China’s Flagging Economy

For most of the last decade, there has been a ubiquitous media narrative that it was just a matter of time before China’s economy surpassed the U.S. economy. However, in the last year, there has been a neck-snapping reversal in that narrative. Now, there is story after story highlighting the weakness of China’s economy and frequently making dire predictions about its future. But a cooling of the Chinese economy was always in the cards and while it faces serious challenges, it is still going to be the second-largest economy in the world for a long time.

In the 1980s, then-Premier Deng Xiaoping led far-reaching, market-based reforms of his country’s economy that resulted in phenomenal growth. Between 1980 and 2020, China averaged an unprecedented annual GDP growth of over 8%. During those four decades, China eliminated more extreme poverty than had ever been accomplished previously in the history of the world.

But China’s growth topped out in 2010 at just over 10% and began a slow but steady decline. By 2019, its growth had slowed to just under 6% for the first time since the early 1990s. Then came COVID and the Chinese government’s bizarre and ultimately disastrous response. Economic growth crashed to below 3% in 2020 and 2022. (In 2021, China’s economy grew by 8%, primarily fueled by the buying spree of Americans quarantined in their homes by COVID. But that boom proved to be short-lived.) While COVID was clearly an exogenous event, the slowdown in China’s economic growth was inevitable. COVID simply accelerated it.

As I discussed in an earlier post, China is in a demographic spiral from which there is no escape. This year, it joined a handful of countries whose population has already begun to decline. The basic economic formula for economic growth is the change in population plus the change in productivity. For China, the first of those addends will be a negative number in the future. Therefore, its growth will entirely depend on its ability to improve productivity.

However, productivity is highly correlated to a functioning market economy. For all the contemporary criticisms of capitalism, many of which have some merit, it is unquestionably an incredible engine for generating innovation and driving improvements in productivity.

But in the last several years, the government led by Xi Jinping has been pulling back from the market reforms originally instituted by Deng Xiaoping. In doing so, the government is undermining China’s growth.

It is hard to divine the motivation behind this pullback as the consequences seem plainly predictable. My guess is that the leadership has found that the burgeoning free market was prompting more social and political change than it found comfortable. As I discussed in another post, civil disorder is one of the great fears engrained in the Chinese psyche. China will continue to struggle with trying to find the right balance between allowing the market to drive productivity and the pace of social/political change, which will be a drag on its economy.

Frequently overlooked is the fact that despite China’s incredible economic growth over the last four decades, the average Chinese citizen is still very poor, at least by American standards. Last year, Chinese per capita GDP was just over $12,000. That is below the current federal poverty level in the U.S. and only 17% of U.S. per capita GDP (~$70,000).

This report from UNICEF estimates that 33% of the Chinese do not have access to a sanitary sewer system. That means that there are more people in China without a sanitary sewer than live in the U.S.

China only releases data on the average size of residences in urban areas, which is currently about 646 square feet. Data on rural residences is sketchy, but most of the commentary I was able to find suggested rural residences are probably even smaller and frequently communal. The average size of a residence in the U.S. is 2,164 square feet.

But as meager as the circumstances are for the average Chinese, they have immensely improved over the last few decades. As a result, there is now an expectation for continued improvement. Meeting that expectation is going to be an increasingly difficult challenge for whomever governs China in the future.

That pressure helps explain why the Chinese government is willing to trample on established international norms, like respect for intellectual property, in their manic attempt to improve economic growth. But in the long run, failing to respect those norms will also undermine China’s ability to grow its economy.

I recently read an article on a comparison of the Chinese and U.S. economies entitled, “Which Nation Will Prevail – China or the U.S.?” I think that is the wrong way to think about the economic relationship between the two countries. While there are definitely elements of competition, it is not a zero-sum game. Neither country must dominate the other to prosper. Indeed, the opposite is probably the case. This recent column by Bret Stephens does a great job of summing up the state of the Chinese economy, our relationship to it, and how we should manage that relationship.

I think it is clear that we have become too dependent on China for some of our supply chains. I am glad to see the efforts to re-shore some critical manufacturing like computer chips. And we need to continue to press China to observe international norms such as respecting intellectual property rights. But at the end of the day, China is not going anywhere, and neither is the U.S. The world’s two largest economies will have to find accommodations they can live with.

This article was originally published by RealClearPolitics and made available via RealClearWire.