The economic slowdown in China: a cause for concern?

In the last decades China has been a powerful drive engine of global economic growth. The dynamism of its GDP, though, seems to be losing force. This is a cause of concern for international organizations, policymakers and analysts. The impact of China on the rest of the world is well known: China is expected to provide almost 35% of global growth in 2023, according to the International Monetary Fund (IMF).

China’s deceleration has important implications for the world economy. It may cause potential disruptions in production in other parts of the world, as the container crisis in 2021 showed. Many countries are closely tied to China’s manufacturing sector through global supply chains. A slowdown in China’s growth can interrupt these chains, impacting industries worldwide. Moreover, China is a major consumer of commodities such as oil, iron and copper. A slower Chinese economy can lead to lower demand for these resources, affecting commodity-exporting nations. And given the size of the Asian country and the high level of leverage of some of the Chinese sectors, financial instability in China may amplify and generate disturbing effects worldwide.

The China economic miracle

After almost three decades of comunism under Mao Tse Tung, in 1978 Deng Xiaoping started to implement economic reforms to liberalize markets and open the country to foreign investment. His approach, a combination of socialism with free enterprise, was called socialism with Chinese characteristics. Thus China evolved from a largely agrarian to a manufacturing and export-driven economy. Economic growth reached very high figures, averaging 9% in 1990-2022 (Figure 1) and allowing China to become the second largest economy of the world in 2010.

Economic growth was grounded on high rates of investment which enabled the country to become the world factory, providing low-cost manufacturing and exports to the rest of the world.

Figure 1. Real GDP growth, China, 1990-2022 (%)

Source: World Bank

Economic growth has remarkably improved the living conditions of the Chinese population. According to the World Bank, between 1990 and 2022 per capita income in China increased by a factor of 22, from 981 to 21.476 dollars (in purchasing parity power). Around 800 millions of people were lifted out of poverty. The provision of health and education in the country, together with the middle class, also developed over time.

The deceleration

While China’s economic growth rate remains impressive in comparison to many Western economies, it started to slowdown over the last decade. The reasons for this performance are several.

First, part of the deceleration is associated to the revival of protectionism which started to pervade the world economy in recent years. The change in the approach of US to their trade relationships with China is one manifestation of this phenomenon. The consequences of this trend for the Chinese economy may have been enlarged by increasing competition from other emerging economies with low labor costs (Indonesia, Philippines, Vietnam).

Another factor, more controversial, may be linked to the path of development in itself. According to some hypotheses, an important cause of the deceleration of the Chinese economy is the unavoidable process of structural change. Supporters of this view claim that China has reached a stage of development where the country is transitioning from an export-driven economy to another more reliant on domestic consumption. This shift in economic structure leads to slower growth as the export sector, once a major growth driver, reduces its participation in economic activity. China’s economic deceleration, thus, would be nothing else than a natural consequence of its evolution to a more mature and domestically focused economy.

This argument, however, is not compelling enough since it is founded on a demand-based view of economic development, at odds with the new growth models of the late years of the 20th century and the beginning of 21th. According to the New Growth Theory, economic growth is associated to the improvement of the production side of the economy, by channels like access to new and more advanced technology, larger levels of human capital, a more efficient allocation of resources or a more stable and effective institutional setting. Hence changes in aggregate demand may impact economic activity in the short run, but they do not alter long run growth.

The Chinese policymakers, therefore, should not give in to the reduction in the rate of growth of the economy, attributing it to the evolution through the normal stages of development. Although some kind of decreasing returns may have showed up in the Chinese economy, authorities should try to carry out the necessary reforms to expand the production capacity of the economy and the productivity of factors. Recent studies of the International Monetary Fund and the World Bank alert about the decrease in the productivity growth of the Chinese economy and the need to carry out structural reforms, supporting this second view.

The necessary reforms ahead

Reforms should come about particularly in three main areas, which are closely interconnected: innovation, human capital and the institutional setting.

