China's economic recovery
Get more with myNEWS
A personalised news feed of stories that matter to you
Learn more
Constraints that Beijing has placed on consumption, manufacturing and monetary policies suggest China is heading down a slower economic growth path. Illustration: Henry Wong

China’s economy downshifts to slower growth path as focus turns to social equality, national safety

  • Beijing still wants to double China’s GDP by 2035, but ‘policymakers feel they need to address social issues to ensure social fairness and justice’
  • Policy change prompts concerns that China is returning to a more nationalised economy that favours stability and protecting state enterprises

This is the first part in a series of stories looking at China’s economic outlook in the second half of 2021 as it continues its recovery from a coronavirus-hit 2020.

As US-China relations continue to deteriorate, Beijing is making a major policy shift towards social and economic governance that looks to be setting up a long-term decline in the nation’s corporate productivity and economic growth, according to analysts.

For starters, a number of restrictive factors – including demographic constraints on consumption, climate constraints on manufacturing, and macro constraints on monetary and fiscal policy – suggest China is facing a downshift to a slower growth path, said Richard Yetsenga, chief economist at ANZ Bank.

And analysts agree that a sweeping regulatory clampdown on the nation’s education, tech and property sectors signals that Beijing has reset its priorities on social equality and national safety to tackle social inequality, data security risks and environmental sustainability, rather than focusing solely on bolstering economic growth.

Why China cracked down on education, upending a US$70 billion industry

After China’s sharp economic recovery in the year’s first half, some economists now expect second-half economic growth to drop to about 5 to 6 per cent, year on year. And analysts say that could also be the full-year growth rate for 2022 – roughly the same growth path the country was on at the end of 2019, pre-coronavirus.

“China’s policy U-turn is tectonic,” Yetsenga said. “If tech is unable to sustain China’s high rate of growth, the focus will shift back to manufacturing and consumption. But both are facing structural challenges of their own.”

To be sure, economic growth remains important, as top leaders still want to double China’s GDP by 2035, said Larry Hu, an economist at Macquarie Capital. But after 40 years of rapid economic growth that has widened China’s wealth and income gaps, policymakers feel they need to address social issues to ensure social fairness and justice, Hu said.
The theme of “ common prosperity” from China’s 14th five-year plan has triggered worries that the nation’s socio-economic model is returning to a planned economy, where its sectors increasingly become nationalised, said Tommy Xie, head of Greater China research and strategy at OCBC Bank.
“The recent regulatory moves remind us the Chinese economy is socialist by nature,” Xie said. “The road to common prosperity means that the Chinese economy is likely to move from a stage of pursuing efficiency to a stage of pursuing fairness.”

President Xi Jinping seemed to reinforce that in October when he said: “Common prosperity is a basic goal of Marxism and has long been a basic ideal of the Chinese people.”

“According to Marx and Engels’ vision, a communist society will completely eliminate the antagonisms and differences between classes, allocating resources according to one’s abilities and needs, so as to truly realise each individual’s freedom and complete development,” Xi said.

The education sector recently became the latest target of regulatory action that has already wiped tens of billions of dollars off the market value of Chinese tech companies listed in the United States, Hong Kong and Shanghai. The decision to overhaul the private tutoring sector – barring core subjects such as math, science and history, alongside tutoring on weekends and public holidays, for all children younger than six years old – caught the market off guard, spreading fears that the ban would widen to other sectors.

“The regulation change regarding education companies is rooted in an attempt to reduce the cost and burden of raising children, and so as to support fertility rates,” said Louis Kuijs, head of Asia economics at Oxford Economics. “I would not say it will help much on productivity growth. It won’t help much with rebalancing [the economy] away from [excess] investment.”

Kuijs expects that China’s economic growth will continue to slow to around 4 per cent by 2030, after the current volatile path of economic growth following the coronavirus crisis.

China has previously said its economic model needs to transition from one based on high levels of investment to one based on productivity growth, to help it catch up to leading global economies, and Beijing has set a goal of raising the nation’s average per capita income to US$20,000 by 2035.

This would mean that the path laid out for economic development would require a growth rate of at least 4.5 per cent each year for the next 20 years, said Chris Leung, an economist at DBS Group.

However, fraught US-China relations have forced regulators to switch gears when designing policies, to take into account priorities other than economic and financial ones, Leung said. For example, the decision to prevent private tutoring schools from raising funds or accepting investments from foreign companies was said to be a direct result of Beijing’s security concerns amid tense relations with Washington.

