Professor Xu Bin is CEIBS’ Professor of Economics and Finance, and has dedicated much of his career to understanding the economic forces at play in China, as well as their bearing on the rest of the world. In his most recent address at the CEIBS Shanghai campus, the professor outlined his understanding of how China is likely to perform in the short, medium and long term, based on current macroeconomic conditions and the bold new direction that the Chinese Government has planned for the economy.

Everybody wants to know what will happen next to the Chinese economy. Not only is it the second largest in the world, it is also one of the most impactful globally. However, if the past two years have proven anything, it’s that the world is more changeable, more vulnerable to economic shocks, than at any point in its history. Even after the high point of globlisation came crashing down in 2008 with the international financial crisis, we still live in a highly interconnected global economy, one that has been battered even more severely by a new crisis – the global COVID-19 pandemic.

However, those familiar with macroeconomics will know that economic shocks, both negative and positive, do not change the long-run economic overview of any given country. While truly substantial in scale and scope, the negative shock of the pandemic will in time fade in importance regarding China’s economic outlook, and that of the wider world.

But what is the current, short-run impact of the pandemic? What is the government’s response to it? Most importantly of all, what will lead on from it? As we assess the medium and long-run implications of China’s current economic conditions and planned government policies?

From short to long-run – What comes next for China’s Economy

While each of these elements necessitates further exploration, we can broadly define the short-run, medium-run and long-run outlooks of China’s economy as follows.

Short-run (Next 1-2 years) – Stabilising: The Chinese Government has seen the rapid growth slowdown brought on by the pandemic and various policy decisions, and will attempt to stabilise this decline.

Medium-run (Next 5-10 years) – Transition: The Government has outlined the necessity for making the difficult transition from the ‘old model’ of Chinese growth – based on quantity of production and high exports – to a new model driven by quality of production, efficiency, and domestic consumption. This is a daunting task.

Long-run (Towards 2035) – People and policy: China must address the inherent economic challenges in its demographics, particularly its slowing birth rate and ageing population. Government policies and societal responses to these issues will be key in determining China’s long-term economic health.

The Short-run: China’s Economy loses steam, but this is the ‘New Normal’

For the past 15 years, China’s economy has grown much more quickly than the rest of the world. Even so, it has been experiencing a significant reduction in overall economic growth during this period. This is what the government calls the ‘New Normal’.

In this instance, the term reflects China’s transition from focusing on speed of growth to quality of growth. This is consistent with the longer-term view that China’s economic transition will be difficult but will ultimately fuel further growth in a more sustainable and reliable manner. This is a positive interpretation of the data. But, behind this downward slope is the difficult reality that China’s economy is indeed ‘losing steam’. It is losing its labour power base – a key ingredient to its past successes – as the population ages and is paid more for its labour. It is also losing steam as efficiency increases, which were easier to capture before, are more difficult to achieve now.

This New Normal is the backdrop for China’s current economic conditions, but things have been undoubtedly skewed in the past two years by the pandemic. The sharp negative shock it has brought to the world was almost three times as impactive in 2020 as the global financial crash was in 2008 (-3.3% global growth in 2020 vs -1.3% in 2008).

However, even though China was first to be hit by the pandemic, it was also first to recover. The chart shows how the growth losses of Q1 2020 were followed by a stabilising period and then a strong rebound in Q1 2021. So far, so predictable. But then followed an abnormality. In Q3 and Q4 of 2021, China was below its predicted growth trend at 4.9% and 4.0% growth respectively.

Why did this happen? And what are the implications for the short-run?

Pressure on three fronts – Stabilisation is required

On December 8-10, 2021, the government acknowledged that the Chinese economy is currently facing pressure on three fronts:

• Shrinking demand
• Negative supply shock
• Weakening expectation

This is a crucial realisation, as macroeconomics is all about the following three words – demand, supply, expectation.

Regarding demand, net exports were up in 2021, as the world recovery sped up and demand for China-produced goods soared, but demand shrank internally. China’s supply is also down, which is understandable, given that some production activities cannot be done during the pandemic.

However, shrinking demand and supply may largely be due to short-lived shocks. The most telling element in this equation is number 3, the weakening expectation. If the expectation is that lower consumption, supply, investment etc will continue beyond the current shock, then such a perception will quickly become reality, with both demand and supply sides adjusting their ambitions downwards in terms of everything from production rates, to consumption patterns, hopes for future living standards, and so on.

In this Central Economic Work Conference, the government explicitly addressed these points, acknowledged them as factors that must be addressed to ensure China’s long-term economic health. There is also the understanding that a raft of new and far-reaching government policies have collectively contributed to the falling economic growth rate. These policies include the reduction of after-school studying activities, cracking down on private sector monopolies, and policies related to the relieving of wealth inequality. These are all policies merit individually, but collectively they have produced lower expectations for future growth.

So, what is the government’s solution to the three problems? For 2022, its overall policy is to focus on ‘stablising’ the economy. If you look at the proposed measures, you will see many of the ‘old tricks’ that are brought out whenever the Chinese economy shows any signs of weakness or vulnerability. However, to stabilise the slowing growth rate, these short-term ‘old tricks’ of infrastructure investment, housing market adjustments and careful inclusion of private sector entities, etc, are both effective and necessary. They are designed to tamp down on the worst effects of current pandemic-related shocks, and restore both confidence and stable market conditions. They’re called ‘old tricks’ because they’ve been successful enough in past crises to merit their repeated use. This is an entirely appropriate response to current conditions, at least for the short-run.

