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Is the Chinese Economy Headed for Japan-Style Lost Decades?

China’s economic recovery coming out of the zero-COVID policies at the beginning of this year has stalled. The economy only grew at a seasonally adjusted rate of 0.8 per cent (quarter on quarter) in the second quarter, slower than many of the quarters when China was in COVID-induced lockdown.

The World Bank last week cut its forecast for Chinese economic growth in 2024 to 4.4 per cent, down from its earlier prediction of 4.8 per cent. That’s still a respectable growth rate for an economy the size of China’s, but will be the economy’s slowest growth rate since the 1960s.

The Chinese economy’s long COVID is due to weak consumption, production and investment, as well as strained balance sheets.

Structural and cyclical factors both now bedevil management of the Chinese economy. China’s population has peaked and is rapidly getting old. While much of the rest of the world is fighting inflation, China is experiencing deflation. The real estate sector — on the assessment of some — is facing collapse.

These similarities have drawn comparisons with the Japanese economy that saw two lost decades of stagnant growth and deflation after its real estate and asset bubble burst in the early 1990s. Japan appeared then to be closing in on the US economy, just as China is today.

But fears of a Japanification of the Chinese economy are misguided. For starters, almost any society would welcome Japanese-style economic ‘failure’ of prosperity, stability, resilience, longevity and a safe, clean and peaceful society. Living standards have stagnated and there are big challenges in Japan, but the comparisons with China are unhelpful.

The structural challenges and circumstances that face the two economies are different.

China is at a very different stage of development from Japan’s when its bubble burst. It still has substantial catch-up potential, where growth is easier than it is when the economy is at the technological frontier. Real per capita incomes in China relative to those in the United States have grown remarkably over the past 40 years, from 2 per cent in 1980 to 28 per cent in 2022. Japan’s is now 65 per cent.

There is still huge scope for growth and economic catch-up in China if policies are directed to facilitate the domestic reallocation of labour into more productive employment. While demographic policies that attempt to lift the birth rate will have no short term pay off, the retirement age in China is 55 and offers scope to bring experienced older workers into the workforce as the population ages rapidly. Though they’ll face the financial and social costs of supporting a large aged cohort, the productivity of the Chinese labour force will be supported by the fact that younger workers are significantly better educated than their forebears.

The centralisation of political power, history tells us, is at odds with an economy trying to reach high incomes. China is getting old before it gets rich. And geopolitical rivalry with the United States is elevating the security imperative over the economic imperative. And structural factors, combined with the cyclical weakness, present particular challenges for Chinese policymakers.

But China has policy space. The lack of government support to households and businesses during the COVID-19 years — one reason why there is little pent up Chinese consumer power and consumption demand isn’t fueling inflation — means emergency fiscal support could be rolled out.

‘Fiscal and monetary responses to China’s current woes have been modest, both during and after the worst phases of the COVID-19 pandemic’, says Yiping Huang in this week’s feature article. Policymakers have avoided the crude Keynesian response of the past.

The government ‘has announced new policies aimed to shore up confidence, and support private enterprise, foreign-invested firms and consumption’, according to Huang, including a 31-point plan released in July that ‘highlights the importance of the private sector and fair competition, eliminating barriers to entry, protecting property rights, and drawing private enterprises into national projects’.

Instead of demand-side responses and rolling out fiscal support, the government“`markdown
is focused on the supply-side — structural reform that aims to lift the capacity of the economy. The optimistic story is that relatively more pain now will deliver longer term gains though only time will tell whether those reforms are enough.

There are clear signs that the Chinese government is easing the regulatory crackdowns of recent years. ‘Some of these policies were implemented to address national security concerns’ says Huang, ‘while others were attempts to deal with legitimate regulatory problems, such as consumer protection and fair competition’. These policies severely dampened business confidence, especially among technology companies and foreign-invested firms. It will take time to rebuild that confidence if security issues continue to dominate economic issues in the government’s thinking.

Short-term risks remain but an economic crisis seems unlikely. Even in the real estate sector things aren’t as bad as they look. Property purchases in China require down payments of 60 to 90 per cent so the sector is not nearly as leveraged as was the real estate sector in the United States in the subprime crisis or in Japan in the late 1980s.

Huang says that the signs are that the Chinese economy bottomed out in July and August. The focus on supply-side reforms — that will help address structural challenges — with the demand-side fiscal and monetary options that are still available are positive.

The big structural questions for the Chinese economy that remain unanswered predate the pandemic. Whether the direction in which Chinese governance is headed is compatible with growing out of middle-income status, and whether there is a way, through negotiation of strategic competition with the United States, to reduce the worsening impacts of the elevation of national security priorities on US-China economic cooperation and the international economy will, as Huang says, be crucial to navigating the uncertainties ahead.

Source : East Asia Forum