First, it is crucial that the Chinese economy favours and promotes innovation to a greater degree. This would enable the elaboration of higher added-value, technology-intensive goods and to compete in quality and not only in costs. This has been, precisely, the route followed by nearby countries like Japan, Korea, Taiwan or Singapur, which produce and sell semiconductors or electronics. Taiwan, for example, benefits from its 60% share of the world’s semiconductors industry; the figure is close to 90% for the most sophisticated chips.

As both History and Economic Theory have shown us, innovation requires an adequate protection of intellectual property in order to flourish. Otherwise there are no incentives for researchers to devote time and money to the pursuit of new products and techniques. And this is something that is not enough warranted in China so far.

Traditionally, China producers have been considered rather adept in the imitatation of goods invented elsewhere. There are historical reasons for this perception. During the communist regime, inventions and the rights to exploit them belonged to the State. The first modern patent law entered into force in China in 1985, and underwent several reforms ever since. The first court specialized in intellectual property was setup in 2014. The enforcement of property rights in China is hence a relatively recent matter. Although legislators have devised Chinese patent regulations drawing inspiration from the US or Europe, the system is still slow and convoluted.

Investment in human capital is also key, especially in a context of ageing population. Many Chinese graduating in universities in the West are reluctant to come back to their country of origin because working conditions are not attractive enough. This trend should be overhauled: to enhance R&D activities and innovation it is important to ensure an adequate climate for talent attraction and retention.

    Furthermore, it has been detected that many in the younger generations are disillusioned and do not expect to progress enough to buy a house or start a family; therefore, they lack motivation and incentives to accept jobs requiring long hours or harsh conditions.

    At the beginning of the economic reforms the scenario was more promising and committed students could eventually find a white-collar job and join the nascent middle class. Now, however, jobs are less abundant while real estate prices have soared. It is more difficult to move up socially and economically. Youngsters respond to these challenges losing vitality and hope; an increasing number of them choose to work in the public sector to ensure stability, as opposed to the more risky jobs in firms or entrepreneurial projects. In parallel, youth unemployment is rising.

    The situation is even more unfortunate since hard-working and entrepreneurship are features deeply embedded in the character of the Chinese population. Since ancient times, Chinese inmigrants flew to many points of Asia, America and Europe. They often started started off with modest trade activities or businesses, which evolved creating prosperous and industrious communities. The testimony of the abundant and quaint shop houses scattered throught South East Asia, from Malacca to Vietnam, illustrates these performances.

    The government does not seem to empathize with the moods of the younger Chinese generations. Authorities recommend them to focus in and be driven by collective goals (instead of by individual aspirations). The motivating capacity of these messages, though, is dubious at best; people need not only high aims but also concrete, feasible incentives to involve in demanding and risky projects.

    Third, reforms are also needed to improve the institutional environment where firms and citizens operate. The Chinese economy has advanced more quickly than the surrounding institutional framework. Now the country would benefit from a clearer, fairer and more stable business environment.

    In recent years authorities have displayed hostility towards entrepreneurs, in particular those in technological activities. In 2018 a campaign to fight corruption was launched. Legal experts say, though, that campaigns ultimately sought to restrain (and even to imprison) those entrepreneurs who might have acquired too much wealth or influence independently from the party.

    These measures, moreover, damage still further the perspectives and opportunities of the younger generations. Some of these entrepreneurs were inspiring models and provided jobs for the youth.

    In conclusion…

    The growth of the Chinese economy, while slowing compared to the double-digit rates of the early 2000s, is still robust by global standards.

    The slowdown in growth should not be regarded as an unavoidable consequence of the development process. It can be handled through the implementation of a new set of reforms intended to enhance R&D, attract and motivate human capital and improve the institutional investment in which the economy operates.

    Maintaining the momentum of growth is important not only for the Chinese population but also for other countries closely related to China by means of trade and financial flows, ultimately most of the countries in the world. This is why the performance of the Chinese economy will be closely followed by policymakers, investors and academics in the next months.

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