the United States has seen the Savings and Loan Association crisis, then the collapse of the high-tech stock bubble, then the financial crisis of 2008, and that doesn’t even include the Great Depression of the 1930s.
Despite facing large economic crises every now and then, the constant adjustment of the relationship between the market and the government has made the United States economy generally thrive and move forward, eventually becoming the largest economy in the world.
This trajectory is true of most developed countries, and emerging market countries are also in line for similar development paths, one such example was South Korea’s financial crisis in 1998. There were many reasons for the crisis, but it all boiled down to the hijacking of public policies and the plundering of public resources by domestic vested interests, which were mainly plutocrats.
For many years, the financial system of South Korea had been suffering under the haphazard influence of the chaebols—large family-owned business conglomerates—and the situation finally became untenable in 1997.
In 1998, Korea experienced a full-blown financial crisis, which dealt a heavy blow to the Korean economy, contracting at a rate of -5.8% that year. The number of poor people increased from 6 million to 10 million, suicide and divorce rates skyrocketed by almost 50%, drug addiction increased by 35% and the crime rate exceeded 15%.
However, the Korean government and people did not back down in the face of the crisis. They rallied and carried out a series of reforms, restructuring and injecting capital into the financial system, dispelling the myth that chaebols are “too big to fail,” and so on.
These efforts quickly yielded results, so despite the severe short-term economic pains felt in the country, it continued to grow soon afterward, and the country’s economic and financial systems became healthier and more sustainable.
According to the World Bank, in constant 2015 dollars, South Korea’s GDP per capita was $15,072 in 1997, fell to $14,196 in 1998, but quickly rebounded to $15,712 in 1999, and in 2022 South Korea’s indicator had risen to $33,645, reaching a point where it is on par with Japan.
The example of South Korea tells us that such a crisis is not scary; it is the fear of facing up to the crisis and the determination to deal with the crisis that can be the most frightening.
I often point out the problems in China’s economy, but I also have great confidence in its long-term development.
Although we are facing a series of difficult problems in the short-term, as long as we face the reality, push forward with the reform and opening up process, and fight hard battles and gnaw on hard bones, no economic crisis can stop China’s economy from realizing its potential for development, and there is certainly still plenty of potential there.
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