The Age of Slow Growth in China

And What It Means for America and the Global

Economy
BY DANIEL H. ROSEN
April 15, 2022
DANIEL H. ROSEN is a founding partner of Rhodium Group and leads the firm’s
work on Asia.

In December 2017, the United States updated its National Security

Strategy, making two notable modifications: labeling China and several
other illiberal countries as strategic competitors and recognizing
economic competition as central to great-power rivalry. Since then,
Washington has used economic tools with increasing boldness in its
commercial and national security dealings with China—and even more
forcefully in response to Russia’s war on Ukraine. This new willingness to
contemplate decoupling from other major powers—a reversal in what had
seemed an inexorable trend toward deeper connectedness—marked the
end of permissive engagement with them as the default U.S. posture,
especially in the economic domain. Now, the burden of demonstrating
that economic interactions with China are benign has essentially fallen on
the private sector.

To rally support for this strategic shift, U.S. officials and security analysts
have emphasized the most intimidating aspects of China’s behavior and
rhetoric, characterizing Beijing as the “pacing threat” to the United States
in all domains. China’s leaders and their factotums have helpfully
provided all the evidence needed to substantiate the sense of rivalry. The
Chinese Communist Party has committed to maintaining an annual
economic growth rate of between six and eight percent, which would
allow China to easily pass the United States in GDP by the end of the
2020s. That economic growth, the CCP has made clear, will directly
support a major increase in defense spending. Meanwhile, China’s Belt
and Road Initiative and other overseas financing programs aim to pull
perhaps 100 nations into an orbit with Beijing as the center of economic
gravity. And Beijing will continue to compel Chinese companies to
master and indigenize all strategically important technologies, with the
goal of eliminating reliance on foreign capabilities within a few years.

This portrait of a Chinese juggernaut warrants Washington’s urgent steps

to reinvest in competitiveness, ensure the United States can parry China’s
spending on defense, and tighten permissive rules for U.S. companies that
Beijing has exploited for strategic gains. The United States and other
liberal democratic states have made strides over the past decade in
recognizing China’s ambitions and their implications for the global
economic balance of power. But by not challenging the narrative of the
inevitable rise of China and the inevitable decline of the United States,
Americans are needlessly doing the CCP’s marketing work.

China’s rise is far from inevitable; in fact, a long-term economic

slowdown is unfolding. Rather than willfully disregard this reality, the
United States should talk about it. Policymakers across the world have
taken Washington’s silence about the risks to China’s economic outlook as
evidence that Chinese President Xi Jinping is telling it straight when he
says that the CCP is in control and has a 100-year plan to put China on
top. Exposing the far less rosy reality would temper China’s appeal to
middle powers as a reliable security partner and draw attention to the
systemic economic risks of partnering with China on development
projects. China’s brand of lending to developing countries risks
undermining governance, saddling countries with debt, and obscuring
hard-learned lessons about economic liberalization.

Washington wants other nations to resist Beijing’s authoritarian allure for

geopolitical reasons. But economists worldwide—including in China—
are on the same page: the CCP’s turn back to statism is dangerous. There
is no basis for the belief that China, or any country, can deliver high,
politically determined growth targets in perpetuity without completing
basic fiscal, financial, and other market reforms. Pointing out the
weakness of China’s economic model and the riskiness of the path the
CCP has chosen is a chance for the United States to demonstrate
geopolitical leadership that like-minded partners can follow.

WISHFUL THINKING
Consider the headwinds China is facing in 2022. At the annual meeting
of the National People’s Congress in March, China’s leaders declared that
2022 GDP growth would be 5.5 percent, a normalization back to 2019,
prior to the COVID-19 pandemic, when growth was 5.9 percent. They
have stuck to this target despite a host of new economic challenges.

