China’s economy is undergoing a profound structural slowdown

The ongoing protests in China against the unnecessary covid policies of the government led by Xi Jinping have attracted international attention. A long sequence of closures in nearly three years of the pandemic has also disrupted economic activity in many important manufacturing areas in the country.

The International Monetary Fund expects China’s economy to grow by 3.2% this year, or 1.2 percentage points less than its peers in emerging markets in Asia. This inefficiency is in stark contrast to its story in recent decades, when China underwent a dramatic economic transformation that lifted hundreds of millions of its citizens out of extreme poverty. The implicit social contract between the Chinese people and the Communist Party was that the latter would bring about a rapid increase in living standards so that the people would accept a political system that gave them only a modicum of freedom.

That social contract may be weakening as China’s economy falters. It is not just a matter of temporary closure. China’s economy is in the midst of a broad structural slowdown due to trends in the three main sectors of economic growth—labour, capital and output. Chinese workers have begun to decline. Investment growth fueled by low bank credit has led to a misallocation of capital, particularly in the real estate sector. And productivity growth has slowed.

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Signs were evident in the years following the North Atlantic financial crisis. The Chinese government has tried to deal with the structural crisis through a combination of monetary, fiscal and credit expansion to better counter the cyclical slowdown. Reversing structural retardation requires more than stimulation.

The numbers tell the story better. China averaged an annual growth rate of 10.7% between 2002 and 2011. Of course, like many other countries, China’s slowdown this decade has also been affected by the covid shock of 2020. Most economic forecasters expect China to manage only 3.5-4% growth in the remaining decade. More importantly, China has been reporting low growth over the past decade despite maintaining a similar investment rate of around 45% of gross domestic product, a sure sign that capital efficiency is deteriorating.

China’s leadership has seen the need to move from the economic model that has been so successful until recently – from manufacturing to services, from international demand to domestic demand and from capital investment to consumer spending. The main cause of this change is the biggest of them all, from economic growth led by more inputs to economic growth led by productivity gains. This was generally done by Japan after 1975 and East Asian countries after 1998.

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One of the most important policy measures to restore China’s economic model was announced in 2015. The ‘Made in China’ program is a ten-year plan to promote ten industries that the government believes are important for the future: robotics, green mobility and energy, information technology, high-speed rail equipment, electrical equipment, aerospace engineering, new materials, agricultural technology, marine engineering and equipment. medical. These will be the building blocks of the fourth industrial revolution.

China’s current industrial policy is different from previous episodes of industrial policy in Asia – from the Nehruvian experiment in India to successful efforts in countries like South Korea. Previous business policy initiatives in this region of the world were aimed at rapid growth, so that businesses located in developed countries could be built quickly at home.

China has a different need. It strives to build new businesses—and standards—at the cutting edge of global technology. That has deep geopolitical implications, which is one of the reasons why the US and its allies are trying to put technology in China. There is very little information if the Made in China program is successful. However, a recent paper by Lee G. Branstetter of Carnegie Mellon University and Guangwei Li of Shanghai Tech University, using data taken from financial statements of listed companies, shows little evidence that firms receiving funding under the Made In China initiative have reported higher productivity. , increased research spending, patents or profits (‘Is “Made in China 2025” Working for China? Evidence from Listed Firms in China’, National Bureau of Economic Research, Working Paper 30676).

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The transition from an input-intensive economy to an output-intensive one is difficult, but also important for China. Its old economic model is now unable to deliver rapid growth. The Western alliance has learned from its past mistakes and is unlikely to give China access to the latest technology. Can China beat them in this game? It needs to move quickly in the innovation economy. The broader question is whether an authoritarian political system can encourage innovation at the global technological frontier. The question that was asked of the Soviet Union will now be asked of China. The political color of the protests across China is important to the future of China’s economy.

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