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Can Xi Jinping resurrect the China growth story?

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Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

China’s malaise is only partly economic. It is becoming apparent that the context behind some of the impediments to growth is increasingly political and even psychological.

China is in trouble. With each passing month, economic data coming out of the Asian superpower goes from bad to worse. 

The domestic impact of slowing growth is mounting as labour unrest spreads, youth unemployment surges and crashing property prices make families feel poorer. 

News last week that China officially fell into deflation, with consumer prices dropping 0.3% last month, has raised concerns that its economy will fall into a Japan-style downward economic spiral.

This comparison between China of today and the Japan of the 1990s is, however, misleading. 

As Paul Krugman argued in a recent note for The New York Times, the reality is that China will in all likelihood not be anywhere nearly as effective as Japan in being able to make the transition from developing to developed nation status and achieve the remarkably high per capita GDP figures that Japan enjoys today. 

Rather than being a cautionary tale, Japan is a kind of role model — an example of how to manage difficult demography while remaining prosperous and socially stable. 

It looks unlikely that China will be able to emulate this example. 

Faced with a myriad of economic and political contradictions, China will probably do much worse. As Michael Pettis has written, the growth model which it has pursued over the last three decades – artificially weak exchange rate, chronic current account surpluses, insanely high saving and investment rates, soaring debt and congruently low domestic consumption – is simply running out of road.

To appreciate why, it is worth revisiting where Japan and China have been similar. 

Countries that have followed the high-savings, investment-led growth model that China adopted in the 1990s – and Japan in the 1970s and 1980s – experience three distinct phases. 

The first, characterised by heavy investment in badly needed infrastructure, delivered years of rapid but unbalanced growth. Debt grows in line with the economy because, with such high returns from investment, GDP expands faster than debt.

Second, as an economy seeks to rebalance away from the infrastructure and export-led model, it resorts to a burgeoning non-productive debt-fuelled property sector. China today is clearly in the second stage. Between 1980 and 2010, China’s GDP rose four times, but debt levels were low and rose slowly. However, between 2010 and 2020, when GDP doubled again, it tripled its debt burden to officially stand at over $43tn, or 280% of GDP. With the economy now stagnating, it stands at a terrifying 360% of GDP.

Finally, in the third stage, the country rebalances its economy towards more sophisticated manufacturing and services, thereby increasing its productivity. This way, the economy moves away from investment and towards consumption – and it is able to grow past the “middle-income trap” and become a fully fledged developed market. Only a handful of countries, notably Japan and South Korea, have successfully managed to achieve this.

Beset with a number of contradictions, China looks incapable of transitioning to this third stage of growth. 

It can in principle reduce its dependence on debt by shifting domestic demand from investment to consumption, as Beijing has long proposed. But that would require that the household income share of GDP rise from 50% to 70%, with wages rising commensurately. 

There is little evidence that the Communist Party is willing to entertain the institutional implications of the large wealth transfers from local governments and elites to households that this would entail. 

Sadly for China, it is therefore looking increasingly unlikely it will be able to escape the dreaded “middle-income trap”.

This brings us to the more fundamental contradiction at the heart of the Chinese development model – the politics. China’s malaise is only partly economic. 

It is becoming apparent that the context behind some of the impediments to growth is increasingly political and even psychological. Concerns around the political direction of the country are driving decisions around consumption and savings. Worries about geopolitics and job market insecurity are becoming pervasive. 

Many Chinese feel that belief in a better tomorrow is being undermined by Beijing’s preoccupation with national security. 

Speculation over whether and when China might seek to attack Taiwan — which it regards as its own territory — has become a feature of private conversations in large cities, with 2027 often cited as a likely date. 

One only has to look at the Russian quagmire in Ukraine and its devastating effects on the Russian economy to get a sense of the likely implications. 

It is therefore astonishing that some economists continue to promote the hackneyed, facile and distortionary policies used in China over the last three decades, arguing they should be adopted in South Africa. 

Devaluing exchange rates in an attempt to make an economy more competitive can only ever act as a temporary boost for exports while exacerbating the contradictions that result in more damaging and complicated side effects later on. 

Long-term economic growth and progress can only ever be the outcome of sustained increases in labour factor productivity within a stable and predictable social and political context. Anything else merely postpones the eventual reckoning. 

Until now, President Xi has shown little willingness or aptitude to manage the complex and unpredictable realities, particularly as they pertain to social issues. He may be forced into dealing with them sooner than he might like to admit. DM

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  • Steve Davidson says:

    Sorry Natale but I missed this when it came out on the 15th.

    But in reply to the article’s headline question “Can Xi Jinping resurrect the China growth story?” for me the answer has to be “no, not until the New Mao and his brainwashed commies are kicked out”. I’ve always felt terribly sad for both the Chinese and Russian peoples: whether ruled by royals, emperors, Bolsheviks, communists, or oligarchs and dictators, they’ve never had a chance, but at least the Chinese seemed to be getting one until the idiot in Peking came along and ruined it all.

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