Do not write off China's economic recovery

SHANGHAI — The strong growth rebound that was widely expected to follow the end of China’s zero-COVID policy has yet to materialise. This is both less surprising and easier to understand than many observers seem to think.

The end of COVID-19 lockdowns was supposed to unleash a powerful wave of pent-up demand. Instead, aggregate demand, which had been slowing before the pandemic, has returned to its previous trajectory. Though Chinese have been traveling, socialising, and dining out more, consumer-spending growth by households has been limited. Fixed-asset investment has not recovered.

With a few exceptions, such as the new-energy-vehicle (NEV) sector, economic activity has remained subdued. As a result, growth has been much weaker than expected. Though real GDP growth reached 4.5 per cent in the first quarter, it is expected to slow in the second. Core inflation is hovering around zero, and the producer price index is in negative territory.

But this situation likely reflects temporary circumstances. In particular, when the new government took over earlier this year, it did not immediately introduce a comprehensive policy package aimed at bolstering the post-pandemic recovery.

To be sure, in the second half of last year, China’s government did pursue some measures aimed at loosening the constraints on households and businesses. But the interventions did not go far enough, particularly regarding the real-estate sector, which constitutes about 40 per cent of China’s annual fixed-asset investment. Market expectations that housing prices are set to plummet have weighed on household balance sheets and deterred new home purchases.

Meanwhile, local governments are facing severe financial constraints, and the interest-bearing debt position of local-government financing platforms has deteriorated sharply, undermining infrastructure investment. While the financial constraints on the corporate sector are somewhat looser, lack of confidence is taking a toll on private investment. Add to this declining employment and wages, owing to the COVID-19 pandemic, and supportive policies are clearly needed.

Fortunately, a policy package aimed at supporting the economic recovery is most likely on its way. A recent briefing by China’s National Development and Reform Commission indicated that such a package would include interventions aimed at raising wages and supporting low-income households to boost consumption spending.

Funding curbs on property developers may also be loosened, in order to reinvigorate the real-estate sector. The People’s Bank of China already appears poised to cut lending rates further, in order to encourage borrowing. And the central government will most likely consider partial local-government-debt swaps, or request policy banks to offer long-term loans, in order to boost local governments’ spending power.

Of course, Chinese policymakers cannot circumvent all of the headwinds the economy faces. Global geopolitical shifts, especially China’s deteriorating relationship with the United States, will undoubtedly hamper China’s economic recovery in the short term. Yet it remains far from clear what the medium- or long-term effects will be. It is entirely possible that beyond the short-term shocks lie long-term opportunities for China, a country with a long track record of flourishing amid instability and crisis.

Already, China has responded to increasing uncertainty in its external environment by expanding and safeguarding its access to strategic resources, such as energy and critical minerals, whether by strengthening its partnerships with relevant countries or overcoming its dependence on foreign suppliers. China already dominates the rare earths market.

China’s strategic thinking and economic resilience are also reflected in the rapid recent growth in NEV exports. In the wake of the pandemic shock and the geopolitical crisis triggered by the Ukraine war, Chinese automakers saw opportunities to boost NEV exports to regions like Europe that were seeking to accelerate their green transitions.

The Chinese NEV industry’s record speaks for itself. China overtook South Korea in total automobile exports in 2021, and Germany last year. This year, China is expected to export four million units, a significant share of which will be NEVs, surpassing Japan to become the world’s largest car exporter. At the same time, to increase NEV adoption at home, the government will extend the purchase-tax exemption on NEVs for another four years.

This record suggests that US-led efforts to restrict microchip exports to China will have limited impact in the long term. They are more likely to spur China to reduce its dependence on technology supply chains involving the US and its partners, whether by shifting its trade relationships or innovating at home.

China’s de-centralised economic structure helps considerably. Flows of complex technology products are likely to be spread across dozens of cities and managed by thousands of firms, which can be state-owned enterprises, indigenous private firms, or foreign-owned companies.

When a sector begins to grow rapidly in China, investors and companies tend to flock to it, not least because of the supportive policies and subsidies that local governments are probably offering. This can accelerate the industry’s development considerably, even if it is an industry with technological thresholds that require huge investment (and large talent pools) to reach. For example, Tesla’s planned new Megapack (battery) factory in Shanghai will provide a further boost to China’s NEV sector, just as its “Gigafactory” has since 2019.

Of course, once the technological threshold is crossed, huge investments in newly thriving sectors can create challenges, not least excessive capital formation, and early-entry firms may be the ones that suffer the most. But as China’s photovoltaic industry showed, demand conditions can stabilise or improve, reinvigorating the sector. In other words, robust economic growth may still materialise, even if a macro boom is yet to come.

Zhang Jun, dean of the School of Economics at Fudan University, is director of the China Centre for Economic Studies, a Shanghai-based think tank. Copyright: Project Syndicate, 2023.

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