Macroeconomic & Geopolitical

China's Complicated Year in the Global Spotlight

January 2022 – 3 min read

For the global economy, the consequences of China’s current economic trajectory are much more difficult to tease out. A healthy top line this year is surely welcome, but the imbalances, the fragilities, and the headwinds will not disappear by themselves.

All eyes turn back to China next week for a period of even-closer-than-normal scrutiny that will stretch from the opening ceremony of the XXIV Olympic Winter Games to the closing session of this fall’s National Congress of the Chinese Communist Party. Geopolitical strategists will ponder the consequences of a more ambitious foreign policy; political scientists will try to measure evolving social pressures; and economists will focus single-mindedly on the country’s likely sustainable growth prospects.

After four decades of rocketing economic expansion that averaged 10% per year and lifted an amazing 800 million people out of poverty, Beijing must find a cruising altitude at which it can maintain a smooth flight. It’s not as easy as it sounds, and the transition carries consequences for the Chinese people, their neighbors, and global financial markets.

The complexity of the challenge—and the risks of the transition to more balanced growth—has been especially apparent since the pandemic hit. Economic policymakers responded zealously at first with generous spending and cheap credit, managing to be the only major economy to expand at all in 2020, with 2.3% growth. Strong momentum into last year delivered an amazing 8.1% overall, prompting stiff measures to rein in excess in the property sector. But when overstretched developers began missing interest payments in the fall and threatening a sector that represents a quarter of the economy, policy pivoted back to more social financing and lower rates.

Chinese authorities, in fact, have been attempting something far more ambitious than simply managing the speed of their economy. They recognize a deeper set of challenges that came with success. The World Bank hails China as an “upper-middle-income country,” but warns that it can no longer depend on resource-intensive manufacturing, low value-added exports, and inexpensive labor. Slowing productivity, falling returns on investment, and a shrinking labor force growth mean that top-line economic results are necessarily headed lower.

“The government has committed to ambitious reforms, including reducing inequality, limiting carbon emissions, and shifting the drivers of growth toward more domestic demand. But this requires a significant redesign and rebalance of their craft while it is in flight—and as it continues to lose speed.”

Perhaps the most vexing headwinds come from China’s aging workforce. These are turning even stiffer than expected, with recent census data showing that population growth last year fell to its lowest level since 1960. A three-child policy and a higher retirement age may help mitigate these trends, but demography is about as close to destiny as economics allows.

The government has committed to ambitious reforms, including reducing inequality, limiting carbon emissions, and shifting the drivers of growth toward more domestic demand. But this requires a significant redesign and rebalance of their craft while it is in flight—and as it continues to lose speed. Turbulent global crosswinds make it all the more uncomfortable.

While last year’s headline growth looked good, it hid the much more worrying deceleration from a whopping 18.3% in the first quarter to an anemic 4% in the fourth. Too much restructuring may not be a good idea when growth is flagging, financial markets look volatile, and a new contagious COVID variant is threatening to upend a zero-COVID policy. Observers guess the government will enshrine a growth target this year above 5%, even though some prominent forecasts are lower.

Speaking of his commitment to a policy of “common prosperity,” President Xi Jinping told the World Economic Forum last week that “first we will make the pie bigger and then divide it properly.” Meanwhile, strict measures to reduce carbon emissions contributed to a severe energy shortage last fall, leading the Central Economic Work Conference in December to ease some of those targets. A crackdown in the tech sector aimed at a range of policy goals has also fallen silent for now, given the chill it blew through financial markets.

For the Chinese people, measures to stabilize growth may seem like good news, but postponing essential reforms doesn’t make them any less essential. The contagion that spread from the property sector defaults are in themselves a warning of how urgently further rebalancing of the economy remains.

China’s regional trade partners may also welcome the continued focus on growth, for now. Australia, Malaysia, Korea, and Thailand are among those whose exports to China represent more than 5% of their own economies. But these are countries that will still inevitably need to adjust their export mix as their giant neighbor restructures. A rebalancing that boosts domestic consumption may even be good news, but it will require a nimble response.

For the global economy, the consequences of China’s current economic trajectory are much more difficult to tease out. A healthy top line this year is surely welcome, but the imbalances, the fragilities, and the headwinds will not disappear by themselves. China’s leaders will hardly abandon these efforts during months of intense international attention. But once the winter athletes and party officials are all safely back home, the economists will be watching even more intensely when the reforms kick off again in earnest.

Christopher Smart, PhD, CFA

Chief Global Strategist & Head of the Barings Investment Institute

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