Policy Center for the New South
China’s economy grew 4.7 per cent year-on-year in the second quarter, after 5.3 per cent in the first quarter of the year (Figure 1). Like last year, the official target has been set up at 5% for 2024 (Figure 2).
Figure 1
Figure 2
Naturally, great attention has been dedicated to the decisions of the Third Plenum of the 20th CPC Party Congress on July 15-18, a four-day meeting in which the country’s leadership sets the direction of economic policy. The last such event was held in 2018. Have the conclusions of the Third Plenum pointed out to policy actions addressing China’s current economic growth challenges?
Four major challenges can be identified for China’s economic growth in the coming years. First, the exhaustion of the real estate sector as a growth factor, after having reached up to a quarter of the country’s GDP. The restrictions established in 2021 by the Chinese government on developers’ access to cheap credit, due to concerns about the proportions reached by the real estate bubble – see Figure 3 -, not only cut the boom, but also exposed the fragility of developers’ assets. Since then, there has been a sharp drop in home sales, new construction, and investment in the sector.
Figure 3 – Housing price to income ratio
In this regard, any comprehensive solution to the challenge must include creating a new source of housing demand. Migrant housing demand may constitute such a source, but that will require a reform of the Hukou system (delinking immigrants and their families from their place of origin and, thereby, giving them access to public health and education facilities in their place of work), as well as allowing collectively owned land to be used as collateral for mortgage loans.
The Third Plenum’s decisions refer to such Hukou and rural land reforms. Housing will likely remain a drag on growth in 2024, stabilizing gradually in 2025, but the proposed reforms indicate a political willingness to proceed with a comprehensive new housing strategy.
In addition to the level of debt of fragile real estate companies, the debt of local governments is another problem. Especially because its revenues from the sale of land to real estate developers have shrunk. The degree of exposure of Chinese banks to both, with possible consequences in terms of loan losses, could negatively affect the supply of credit in the economy.
The Third Plenum decision stresses the need of a fiscal policy reform, with the establishment of a fiscal structure under which revenues and expenditures of central and local governments are more precisely defined and better-aligned. The decision lacks details of stricter discipline of fiscal expenditure, including prevention of new increases in local government hidden debt. In the near term, it will be worth watching whether the government will roll out new measures to mitigate fiscal difficulties of local governments.
A problem with domestic demand by families represents a third challenge for growth. Chinese families took on heavy debt to buy real estate during the boom, and spending cuts accompanied the housing turbulence. Even though it increased after the end of “Covid zero” last year, consumption remains on a trajectory below that before the pandemic. Measures of consumer confidence point to this. Private investments for the domestic market, as well as hiring, accompanied this retraction of domestic consumers.
What about the external sector as a form of compensation for the weakness of domestic demand? A fourth challenge to growth lies in external resistance to such an increase in exports as an alternative do domestic demand, given that they now face the resistance that has followed the intensification of geopolitical rivalry abroad, especially in the USA and other advanced economies.
The Chinese lead in clean energy technology has, in fact, been accompanied by a strong expansion, for example, in sales of electric vehicles abroad. Chinese passenger car exports have surpassed Japan’s, while Chinese companies are seeking to strengthen investment positions abroad.
Chinese exports are showing no sign of slowing, despite facing new tariffs and extensions of trade restrictions abroad (Figure 4). But the risks of facing additional market access restrictions are high.
Figure 4
The Third Plenum showed no change in the leadership’s approach of stimulating the supply-side of the economy rather than the demand side and insulating the economy from external threats. Supporting consumption received very little attention. Idle capacity is high in many sectors, reflecting the excess investments relative to levels of demand.
To understand how these four challenges above intertwine, it is worth going back to the beginning of the last decade. In December 2011, when the writer was one of the vice-presidents of the World Bank, I was at a ceremony in Beijing in which then-president Hu Jintao made a major statement about the need for an inevitable “rebalancing” of the Chinese economy. There would have to be a gradual redirection towards a new growth pattern, no longer associated with investment rates close to 50% of GDP and with domestic consumption increasing in relation to investments and exports.
Also, President Hu Jintao said, an effort would be needed to consolidate local insertion in the highest rungs of the added-value ladder in global value chains, something that was effectively sought. Services should also increase their weight in GDP relative to manufacturing. There would no longer be the double-digit GDP growth rates of previous decades, but growth would no longer be, as then-premier Wen Jiabao had said in 2007, “unstable, unbalanced, uncoordinated and unsustainable”.
Given the low level of domestic consumption in GDP (a fact that is still present) and, therefore, the dependence on investments and trade balances, the transition would run the risk of experiencing an abrupt drop in the pace of growth. To allay fears of an abrupt slowdown, waves of credit-driven overinvestment in infrastructure and housing followed in later years. A second round was implemented in 2015–2017 in response to a housing slowdown and stock market decline. In addition, of course, to the expansion policies adopted during the pandemic crisis in 2020.
In effect, the decline in Chinese GDP growth rates occurred only gradually to 6% in 2019. Now, however, the lever of overinvestment in real estate and infrastructure has run out. Not only because of the debt levels that accompanied its extensive use, but also because, at the margin, its returns in terms of GDP growth started to yield a declining contribution.
Two reforms would have a strong effect on growth. First, reinforce social protection to convince Chinese people to save less. Furthermore, resume the proposal made by President Hu Jintao in 2011 to “rebalance” public and private companies, with a consequent gain in productivity due to the differences favorable to the latter shown where they operate together.
Such reforms do not seem to be on the frontline ahead and did not appear at the conclusions of the Third Plenum. A radical change in the mood of foreign investors since the third quarter of last year, as well as demographic dynamics, also constitute economic growth challenges.
However, even if China’s economic growth path remained steady in the first half of the year – with exports, manufacturing investment and travel-related consumer spending compensating for the drag from the property sector – rebalancing demand dependency from abroad to domestic consumers was a glaring absence at the Third Plenum.
Otaviano Canuto is a former vice president and a former executive director at the World Bank, a former executive director at the International Monetary Fund, and a former vice president at the Inter-American Development Bank. He is also a former deputy minister for international affairs at Brazil’s Ministry of Finance and a former professor of economics at the University of São Paulo and the University of Campinas, Brazil. Currently, he is a senior fellow at the Policy Center for the New South and a nonresident senior fellow at Brookings Institution.
