Judging by the Davos World Economic Forum consensus, global economic policymakers are expecting China to soon provide major support to a flagging world economy now that it’s abandoned its zero-COVID policy. This newfound optimism is surprising — since major Chinese economic weaknesses are in plain sight.
President Xi Jinping’s zero-COVID policy locked down large parts of the economy, leading last year to China’s worst performance in nearly a half-century. Rather than the 6% type of rate to which we’d become accustomed, Chinese economic growth slowed to less than 3%, its slowest rate in decades. It was the last thing Chinese leadership needed amid rising social tensions and youth unemployment exceeding 20%.
Now that Xi has made a complete policy U-turn and abandoned all COVID controls, there is certainly reason to hope the economy will bounce back once COVID has run its course. But it’s wishful thinking to believe any bounceback will be strong or long-lived.
One reason to be fearful about China’s longer-run economic prospects is Xi’s complete grip on economic policy in a manner not experienced since the unfortunate days of Chairman Mao. It’s led to great uncertainty over the country’s economic direction, seen not only in Xi’s erratic COVID policy but also in his inconsistent stance toward China’s high-tech sector and to foreign investment. This is already resulting in a cooling of foreign investment and in foreign companies now making serious efforts to reduce their reliance on the Chinese supply chain.
An even more serious reason to worry China will not regain its earlier economic growth path any time soon is other countries’ poor economic experience in the aftermath of the bursting of their large credit and property market bubbles. It’s especially a concern in China today given the very size of its bubbles and its economy’s overdependence on its property sector.
Over the past decade, per the International Monetary Fund, Chinese private-sector credit grew by more than a staggering 100% of gross domestic product. That credit explosion exceeded those that preceded Japan’s economic “lost decade” in the 1990s and the bursting of the US housing and credit market bubble in 2006.
Meanwhile, according to Harvard’s Kenneth Rogoff, housing prices in relation to incomes in major Chinese cities became considerably higher than in London and New York, while the Chinese property sector accounted for almost 30% of the economy. That is almost double the level seen in other major countries.
One sign the Chinese credit and property market bubble has burst is the fact that after rising rapidly, Chinese home prices have declined in each of the last 11 months. Another sign is the wave of Chinese property-developer debt defaults, including most notably that of Evergrande, the country’s largest developer.
Yet another reason to be doubtful about China’s longer-run growth prospects is its dreadful demographics. As a result of its earlier one-child policy, the Chinese labor force is already shrinking at the rate of around 0.5% a year and will continue to do so for as far as the eye can see. This is bound to be a major headwind to future economic growth as the country becomes old before it becomes rich.
All this has major implications for the US and world economies since China is the globe’s second-largest economy. It means no longer can we count on China to be the world’s engine of economic growth, and no longer can emerging-market countries count on China to provide support to lofty international commodity prices.
On the positive side, it also means our earlier fears that the Chinese economy will soon surpass ours are likely misplaced. In much the same way that after fearing the Russian economic challenge in the 1960s and the Japanese economic challenge in the 1970s, we found the Russian and Japanese economies had clay feet, so too we will find the Chinese economy is but a paper tiger.
American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.