What can China do to turn the tables around?

Discussions on what could be done by China to revitalize its post-Covid growth performance are at the center of the global policy debate – while the 5.2% GDP growth in 2023 was above the 5% target, the overall growth trajectory last year underperformed market’s expectations. With the world economy becoming so dependent on China’s performance over the course of the past several decades, the focus was on the priorities that China was to promulgate at the “Two Sessions” congress earlier this month. The markets were eagerly expecting an impressive scale of stimulus as well as measures to support consumption. The actual list of priorities appeared to be more nuanced, with longer term competitiveness set to be supported by a broader set of drivers of economic expansion.

It almost seemed that going into the beginning of March most observers wanted to see China prioritize consumption over export growth for fear of China’s over-capacity ravaging the manufacturing base in the US and Europe. This “over-capacity scare” is giving rise to new protectionist measures and these restrictions could well be taken to a whole different level in case Trump comes to power at the end of this year. So it is no wonder that China is re-directing its trade flows away from the increasingly protectionist developed world towards the Global South. In 2023 China posted record-high levels of trade turnover with its main BRICS partners, including increases in trade turnover with India and Brazil. The latter recorded growth in trade turnover with China of more than 30% YoY in January 2024. While China’s export growth exceeded 7% in January-February 2024, growth of exports into ASEAN surged by more than 9% compared to 1.6% for the EU[1].

According to China’s BRI portal, in 2024 China will be seeking to upgrade its FTA with ASEAN, which in turn could also result in new version of the Regional Comprehensive Economic Partnership (RCEP). China further “aims to complete the FTA negotiations with Honduras, and the negotiations involving the FTA upgrade with Peru this year. Advancements will be made in negotiations or upgrades of FTAs with the Gulf Cooperation Council”[2]. In a way, this may be seen as China’s version of friend-shoring in response to the headwinds experienced in the advanced economies, though this shift may also harbor several important benefits for China in the medium- to longer term:

  • More economic growth in the developing world that can increasingly absorb China’s exports compared to advanced economies
  • More scope to reduce import barriers via preferential agreements as import tariffs remain elevated in the majority of developing economies  
  • Lower geopolitical risks and greater latitude in building secure value-added chains

To increase the capacity in the developing world to absorb its exports China may well pursue a more emphatic re-direction of outward FDI capital flows towards the Global South. The reduction in FDI outflows away from the advanced economies may in part also compensate for the decline in FDI inflows that became pronounced in recent years. FDI flows into the developing economies are likely to be increasingly channeled towards sectors that are coming to the fore in the global competitive race, namely IT equipment, digital and green economy – resource allocations within China’s Belt and Road Initiative (BRI) could well be geared to a greater degree towards these sectors in the coming years.

Addressing structural imbalances will necessitate a range of measures in the property sector and the labour market. One track of action as rightly pointed out by the IMF, needs to involve “decisive steps to reduce the stock of unfinished housing and giving more space for market based corrections in the property sector could both accelerate the solution to the current property sector problems and lift up consumer and investor confidence”[3]. Elevated levels of youth unemployment call for more active measures for de-regulation and a boost to the competitiveness of the start-up sector (China lost ground in the 2023 ranking of start-ups)[4]. High debt levels at the corporate and regional levels will need to be countered via stronger spending discipline, with some of the more indebted regions already discarding some of the large-scale infrastructure projects.  

Looking at China’s growth equation, the economy will be increasingly pressed to garner a greater contribution from productivity as opposed to greater labour and capital inputs. This is due to the rising challenges faced by China on the demographics front (UN’s baseline projection is for China’s population to decline to 766.67 million by the end of this century – this is nearly a halving compared to current levels of around 1.4 billion) as well as the difficulties faced in piling more capital inputs after extensive periods of investment-led growth. It appears that China is aiming to re-balance its growth mix towards higher productivity growth that is to be secured in high-tech sectors such as AI and the digital economy. A more balanced growth mix would need to address the weaknesses in labour and capital inputs via a greater scope for migration and female labour force participation (according to the World Bank currently it is just above 60% compared to 72% for males), while also providing a greater role for capital markets in driving further investment growth.  

A balanced set of growth drivers that is less dependent on massive investments in priority sectors of economy may also attenuate the over-capacity concerns that are becoming so prevalent across the developed world. Going forward such sectoral investments will need to be considered by China with respect to levels of foreign demand in markets abroad. Indeed, there may need to be a broader evaluation and strategy for such investments, with regional/bilateral trade deals together with strategic outward FDI serving to expand the absorptive capacity in foreign markets.

While there are a number of notable headwinds to growth in China, such as demographics and lower FDI inflows, there are also important reserves that may serve to revitalize the GDP growth dynamics. Some of these reserves include potential catch-up plays such as further increases in migration and urbanization, catch-up growth of inward regions to the levels of affluence attained by the leading coastal regions, greater share of services and welfare in GDP / consumption of the population (services are at around 53-54% of GDP compared to nearly 80% for advanced economies). The latter factor is of particular importance as a stronger and well-funded social welfare system would raise the level of social protection, attenuate socio-economic imbalances and contribute to the sustainability of consumption and overall economic growth.    

Perhaps the most significant reserve wielded by China’s economy is the large pool of savings emanating from the high savings ratios of the past decades – IMF estimates suggests that in 2023 China accumulated 28% of global savings, a figure that is comparable to the 33% of GDP combined share for the US and the EU. This according to Martin Wolf from the FT “is quite extraordinary. It also has several implications. One is that if China were an open market economy, its capital markets would be the biggest in the world. Another is that how these savings are managed is likely to be the most important single determinant of global interest rates and the global balance of payments[5].” In other words, with the right regulatory framework these savings could be a key reserve for China’s capital markets as well as its efforts to further strengthen its presence in the innovative segments of the world economy.

Overall, China faces multiple dilemmas – between prioritizing consumption over investments and exports, between short-term exigencies and longer term goals, between providing more stimuli as demanded by the markets and placing the emphasis on structural adjustment. The choices that are currently made by China appear to be more balanced and broad-based in terms of the possible drivers of economic growth compared to the past, with productivity likely being the main factor that is to determine the success of China in yet again proving the naysayers wrong. The latter in turn will be decided to a major degree by the competition unfolding in the innovative sectors of the world economy, most notably in the AI race and the “green economy”. Thus far, the rising intensity of protectionist winds blowing from the West suggests that China has been prescient in its long-term planning of where the main competitive battles are to be waged.   

[1] https://think.ing.com/snaps/china-trade-data-showed-a-recovery-of-trade-to-start-2024/

[2] https://eng.yidaiyilu.gov.cn/p/07RKQKIL.html

[3] https://www.imf.org/en/News/Articles/2024/03/24/sp032424-md-cdf-remarks

[4] https://startupgenome.com/article/global-startup-ecosystem-ranking-2023-top-30-plus-runners-up

[5] https://www.ft.com/content/cc40794b-abbb-4677-8a2a-4b10b12b6ff5

Image by Peggy_Marco via Pixabay