What the brand new norm of slower Chinese language development might imply for the worldwide economic system

A view of high-rise buildings along Suzhou Creek is seen in Shanghai, China, 5 July 2023.

YingTang | OnlyPhoto | Getty Images

The Chinese economy could face an extended period of slower growth, a prospect that could have global ramifications after 45 years of rapid expansion and globalization.

The Chinese government is stepping up a range of measures to boost the economy. On Monday, leaders vowed to “timely adjust and streamline” policies for the struggling real estate sector while pushing stable employment towards a strategic goal. The Politburo also announced commitments to boost domestic consumer demand and eliminate local debt risks.

China’s gross domestic product grew 6.3% year-on-year in the second quarter, Beijing announced on Monday, beating market expectations for 7.3% growth after the world’s second-largest economy emerged from strict Covid-19 lockdown measures.

On a quarterly basis, economic output grew by 0.8%, slower than the quarterly increase of 2.2% recorded in the first three months of the year. Meanwhile, youth unemployment hit a record 21.3% in June. On a more positive note, industrial production growth accelerated to 4.4% in June from 3.5% yoy in May, well beating expectations.

China’s ruling Communist Party has set a growth target of 5% for 2023, which is lower than usual and remarkably modest for a country that has posted compound annual GDP growth of 9% since opening up its economy in 1978.

In recent weeks, authorities have unveiled a series of pledges aimed at targeting specific sectors or persuading private and foreign investors that a more favorable investment environment is on the horizon.

However, these were largely far-reaching measures that lacked some key details, and the recent announcement from the Politburo’s quarterly economic meeting struck a dovish tone but fell short of significant new announcements.

Julian Evans-Pritchard, head of China economics at Capital Economics, said in a statement Monday that the country’s leaders were “clearly concerned,” with the release describing economic development as “tortuous” and highlighting the “many challenges facing the economy.”

These include domestic demand, financial difficulties in key sectors such as real estate and a gloomy external environment. Evans-Pritchard pointed out that the latest news item mentions “risk” seven times, up from three in April, and that the leadership’s priority seems to be boosting domestic demand.

“All in all, the Politburo meeting struck a dovish tone and made it clear that the leadership believes more work needs to be done to get the recovery on track. This indicates that further political support will be provided in the coming months,” said Evans-Pritchard.

“But the lack of any major announcements or policy details suggests there is a lack of urgency or that policymakers are struggling to find appropriate measures to support growth. In any case, it’s not particularly reassuring for the short-term outlook.”

triple shock

According to Rory Green, head of China and Asia research at TS Lombard, the Chinese economy is still suffering from the “triple shock” of Covid-19 and ongoing lockdown measures, its ailing real estate sector and a series of regulatory changes linked to President Xi Jinping’s vision of “shared prosperity”.

With China less than a year away from reopening following the zero-Covid measures, much of the current weakness is still due to this cycle, Green suggested, but adding that without an appropriate policy response, these could solidify.

“There’s a possibility that if Beijing doesn’t step in, the cyclical part of the Covid cycle damage could be reconciled with some of the structural headwinds that China is facing — particularly in terms of real estate sector size, decoupling from the global economy, demographics — and propel China to a much, much slower growth rate,” he told CNBC on Friday.

TS Lombard’s baseline scenario sees the Chinese economy stabilizing in late 2023, but assumes that the economy will enter a longer-term structural downturn, albeit not yet a Japanese-style “stagflation” scenario, and that it is likely to achieve average annual GDP growth closer to 4% on the back of these structural headwinds.

Though the need to engage with China will still be crucial for international companies as China remains the world’s largest consumer market, Green said the slowdown could make the country “slightly less enticing” and accelerate “decoupling” from the West in terms of investment flows and manufacturing.

For the global economy, however, the slowdown in China is likely to have the most immediate impact on commodities and the industrial cycle, as China reshapes its economy to reduce its reliance on a real estate sector that has “absorbed and buoyed commodity prices”.

“Those days are over. China will still invest a lot, but there will be a kind of more advanced manufacturing, technical hardware, like electric vehicles, solar panels, robotics, semiconductors and such areas,” Green said.

“The real estate driver – and with it this pool of iron ore from Brazil and/or Australia and machinery from Germany or equipment from around the world – is gone, and China will be a much less important factor in the global industrial cycle.”

second-order effects

The rebalancing of the economy away from ownership and toward more advanced manufacturing is evident in China’s massive push toward electric vehicles, which saw the country overtake Japan as the world’s largest auto exporter earlier this year.

“This shift from a complementary economy, where Beijing and Berlin somehow benefit from each other, to a competitive economy is another big consequence of the structural slowdown,” Green said.

He pointed out that beyond the immediate loss of demand for commodities, China’s response to the changing economic landscape will also have “second-order effects” on the global economy.

“China still makes a lot of things and they can’t consume everything at home. A lot of the things they make now are of a much higher quality and will continue to be, especially as less money goes into real estate and trillions of renminbi go into these advanced technology sectors,” Green said.

“So the second-order effect is not just less demand for iron ore, but also much more global competition in a range of advanced manufactured goods.”

While it’s not yet clear how Chinese households, the private sector and state-owned enterprises will manage the transition from a real estate- and investment-centric model to an advanced manufacturing model, Green said the country is at a “crucial juncture.”

“The political economy is changing, partly by design, but also partly by the fact that the real estate sector is effectively dead or if not dying, so it has to change and a new development model is emerging,” he said.

“It’s not just going to be a slower version of the China we had before Covid. It will be a new version of the Chinese economy, which will also be slower, but it will be one with new drivers and new types of quirks.”