The Chinese economy navigated the ramifications of the pandemic impressively.
After recording a GDP contraction of 8.7% in Q1 2020, the economy is now not only back to its pre-COVID size but in Q2 2021 was 8.2% larger. In comparison, the US economy has only just regained its pandemic size (Figure 1).
China’s economic outperformance during the pandemic is largely attributed to its initial virus suppression strategy, which although highly disruptive, allowed its economy to re-open faster than most western counterparts, and its export sector to benefit from strong demand for personal protective equipment, electronics and work-from-home goods as the rest of the world grappled with further virus waves.
Risks have risen sharply in the short term
Yet, arguably China is now confronted with even larger risks, both short-term risks – especially within the property market – as well as deep-seated structural challenges which have come closer to the fore. The government’s financial de-leveraging campaign and efforts to tame property price speculation has pushed property developers to the brink. The potential collapse of Evergrande – China’s second largest property developer and the world’s largest indebted property company with liabilities of over $300bn– would invariably affect China’s economy. Deeply intertwined with the broader economy, the property market accounts for as much as one quarter of the Chinese economy, and with high home ownership rates, and as much as 75% of households’ wealth tied to the fate of the property market, a burst of the property market bubble could detract around 1.5% from China’s GDP. The risk is even more acute as consumption has lagged the economic recovery and households remain cautious, with the government’s zero-COVID strategy meaning that mobility restrictions are quickly re-imposed in the face of comparatively small virus outbreaks.
An additional risk stems from the government’s policy of “dual control” to reduce energy consumption and energy intensity as part of the wider decarbonisation agenda. In order to meet end-of-year targets energy-intensive industries, like steel and cement, have limited production, and local governments have rationed energy, resulting in power outages. While this risk is more directly within the government’s control, it is clear that the government is willing to compromise economic activity for longer-term strategic objectives.
Demographic challenges are even closer than thought
Looking further out to the horizon, the publication of the results of the census this year brought China’s demographic challenges into sharp focus. Why this matters is that population growth is one the key drivers of potential economic growth together with productivity growth, both of which are estimated to have declined significantly as the country ages and incomes converge to rich countries. The census showed that China’s population growth has slowed further over the past decade, and birth rates have been lower than anticipated, the corollary being that the population is likely to peak before 2025 – around seven years earlier than current UN medium fertility projections.
In a major policy shift, the government responded: the two-child policy was eased to a “three-child” policy. Social policies are rising higher on the priority list in line with the so-called “Common Prosperity” agenda which aims to narrow the country’s wealth gap. These include pledges to support families with the high cost of childrearing, but much more needs to be done including reducing out-of-pocket healthcare costs, expanding coverage of unemployment insurance and increasing the portability of pension benefits nationally. The OECD, in its “Going for Growth” 2021 publication, notes that the pandemic widened inequalities in China, including between inland vs coastal regions, poorer vs wealthier households, and private corporate vs state-owned enterprises. Reducing these divides will help make growth more inclusive and sustainable. These policy changes are welcome but also need to be carefully managed to ensure a smooth transition.
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