Where could such an expansion come from? There are three possible
sources: business investment, household and government consumption,
and trade surpluses. The size of China’s economy was $17.7 trillion in
2021, according to official figures, so 5.5 percent growth would mean
about $1 trillion more in 2022. Using growth in 2019 as a basis for
comparison, business investment in China would need to contribute
about 1.5 percentage points toward the 5.5 percent growth Beijing
promises this year. Because net exports are likely to be negative and
consumption is likely to decrease, investment would need to contribute
even more—around 2.5 percent—to growth this year. But nearly half of
all growth in business investment in recent years has been related to the
property sector. The authorities tolerated this overinvestment despite the
risks in order to achieve political growth targets, leaving the largest
property developers in debt default crises. There is no logical way
investment can add 1.5 points to GDP growth in 2022, let alone 2.5
percent. In “sunrise” higher-tech industries, a series of unanticipated new
regulatory moves has frightened away investors. New business starts by
entrepreneurs have dried up and are in deeply negative territory.

Household and government consumption combined would need to add

about 3.5 percentage points in 2022 toward the 5.5 percent growth target.
But with almost 100 million consumers in lockdown from COVID-19
outbreaks, retail activity is frozen. Promising high-tech, job-creating
sectors are shedding employees owing to government interventions aimed
at control, reducing income growth and hence consumption potential.
And local governments have shrinking resource bases to support their
spending, since they were ordered to stop selling land to property
developers but don’t have permission to replace that lost revenue by
raising taxes or imposing new ones. Local officials are now being told to
do what was condemned not long ago: quickly issue special revenue bonds
without concern for repayment. But even a municipal debt binge cannot
offset the fall in the housing bubble and the consumption slowdown that
resulted from COVID-19. It looks as if it will be hard to replicate even
last year’s base of consumption expenditure, let alone grow it by hundreds
of billions of dollars.

As for China’s trade surplus, there are clear reasons to be cautious about
growth. First, with exports already at historic highs thanks to the once-in-
a-century conditions produced by the pandemic, there is no likely
direction but down. Second, China’s terms of trade (the ratio of export
prices to import prices) has gotten worse owing to Russia’s invasion of
Ukraine and other geopolitical tensions affecting prices, which is driving
up China’s import bills. Third, elsewhere in the world, COVID-19 is
receding and factories that were temporarily shuttered are coming back
online, whereas export regions of China such as Shenzhen and Shanghai
are facing the most acute COVID-19 crises China has experienced since
the pandemic began.

Taking all this into consideration, it will be challenging for China to

maintain two percent growth this year. As Beijing continues to report
results that appear much stronger than that, as it did for the first quarter
of 2022, the CCP’s credibility will take a hit. Doubts about China’s
numbers are already frightening domestic and foreign investors alike away
from China’s markets. Accurately measured, zero growth or even
economic contraction should not be ruled out this year.

NO QUICK FIX
Unlike Japan in the 1990s, which was one of the wealthiest nations in the
world on a per capita basis when it downshifted to low growth, China is
relatively poor. Per capita income in China is about one-fifth of that in
the United States, at around $12,000 a year. Nine hundred million
Chinese citizens are not yet living comfortable urban lives and are waiting
for their turn. Given that unmet potential, one would expect China to
return to a faster growth rate after a bad year such as 2022. But the
problems contributing to the current malaise will weigh on China’s
economy for years.

Most striking is the country’s demographic challenge. China has seen

declining population growth for years, a trend that is not unusual as
nations become wealthier. But since 2015, China’s population growth has
fallen from around ten million a year to around zero, and the trend points
further down. There are as many as 130 men for every 100 women in their
prime, so naturally not everyone can marry. Many people who are married
are deciding not to have children or to wait much longer to do so than
earlier generations did, for a variety of reasons. In simple terms, they are
anxious about their economic burdens. Although there are hundreds of
millions of people who have not yet migrated into the modern urban
economy, education and health levels for people in rural China are poor,
and some researchers have cast doubt on their ability to fill even labor-
intensive factory jobs. Fewer workers, fewer future buyers for unbuilt
apartments, fewer consumers: these demographic fundamentals are
impossible to hide or change in just a few years.

