What we’ve learned from China’s plenum
China’s economy may be slowing, but is still likely to comfortably outpace developed markets over the next ten years.
Chinese policymakers met last week at the fifth plenary session of the nineteenth Communist Party of China Central Committee – known more snappily as the “plenum”.
This is where they thrash out their economic strategies for the future. On top of the usual five-year plan, the government also formulated its long-term vision.
The meeting and the new five-year plan come at a crucial time for China, when:
- China’s slowing economy threatens to leave it stuck in the “middle income trap”
- Old growth drivers have been largely exhausted
- US curbs threaten the development of China’s high tech sectors
- China is trying to improve its economic self reliance through a new “dual circulation” strategy
Will China get stuck in the middle income trap?
China’s economy is rebounding strongly from the deep recession suffered earlier this year. We expect the lagged effects of looser monetary and fiscal policy to drive a further acceleration in growth in the near term. This should ensure that GDP growth accelerates from about 2% this year to around 7% next year.
However, there is no room for complacency. After all, China’s economy has been slowing for a decade and once the current growth impetus has faded, the prolonged slump is likely to continue.
It is natural for emerging economies to slow as they “catch up” with higher income levels in developed markets. But the slowdown in China has come sooner and more abruptly than in other Asian markets such as Taiwan and South Korea, which have successfully transitioned to higher income levels.
Those previously fast-growing economies that don’t make that transition are at risk of getting snared in a so-called “middle-income trap”. This is a concern for China right now.
How the old drivers of growth have been largely exhausted
The gradual slowdown during the past decade has been due to three factors, all of which are likely to worsen in the future.
The first is that export-led industrialisation seems to have run its course. As the chart below shows, China already has a very large share of the global export market. Meanwhile, the manufacturing sector faces the twin obstacles of trade wars and supply chain diversification. This is important, since manufacturing jobs tend to be highly productive and thus a key pillar of economic development.
Second, whereas China’s demographics were in the past supportive, they are now turning into a drag. An ageing population means that the dependency ratio will rise, while the working-age population (defined as people between 15 and 64) is expected to start shrinking in the years ahead.
Third, rapid investment is unlikely to continue. The deterioration in China’s demographics is likely to reduce demand for housing in the future, while the big gains from urbanisation have already been made. In addition, the government cannot continue to build infrastructure forever.
Targeting slower but better quality growth
The government is of course aware of this and will encourage sustainable and healthy economic development, with a focus on increased quality of growth.
Government policies can determine the severity of the downturn, and in this respect the so-called “dual circulation” strategy is encouraging.
The strategy was announced in September in a bid to increase China’s economic self-reliance. Its key planks are promising. For example, further increasing research and development (R&D) investment in industries such as technology could have a positive impact. Not only would it blunt US government restrictions on the supply of key inputs such as semiconductors, but it could also create some higher value and more productive jobs that would help to cushion fading growth impetus.
Higher incomes would help with the government’s long-term ambition of rebalancing growth towards consumption, by allowing China to consume more of what it produces. Meanwhile, any boost to the productivity of workers would help to offset their declining numbers.
One way to think about the long-run growth outlook for economies is through the lens of the evolution of the workforce.
The usual lags between birth rates and ageing mean that we can confidently say that China’s working age population will begin to contract in the coming decade.
Estimates point to an average annual rate of decline of about 0.2% a year. However, there is scope for this to be cushioned by an increase in the labour force participation rate – that is the number of working-age people in a population that actually join the labour force. If the participation rate were to increase, then this could actually mean that the impact on growth from demographics would be broadly neutral.
Either way, the more important driver of long-term growth in China will come from the output that those workers are able to generate. The key point here is that the rapid pace of productivity growth seen during the past two decades as China industrialised simply cannot be maintained. In a relatively good scenario, productivity growth might fall from an annual average of over 8% per annum in the period 2000-19, to only around 4.5% during the next decade.
Chinese growth is still likely to remain faster than in developed markets
By adding up these projections for growth in the labour force and productivity, we arrive at a long-term average potential growth of 4.6% over the next decade.
That would still be impressive when compared to the rest of the world. Particularly developed markets, where potential growth is likely to be below 2% virtually everywhere during the next decade. But it does still imply that the structural slowdown in Chinese GDP growth will continue.
The concern is that further escalation in tensions with the US stunts China’s future evolution, or that the government increases rather than decreases its influence over economic development and the allocation of resources. This could result in productivity growth shrinking more quickly, leaving potential growth at much lower levels.
This is why Beijing must get the balance right.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.