“The Chinese government now is very sensitive on foreign participation in all its industries,” Leung said. “They are afraid of importing Western ideologies that influence the thinking of China’s youth.” 

This full year’s expected high economic growth rate of 8 to 9 per cent reflects last year’s low growth and is unlikely to be sustainable, said Chris Kushlis, a fixed-income sovereign analyst for Asian markets at T. Rowe Price.

Growth appears on track to slow to 5 to 5.5 per cent over the second half of the year. But there are a number of uncertainties around this outlook, Kushlis said, particularly pointing to the strength of export demand being more robust than expected this year, though this may fade as stimulus measures in other countries ease back and as reopening efforts potentially shift demand from goods to domestic services.

Moreover, efforts to control the real estate sector, along with the deleveraging agenda to curb the off-balance-sheet risks of local government borrowing, remain a high priority for policymakers, suggesting that there are will be continued downward pressure on local government spending that could slow activity. International experience strongly suggests that even orderly deleveraging is associated with lower growth rates, Kushlis said.

Kushlis also said China’s slowdown was inevitable because of structural factors, noting that “it becomes harder to continue to generate high rates of return on investment as it catches up with developed nations”.

“Reforms in the financial system are likely to be associated with some sacrifice to growth before longer-term benefits can be realised,” he said.

The International Monetary Fund now forecasts China’s GDP growth will slow from 8.1 per cent this year to 5.7 per cent in 2022, and continue easing to 5.1 per cent by 2025.

Capital Economics chief economist Mark Williams predicts 8 per cent growth this year, followed by 5.7 per cent in 2022, then a decline to around 2 per cent by the end of this decade.

Given macro constraints on monetary and fiscal policy, China may continue cutting banks’ reserve requirement ratio to maintain ample liquidity, but another round of large-scale stimulus like that enacted in the spring of 2020 to combat the effects of the pandemic is unlikely, and this could lead to worsening corporate balance sheet strains in the coming quarters as the economy simmers down, Williams said.
During a Politburo meeting on Friday, China’s top decision-making body said it had reaffirmed its plans to maintain the “continuity, stability and sustainability of macro policies” for the rest of the year, including constraints on credit growth and tight property controls. The meeting also emphasised the need to strengthen employment services for college graduates, and to improve labour rights protections for those with flexible jobs.

The Politburo also warned that the pace of economic recovery would likely moderate in the second half of the year, mirroring the forecasts of analysts and economists.

[Beijing] is concerned with maintaining control over key parts of the economy. To that end, the state sector will remain protected
Mark Williams, Capital Economics

Williams speculated that productivity growth may no longer be one of Beijing’s primary objectives. “Instead, the leadership is concerned with maintaining control over key parts of the economy,” he said. “To that end, the state sector will remain protected.”

As the threat of decoupling with the US intensifies, China’s push for greater supply-chain self-sufficiency will prioritise policies to enhance industrial and national security while reducing reliance on technological imports, and this will exacerbate economic inefficiencies over time, said Nick Marro, The Economist Intelligence Unit’s lead for global trade.
Through the dual-circulation model outlined in the latest five-year plan, these goals will be realised under the Communist Party’s vast state-planning agencies to promote domestic self-reliance and to ensure that industrial supply chains are not disrupted. China has vowed to make state-owned companies “ stronger and bigger”, pointing to a trend of the state playing an outsize role in the economy at the expense of private enterprise, particularly in technological sectors that work with 5G, artificial intelligence and data centres.

But state companies are not known for their effective operational management, prudent resource allocation or market-based decision-making, despite several rounds of rather tepid reforms aimed at addressing these deficiencies, Marro said, adding that this inherently carries risks of dampening optimisation and productivity.

“As national security concerns increasingly overshadow much-needed economic-reform policies, the structural issues in the economy – such as around debt, employment or low productivity – risk worsening,” Marro said. “This localisation push is at risk of forcing companies to switch away from foreign suppliers simply because they’re foreign, and not because it makes commercial sense to do so.”

For example, Reuters reported this week that Beijing quietly issued new procurement guidelines for state firms in May, requiring that only domestically made materials be used on hundreds of items, including X-ray machines and magnetic resonance imaging (MRI) equipment, erecting fresh barriers for foreign suppliers.

Marro expects China’s GDP growth to hover around 3 per cent by the end of this decade, suggesting this would be a respectable pace of expansion given the size of China’s economy, but does not imply that issues around economic stagnation and financial risks will have receded by then.

And that, he said, makes this a tricky decade for Chinese policymakers to navigate.