A Transformative Strategy is needed to Turn Around China's Ailing Economy and Mitigate its Fallout on the Global Economy.
China's $18 trillion economy is decelerating. In July 2024, Chinese official data revealed that GDP growth was falling behind the government’s target of about 5%.
This bleak picture can be explained by a number of factors. These include China's sustained real estate crisis, its rapidly aging population, the tightening grip of Chinese leader Xi Jinping on the economy and his extreme response to the pandemic. Yet the current stagnation reflects a decades-long economic strategy, deeply rooted in the Communist Party's tradition of economic planning, which favors industrial production and infrastructure development at the expense of household consumption needs.
The interconnectedness of the world's economies means that the health of China's economy has major implications for Western countries in terms of geopolitical stability and trade relations, market potential and investment opportunities, as well as environmental and health initiatives.
China’s economic troubles briefly explained
China is suffering from a fundamental imbalance in its economy: It has relied disproportionately on government spending and commercial investment to fuel its economic development, rather than consumer spending, which is the engine of sustainable economic growth in most developed countries. For example, in China, consumer spending accounted for just 53% of GDP in 2022, while in the US, it represented around 68% of GDP.
In the wake of the 2008 financial crisis, local governments invested heavily in domestic infrastructure and real estate development, betting on property prices continuing to rise. Today, real estate accounts for around 25% of China's GDP. However, the country has been unable to maintain this pace of expansion, with per capita income remaining low compared to other advanced economies. Major property developers such as Evergrande have gone bankrupt. Ghost cities now sit abandoned all over the country.
By the end of 2023, China’s accumulated debt had grown to nearly three times its economic output, reaching a record level. Some economists have likened China’s current economic situation to Japan’s “lost decade” of the 1990s, a period of deflation and economic stagnation due in part to excessive debt.
Economists argue that boosting domestic consumption is the best way for China to emerge from its current economic slump. This will require income redistribution in favor of poor and middle-income households, to give them more disposable income to spend - in part by reducing the factors that drive them to save the bulk of their income.
The elephant in the room is a huge sense of insecurity and loss of confidence among consumers. The tremendous stress caused by the lack of social benefits and state pensions, coupled with exorbitant housing (falling property prices), education and healthcare costs, is accentuating the savings mentality.
If China is to put its growth on a more sustainable footing, it must empower its consumers. Therefore, strengthening the social safety net could improve consumer confidence and, thus, spending.
What’s in China’s new economic plan? Boost domestic spending
On March 4, 2024, the Chinese authorities announced a 1 trillion yuan ($142 billion) fiscal stimulus package for essentiel consumer goods and construction projects. The aim is to boost consumption by addressing the country's demographic challenges, including policies urging people to have more children, as China's aging population presents a structural risk to the nation’s long-term economic prospects.
The plan also includes measures to lift restrictions on foreign investments in manufacturing and a renewed commitment to competing globally in technologies such as quantum computing, big data and AI.
But while Li promised to “push ahead with transforming the growth model,” his speech was short on specifics about planned changes and time frames. His lack of conviction, despite a growing crisis, reflects Chinese President Xi Jinping’s reluctance to undertake radical structural reforms to the nation’s economy. Yet this is what many economists believe is necessary if China is to adopt a model of sustainable economic growth.
How can western countries mitigate the fallout of a weakening China?
The slowdown of China's economy may undercut Xi's ideological assault on the world order.
Industry after industry, China's chronic policy-driven approach of turbocharging its manufacturing and innovation sectors to the point of overcapacity is creating complex dilemmas that exacerbate trade tensions with the US and the West.
It means that China is hampering innovation and competition in the global marketplace, threatening jobs and restricting the ability of Western countries to build supply chain resilience. For example, European manufacturers of electric vehicles are already facing fierce competition from cheap Chinese imports. Manufacturing plants in this and other emerging technologies in the West are at risk of closing or, worse, never being built at all.
For the West, the problems of China's overcapacity represent a long-term challenge that cannot be resolved simply by erecting new trade barriers.
Rather than seeking to encourage China's aspirations for “self-sufficiency”, particularly in such areas as artificial intelligence and semiconductors, the West should ensure that it keeps China firmly within the global trading system. So long as China is closely linked to the US and Europe by the trade in high-value goods that are not easily substitutable, then the West will be much more effective in dissuading the country from taking destabilizing action.
In the absence of such a strategy, China will be progressively less constrained by international economic ties, and willing to redouble its efforts in its state production strategy, albeit at the risk of damaging the global economy and its own prosperity.
Western countries have a vested interest in discouraging Beijing from erecting a sanctions-proof wall against the Chinese economy. To this end, they should foster alliances, restore damaged multilateral institutions and create new structures of interdependence that make isolation and self-sufficiency not only unattractive to China, but impossible to achieve. A good starting point would be to craft more policies at the negotiating table, rather than simply imposing tariffs.
Final thoughts
The Chinese economy is by no means beyond repair, but the road to recovery will be both costly and painful.
Geopolitical and trade tensions with the US and Europe are threatening China's sustainable growth strategy, which is focused on turbocharging its manufacturing and innovation sectors to the point of overcapacity. Clearly, the Chinese economy needs to strike a new balance between domestic investments and consumption to sustain a growth rate that is acceptable to the country's leaders.
As a result, the challenge for China will be to find alternative sources of sustainable growth, particularly by boosting consumer spending in its gigantic domestic market. The potential for massive new revenue streams also has the advantage of mitigating China's expansionist instincts, such as its conquest of Taiwan, by removing the need to seize foreign economic resources or markets to remedy its ailing economy.
China's economic difficulties suggest that authoritarian regimes cannot simultaneously increase their control and promote economic progress - and that, ultimately, political reform must accompany economic reform.
