Is China's Economic Miracle (un)Exhausted?

Most analysts expect China's growth rate to decline sharply this year, and beyond. In practice, the PRC expects GDP growth above 6% – here is why

Many Western observers have been predicting a halt in China's economic growth since about 2012. Their logic is simple: Its economy has become too big to grow at the expense of Western export contracts. In addition, its labor force should dwindle at some point in the future, further undermining growth. 

In 2023, these unfulfilled predictions are louder and more frequent than ever. But Beijing is in no hurry to prove them right: Its GDP is growing faster there than last year. Why is this happening, and how long will China be able to keep its economic growth going? How will this affect its place in the world?

A gloomy picture 

If you open up The Economist in May and June of this year alone, you will find a number of articles with a very similar message: China's economy is in dire straits; its economic influence in the world has peaked and will decline rapidly. You can find the same line of thought in the American business press. But why?

They give several reasons. Current statistics show weak consumer demand in April and May 2023, which makes it questionable whether the Chinese economy could even grow beyond the first quarter of the year. In addition, producer prices in China are seriously falling. Unlike consumer prices, rising producer prices are always a good indicator of economic growth. Conversely, if they are falling, that indicates a crisis of demand.

Another factor is that the local construction industry and local government budgets are overwhelmed by debt and will not take on any new debts even though the Chinese financial authorities lowered the discount rate in June of this year. 

Many analysts look further into the future: China's population fell by 0.85 million last year, and its labor force is expected to shrink sharply in the future because China's birth rate has long fallen below the reproductive threshold (2.1 children per woman). Thus, future economic growth would be limited in any case. Production will not keep pace with demand, and the country will therefore face high inflation in the future – something reminiscent of the current situation in Britain, where the labor force is also shrinking.

A recent World Bank Group study suggests that China's GDP growth slowdown this year will become a future trend. From 2030, China's average economic growth rate will be 2% if no "comprehensive reforms" in terms of government regulation of private business are enacted, and only 4% if such reforms are successfully implemented.

The picture is truly grim. And not just for China: In terms of purchasing power parity, its economy has long been the first in the world and is now about 20% larger than that of the US Poor growth from the leading economic power will inevitably retard the development of most countries in the world.

One thing remains to be seen: How close is this picture to reality?

Prospects for the nearest future

A sober analysis shows no serious economic problems for China this year. Consumer demand in April and May appears weak only as compared to a very strong Q1 (+4.5% of GDP to Q1 2022). At that time, demand was torn by the PRC's exit from the COVID quarantine system. Clearly, the high wave was followed by a smaller wave. But that certainly does not mean that the wind has stopped blowing out at sea.

To get an idea of China's economic prospects for the year as a whole, we have to look not at the individual results of April and May, but at more inclusive indicators, the most universal being broad money, i.e. the money supply. 

According to the latest data, the money supply has been growing at a rate of 11.6% in recent months and 12.3% over the past year. Such rates have historically corresponded to about 8% GDP growth for the Chinese economy.

It is worth noting that China has already faced a situation like this, in 2009. Exports seriously declined, causing producer prices to fall as well. But because of the strong growth in money supply, domestic demand soared, causing China's GDP to grow by more than 9%.

Why hasn't such growth been seen in practice so far? The key reason is the great inertia of the truly huge Chinese economy. Robin Xing of Morgan Stanley points out that China's service sector now has 30 million fewer jobs than it would have had if not for the COVID pandemic – hence the unemployment rate of more than 20% among Chinese urban youth, previously unseen in this century.

It is clear enough, notes Xing, that this figure will mostly return to normal this year, which means consumption will also increase (the employed spend more) and growth will accelerate. It is impossible to restore such a large sphere instantly, so there is undeniably a second-quarter "sag," but this is clearly temporary.

The long-range view

The idea that China's economic growth will fall further – to 2% in the 2030s – is also rather dubious. References to China's declining birthrate seem to disregard the experience of the "other China" – Taiwan, which stopped reproducing itself demographically back in 1985, when its total fertility rate dropped below 2.1. So what happened to its growth?

Since 1985, Taiwan's GDP in constant prices has grown sixfold, which corresponds to an average growth rate of 4.9% a year – much higher than any Western nation over the same period. What's more, even the population has grown by more than 20% in those 38 years.

One might try to argue that Taiwan received a serious influx of migrants from Indonesia, Vietnam, and the Philippines. Obviously, "big China" with its 1.5 billion people is too big to expect migrants to compensate for the population decline. Well, let's assume so.

To cancel out the migration factor, let's consider only per capita GDP changes in Taiwan. It turns out that this also grew more than 4.5 times during the same period. 

In general, there is nothing unexpected here. Recall that Russia's GDP almost doubled in 2000-2008, despite the fact that its labor force did not grow appreciably. It is clear from this that in today's economy, limited population growth only negatively affects countries with a very high per capita development base, like Germany, France, or the United States. 

For states far from developed status – which of course now includes China and, until recently, Taiwan – GDP growth is possible without any growth in the labor force. And even when it declines too – simply through the rapid growth of labor productivity.

Why is the obvious so hard to grasp?

From what has been said above, one might get the feeling that we are parsing out the plain truth. It should not have to be explained in 2023 that technological progress can produce economic growth even with a dwindling population. This is an obvious fact that children are taught in school.

Equally surprising are the alarmist estimates for the Chinese economy in the second quarter of 2023. Did people really not know that it would take a long time for the service sector to recover from the COVID pandemic? Given that the process took more than a year in the US, who thought it could happen in a couple of months in China, and why? And is it not obvious that since this recovery will not be instantaneous, it is premature, to say the least, to draw conclusions about consumer activity in April and May?

Finally, the blindness to the Taiwanese example is striking. Taiwan has shown that a country populated by the Chinese can achieve a per capita GDP of up to USD 69,000 a year, i.e., to the level of the United States, relatively easily. Even if one expects the current demographic contraction in China to continue until 2100 – although it would be rash to predict that far in advance – it would still be strange to expect China's economic weight in world affairs to decline. When it reaches the per capita GDP of the US, it will certainly continue to hold the top spot in the world in terms of purchasing power GDP for a very long time to come.

The real mystery in the economic analysis of the Chinese question is not whether the Chinese economic miracle has run out of steam. There is no mystery here: China continues to grow faster than the West and the world economy as a whole. And it will set another record this year, with GDP growth of 6-8%. The true mystery is elsewhere: Why does the economic mainstream expect China's economic growth to "deflate" in the first place? That is an assumption that clearly contradicts the observed facts.

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