CHINA´S ECONOMY CANNOT EXPORT ITS PROBLEMS AWAY / PROJECT SYNDICATE

China’s Economy Cannot Export Its Problems Away

China continues to treat only the symptoms, rather than the underlying cause, of its economic malaise. It ought to be doing whatever it can to increase domestic consumption and reduce excessive savings; instead it is relying on export markets in a world that is quickly abandoning free trade.

Alicia García-Herrero, Alessio Terzi

TAIPEI/CAMBRIDGE – In less than a month, leaders from business, government, civil society, and international organizations will be heading to China for an annual meeting organized by the World Economic Forum. 

This year’s “Summer Davos” is expected to focus on the next frontiers for growth, and China’s economy is set to be in the spotlight. 

It is well known that the world’s second-largest economy is struggling to achieve the government’s desired level of growth as it confronts large capital outflows, a real-estate bubble, an incipient debt crisis, and other issues. 

Yet deciphering the exact state of the country’s economy is difficult. 

With access to official data decreasing fast, some analysts question the credibility of publicly reported GDP statistics.

Among several China-related topics expected to be discussed in Dalian, trade is likely to feature prominently, given its direct implications for the rest of the world. 

China’s export performance was exceptional through 2020 and 2021, when it had the excess capacity to produce for a world in lockdown. 

And in 2023, its reported trade surplus, at $823 billion, was more than double that of the pre-COVID era. 

(Although its exports actually fell somewhat since 2022, that was from a very high base).

Meanwhile, imports have remained subdued as China has substituted foreign goods for domestic production, especially manufacturing. 

Intuitively, this all sounds like a story of an economy with very strong foundations, making its recent sluggish macroeconomic performance look like a cyclical downturn. 

But the reality is quite different. 

A MORBID SYMPTOM

Exports are normally considered to be good for an emerging economy’s growth, because they represent external demand, which in turn supports economic convergence (faster per capita income growth relative to high-income economies). 

This has clearly held true for China in recent decades, and one finds similar patterns in other Asian economies. 

In fact, all episodes of “miracle growth” in emerging markets since the 1950s have been associated with a rapid expansion of exports.

But China’s large trade surplus is not a sign of renewed strength and upgraded industrial capacity. 

On the contrary, China’s huge share of global exports (including 21% of manufactured exports) stems directly from the government’s inability to increase domestic consumption by reducing the domestic savings rate, which remains excessive. 

If left unresolved, this problem will cripple China’s rise to high-income status.

For the past two decades or so, China relied on the real-estate sector to drive fixed-asset investments, and thus domestic demand. 

The recent boom in Chinese real estate reduced the very large current-account deficits that China had been maintaining for many years, especially following the 2008 financial crisis. 

Yet even then, domestic consumption remained low, hovering around 35% of GDP, roughly half the average in developed countries. 

Worse, the real-estate boom would soon become a bubble, owing to developers’ heavy reliance on debt and widespread overbuilding.

A combination of increasingly low marginal returns on investment and a regulatory crackdown on real-estate developers has now exposed China’s large macroeconomic imbalances. 

The re-emergence of a large current-account surplus is a clear sign of this, and the situation has gotten only worse with the shift from overreliance on real-estate investment to overreliance on manufacturing investment. 

It is worth emphasizing that this structural shift is only partly the result of a large industrial-policy push. 

Subsidies represent merely the tip of the iceberg, at roughly 2% of GDP. 

The origins of the manufacturing frenzy are found in the lack of better alternatives, given low investment returns in both real estate and infrastructure.

This renewed investment has created more capacity than China’s economy can absorb. 

Domestic consumption remains stubbornly low, and discretionary savings stubbornly high, because Chinese consumers are uncertain about the economic outlook. 

Bearish sentiment makes intuitive sense. 

Chinese consumers have endured draconian “zero-COVID” policies and watched regulators arbitrarily crack down on specific industries such as gaming and private education. 

They also will have felt the effects of growing deflationary pressures, particularly in real estate. 

If most of your household’s wealth is held in an apartment unit, a widespread decline in apartment values will make you feel poorer and less inclined to spend.

DUMPING AND DEGLOBALIZATION

The predictable consequences of large investments in manufacturing and subdued domestic demand are downward pressure on prices and overcapacity. 

Under these conditions, external demand is left to pick up the slack. 

China is not only exporting more manufactured goods overall; it is also shipping them everywhere it possibly can.

One of the main destinations is the European Union, which remains China’s largest export market, despite its economy being smaller than that of the United States. 

The trend is particularly striking for specific goods in which European companies previously had a competitive edge. 

For example, the Chinese carmaker BYD’s share of electric-vehicle sales in Europe grew from 0.4% in 2019 to 8% in 2023; and according to some estimates, Chinese imports could represent 25% of the European EV market in 2024. 

For batteries and solar panels, imports from China account, respectively, for 80% and 90% of the European market.

Globally, one finds widely diverging views on whether other economies are ready or even able to absorb China’s overcapacity. 

At one end of the spectrum, the US is increasingly resistant to importing manufactured goods – especially strategic products, such as green technologies – from China. 

Not only is the Biden administration barring Chinese products from its vast green subsidy program; it is also considering outright bans on national-security grounds, on top of tariff increases for EVs, batteries, semiconductors, solar cells, and other goods.

