The sharp slowdown in China’s growth in the past year is
prompting many experts to reconsider when China will surpass the U.S. as the
world’s largest economy—or even if it ever will.
Until recently, many economists assumed China’s gross
domestic product measured in U.S. dollars would surpass that of the U.S. by the
end of the decade, capping what many consider to be the most extraordinary
economic ascent ever.
But the outlook for China’s economy has darkened this year,
as Beijing-led policies—including its zero tolerance for Covid-19 and efforts
to rein in real-estate speculation—have sapped growth. As economists pare back
their forecasts for 2022, they have become more worried about China’s longer
term prospects, with unfavorable demographics and high debt levels potentially
weighing on any rebound.
As he embarks on a third term, Xi Jinping’s goal is to make China a mid-level developed country in the next decade, which implies that the economy will need to expand at a rate of around 5 per cent. But underlying trends — bad demographics, heavy debt and declining productivity growth — suggest the country’s overall growth potential is about half that rate.
The implications of China growing at 2.5 per cent have yet
to be fully digested anywhere, including Beijing. For one thing, assuming that
the US grows at 1.5 per cent, with similar rates of inflation and a stable
exchange rate, China would not overtake America as the world’s largest economy
until 2060, if ever.
Growth in the long term depends on more workers using more
capital, and using it more efficiently (productivity). China, with a shrinking
population and declining productivity growth, has been growing by injecting
more capital into the economy at an unsustainable rate.
China is now a middle-income country, a stage when many
economies naturally start to slow given the higher base. Its per capita income
is currently $12,500, one-fifth that of the US. There are 38 advanced
economies today, and all of them grew past the $12,500 income level in the
decades after the second world war — most quite gradually. Only 19 grew at 2.5
per cent or faster for the next 10 years, and did so with a boost from more
workers; on average the working age population grew at 1.2 per cent a year. Only
two (Lithuania and Latvia) had a shrinking workforce.
China is an outlier. It would be the first large
middle-income country to sustain 2.5 per cent gross domestic product growth
despite working-age population decline, which began in 2015. And in China this
decline is precipitous, on track to contract at an annual rate of nearly 0.5
per cent in the coming decades. Then there’s the debt. In the 19 countries that
sustained 2.5 per cent growth after reaching China’s current income level, debt
(including government, households and businesses) averaged 170 per cent of
GDP. None had debts nearly as high as China’s.
Before the 2008 crisis, China’s debts held steady at about
150 per cent of GDP; afterwards it began pumping out credit to boost
growth, and debts spiked to 220 per cent of GDP by 2015. Debt binges normally
lead to a sharp slowdown, and China’s economy did decelerate in the 2010s, but
only from 10 per cent to 6 per cent — less dramatically than past patterns
would predict.
Total debt is up to 275 per cent of GDP, and much of it
funded investment in the property bubble
China avoided a deeper slowdown thanks to a tech sector boom
and, more importantly, by issuing more debt. Total debt is up to 275 per cent
of GDP, and much of it funded investment in the property bubble, where all too
much of it went to waste.
Though capital — largely property investment — helped pump
up GDP growth, productivity growth fell by half to 0.7 per cent last decade.
The efficiency of capital collapsed. China now has to invest $8 to generate $1
of GDP growth, twice the level a decade ago, and the worst of any major
economy.
In this situation, 2.5 per cent growth will be an
achievement. Sustaining basic productivity growth of 0.7 per cent will barely
offset population decline. To hit 5 per cent GDP growth, China would need
capital growth rates near those of the 2010s. Most of that money went into
physical infrastructure: roads, bridges and housing. Given the scale of the
housing bust, it’s likely overall capital growth will fall back to about 2.5
per cent.
Of course, the consensus is that China can achieve whatever
target the government sets, but consensus forecasts have fallen short of
recognising the pace of China’s slowdown in recent years, including this one,
when growth is likely to fall below 3 per cent. Around 2010, many prominent
forecasters thought China’s economy was going to overtake the US’s in nominal
terms by 2020.
By 2014, some economists were claiming that China already
was the world’s largest economy in terms of purchasing power parity — a
construct based on theoretical currency values with no meaning in the real
world. These theoreticians argued that the yuan was grossly undervalued and
bound to appreciate against the dollar, revealing the dominance of China’s
economy.
Instead, the Chinese currency depreciated, and its economy
is still a third smaller than the US’s in nominal terms. If anything, 2.5 per
cent is an optimistic forecast that plays down the risks to growth, including
growing tensions between China and its major trade partners, growing government
interference in the most productive private sector — technology — and mounting
concerns about the debt load.
China at 2.5 per cent growth has major implications for its
ambitions as an economic, diplomatic and military superpower. A lesser China is
more likely than the world yet realises.