The Medium-run: Dual transition is essential

The medium-run outlook for the Chinese economy will be dominated by the necessary transition from focusing on ‘speed of growth’ to ‘quality of growth’. While we’ve established that China has little to no choice but to rely on the old model growth drivers of investment and other ‘old tricks’, the medium-run should see the economy undergo a ‘dual transition’:

• On the demand side, it must move from relying on infrastructure investments and exports for growth, to a domestic consumption-driven model.
• On the supply side, it must move from quantity/resources driven to quality/efficiency-driven.

We’ve moved on from Deng Xiaoping’s time, where he had abundant cheap, young labour at his disposal (as described in the old model above). Today, the government wants to strike a balance between domestic consumption and export levels.

More specifically, since 2008 the financial crisis, subsequent deglobalisation, recently deteriorating international relations, and the pandemic – these combined factors have caused the Chinese Government to believe that it cannot rely on external circulation to meet its future growth ambitions. This realisation is the driver behind the ‘Dual Circulation Strategy’, with Xi Jinping citing the need for a development programme that “takes the domestic market as the mainstay, while letting internal and external markets boost each other.”

Can China generate enough domestic consumption to make dual circulation work?

This depends on whether the government, the private sector, and the average Chinese citizen can jointly achieve three key things:

1: Directly prompting more consumption

Put simply, Chinese people currently save too much and spend too little. You cannot take your income and then both save it and spend it. Advanced as we are as a species and global civilisation, no human has managed yet to ‘have their cake and eat it too’!

China’s gross domestic saving rate remains high. This was useful in the old growth model, as it meant that capital was abundant. However, this must go down if domestic consumption is to rise to the point where it satisfies the internal circulation part of the government’s dual circulation strategy.

2: Reduction of inequality

China has one of the highest income inequality rates in the world. This inequality level must fall – i.e.: China must become more equal in its distribution of wealth across all of society – if domestic consumption is to rise. Put simply, giving more money to rich people is unlikely to cause them to consume more than their current level. However, if poorer people receive more income, they are much more likely to put at least some of it into direct consumption.

3: Greater disposable income for Chinese citizens

China also has one of the lower-end rates of share of disposable income. In 2010-2019, the average Chinese citizen could expect to have just 42.6% of their whole income available to them. Compare this to South Korea (61.8%) or the United States (82.4%) and this represents a relatively low amount of ‘take home’ income, or money in your pocket. While this higher rate of income retention by the government has been essential in past decades for enacting its vast and ambitious infrastructural development plans, it may now be time to rebalance the scales and allow more money to end up in citizens’ pockets so they can spend more freely, hence bolstering domestic consumption.

If these three elements can be achieved through the coordination of public/private efforts and general societal trends, then rising domestic consumption should inevitably follow. This medium-run objective is critical for China’s long-run economic efforts, as we will see.

The Long-run: GDP trends will be determined by supply-side forces

The fundamental economic strength of a country comes from its “IQ” (its resource endowment) and “EQ” (how well you use the resources at your disposal).

In terms of IQ, as mentioned, China’s starkest long-run challenge is its worrying demographic trends (ageing population, lower birth rate, etc). Crucial to its economic future is what I call the “human vitality” factor. Clearly, China’s economic rise to become the second-largest in the world is attributable to many factors, but the vitality and productivity of the Chinese people is a central facet, one that cannot be ignored today.

Today, the concept of tang ping ‘lying flat’ – i.e.: not overworking and being content with more attainable achievements – is taking on great importance. Those practicing tang ping are losing interest in being vital and striving to achieve all that they can. This is one example of a societal trend that directly translates into tangible economic consequences. Whether tang ping takes hold or not is a question of significant importance, as the future, like the past, is dependent on the vitality of Chinese people, especially the young.

As for EQ, better use of resources partly depends on technological trends. This is an area of strength for China, as the ongoing revolution in digital and AI tech is providing abundant opportunities for Chinese companies to innovate and pursue dynamic new business strategies. Young Chinese entrepreneurs and tech specialists are in the front seat when it comes to creating and leveraging these technologies.

What is less clear-cut, but equally crucial, is how the Chinese Government will improve its own effectiveness in the long term. Given the size, reach and importance of the government as an employer, how it uses technology to become more effective will have considerable bearing on the future health of the Chinese economy. Government communications have already stated its desire to “improve markets” and “enable more capable government”, and this may be achieved by building leaner, more responsive government infrastructure and operations through tech advances and proper talent management.

Equally, it is vital that the government sets the right policy direction for the future. Throughout Chinese history, recent and long past, we have seen the importance of successive government policies acting as ‘pushes’ towards either high or long growth equilibrium points. This will undoubtedly be the case in the coming decades, as the government continues to keep a firm hand on the direction of the economy.

Can the transition work? Will a New Chinese Economy be realised?

What does China’s economic future look like? The final slide above shows an optimistic prediction.

There is little we can do to influence the impact of short-term economic shocks. The government’s immediate action plan has been to stabilise the economy to ride out the pandemic, through the rebound and into the full recovery.

The medium-run, continuing for the next 5 years, could see the successful realisation of the government’s dual circulation strategy, where domestic consumption rises and the economy successfully transitions to the point where it no longer relies so heavily on exports to fuel growth.

This will then pave the way for a long-run success story where China becomes a genuine ‘high-income country’, where the economy is characterised by high equality and domestic activity, and driven by the energy of its internal markets – buoyed by domestic consumption, technology development, good governance and so on.  

This is an optimistic yet entirely feasible outcome. I leave more negative predictions to your own imagination!