For its part, the EU has called for a “de-risking” strategy to reduce its reliance on imports from China, and it has opened several investigations into China’s use of subsidies, including for EVs, wind parks, solar firms, railway firms, medical devices, and tinplate steel. 

But as of now, European economies remain open for business, and on his recent diplomatic tour through France, Serbia, and Hungary, Chinese President Xi Jinping sought to ensure that this remains the case.

Most emerging economies also remain largely open to imports from China. 

But the mood may be starting to change in those countries, such as India and Turkey, that also aspire to become industrial powers and important geopolitical players.

While some governments complain that China’s trade practices are unfair under World Trade Organization rules, proving the charge is very difficult, because China’s industrial policy is not limited to outright subsidies. 

If anything, subsidies are merely the tip of the iceberg. 

On the supply side, subsidies are small and tend to be complemented by state-guided funds that inject capital into the companies and sectors deemed relevant for upgrading China’s industrial capacity under the national “Made in China 2025” plan. 

Moreover, additional forms of support – such as preferential tax arrangements and financial conditions – further cloud the picture, making it harder to determine exactly how significant subsidies are for Chinese competitiveness.

The scope and opacity of China’s industrial policies have invited knee-jerk protectionist responses from other governments – including those, like the EU, that have traditionally championed the rules-based multilateral trading system. 

Those advocating such measures point not only to the supply-side issues, but also to demand. 

China’s own imports of manufactured goods from the rest of the world – and especially from the EU – are shrinking as a result of its defensive trade barriers, national-content provisions, and policies to control market access in the name of national security.

A PROBLEM MADE IN CHINA

Through “Made in China 2025,” the recent “New Industrial Forces” initiative, and other programs, the Chinese leadership has taken great pains to upgrade China’s industrial capacity, climb the global value chain, and achieve greater economic self-sufficiency. 

But the overall result of this strategy has not been as positive as one might expect just by looking at the size of the current-account surplus.

In an environment of growing geopolitical tensions, depending so much on exports is a risky strategy. 

With great-power conflicts and rivalries increasingly trumping narrow economic considerations, China is giving other countries significant leverage over its economy. 

Moreover, while China has been one of the great beneficiaries of the rules-based international trading system, and of globalization more broadly, the world order appears to be undergoing a shift. 

Rules-based trade is less of a sacred cow, and economic and commercial dependencies are more readily weaponized. 

The irony, of course, is that China has been creating strategic dependencies for years, apparently failing to anticipate that the West might eventually do the same.

As China’s rivalry with the West has intensified, it has sought to increase its exports to the Global South, since those economies are seen as a safer place to accumulate large trade surpluses. 

Yet the mood in these countries is changing, too. 

For example, Brazil and India, clearly worried about being flooded with Chinese manufactured goods, are considering their own new trade safeguards.

Now that industrial policy has come back into favor, countries throughout the Global South are eager to take a page from China’s playbook. 

Why shouldn’t they protect their infant industries and try to emulate the manufacturing-led growth model that China deployed so successfully over the past four decades? 

As much as China wants to position itself as the leader of the Global South – or at least the leader of the new expanded BRICS (Brazil, Russia, India, China, South Africa, plus Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates) – it will have to tread carefully. 

New political tensions over trade and other issues are all but assured.

HEADING THE WRONG WAY

If Chinese leaders think that boosting exports of manufactured goods will mitigate the economy’s structural deceleration, they are in for a rude awakening. 

That strategy relies on a world that no longer exists – namely, one fully committed to unfettered free trade. 

The US already debarked from the free-trade train during Donald Trump’s presidency, and now many countries in the Global South are poised to do the same.

The Chinese regime continues to treat only the symptoms, rather than the underlying cause, of its economic malaise. 

It ought to be doing whatever it can to increase domestic consumption, but it is relying instead on foreign demand. 

That is an especially problematic strategy for a non-democratic regime that has long derived its legitimacy from hitting its GDP growth targets. 

By erecting trade barriers, foreign governments can undermine the political legitimacy of the Communist Party of China, and this prospect might make them particularly inclined to do so.

The question is whether China can still change course before the economy stalls out. 

Its small welfare state has been a chronic cause of precautionary saving, and with public debt having already reached 100% of GDP, the government no longer has the fiscal space it once did. 

Chinese policymakers will need to devise more innovative ways to support consumption and reduce the economy’s dependence on export markets. 

For now, they at least seem ready to do more to support domestic demand, both through fiscal and monetary policies, including with further issuance of local-government bonds.

To be sure, if the West turns trade with China into a weapon, China has built up many strategic dependencies through which it can retaliate. 

But the West has many tools of its own – not least its massive markets and purchasing power. 

The path ahead is narrow, and addressing the Chinese economy’s structural problems will require a variety of different policies and approaches. 

But further boosting exports is not one of them.

Alicia García-Herrero, a senior fellow at Bruegel, is Chief Economist for Asia Pacific at the French investment bank Natixis and an independent board member of AGEAS insurance group.

Alessio Terzi, a lecturer at the University of Cambridge and Sciences Po, is an economist at the European Commission and the author of Growth for Good: Reshaping Capitalism to Save Humanity from Climate Catastrophe (Harvard University Press, 2022).