Likewise, it is no longer possible for the CCP to allow a property bubble

to act as a supercharger of growth: construction investment will
necessarily be subdued for years relative to the past. There is room to shift
investment to new, unmet needs such as green energy, schools, hospitals,
retention walls to hold back rising sea levels, and a myriad of other
priorities. But China’s financial sector is not yet incentivized or organized
to push investment toward those areas. A “big bang” of financial reform is
first required to achieve that; that would necessarily be followed by a
period of slow-growth structural adjustment. Only then could next-
generation business investment approach the levels seen in past years.
And there is no evidence that such a transformation is on the horizon.

Further, the most important driver of economic growth in the very long
term is technological innovation. China has absorbed more technology
from abroad, and benefited from it, than perhaps any country in history.
But foreign firms and other countries are now taking a far less permissive
stance. It is unclear if truly indigenous Chinese innovation can take the
baton and drive future growth. Firms that have innovated have frequently
been the target of reasserted state control, for fear of independent actors.
Other firms are building out a massive technology base, but only with
support and subsidies from the state, which calls into question how
efficient they are at research and development and how much longer the
state can afford to support them. No doubt, given the effort the CCP has
put into industrial policy, there will be successes. But as a system, Chinese
innovation funding is underperforming.

These are structural problems; they are embedded in the system. They
could be remedied. From 1978 to 2012, structure impediments were more
often than not remedied, unleashing the growth and development of the
past 35 years. But such problems are not being remedied today, and at
best it will take years to make a credible dent.

SECOND THOUGHTS
A great deal of global economic sentiment hinges on the widespread
belief that, like diamonds, Chinese growth is forever. Once confidence in
that narrative slips, the implications will be significant. Some companies
have high stock prices because investors assume they will generate future
profits from China-related businesses. As China’s growth slows, their
valuations are likely to fall. The stock prices of other companies may be
depressed because of concerns about Chinese competition, and their
valuations could rise. The same goes for long-term valuations of
commodities and other assets that are based on expectations of another
decade of relatively fast Chinese growth.

Other implications of China’s economic reckoning are clear as well.

Foreign investors—both those buying bonds and those building factories
—have appreciated China for its political predictability and associated
growth: if the CCP said growth would be eight percent, then growth was
usually eight percent. If there is uncertainty about that outlook, then
investors will require higher profit premiums to justify the risks they are
taking. In recent years, strategists in democratic countries have looked for
ways to discourage their firms from going to China or to put pressure on
those already there to leave. Ironically it is the market itself, in the form of
hedging against the prospect of lower economic growth, that is starting to
compel those decisions. Western authorities don’t need to command firms
to curtail their China ambitions: transparency about the extent of China’s
macroeconomic stress will do that job naturally. An elective decoupling is
taking place, even without maximum arm-twisting.

The repercussions from China’s slowdown will stress market-based

democracies unevenly, and that will cause tensions among like-minded
friends. Beijing will induce some firms to stick it out in China and punish
others. This will sow discord and mistrust. But at the same time, less
Chinese growth means less to fight over and fewer reasons to risk
reputations and compromise on values. If China accounts for 30 percent
of marginal growth in global demand for luxury vehicles, for example,
U.S.-EU alignment on trade policy is harder than if the Chinese share is
only five percent.

For countries that see China not just as an economic rival but also as an
engine of their own growth, a diminished Chinese outlook means a
weaker outlook for them, too. This applies to the 55 or so nations that
have a trade surplus with China, the 139 countries that have signed up for
the Belt and Road Initiative, and others that depend on Chinese tourists
(France), corporate services demand (Hong Kong, Singapore, the United
Kingdom), or other China-dependent growth drivers. The weakest of
these countries may catch pneumonia if China catches a cold, meaning
that they may have trouble servicing debt burdens they took on in
anticipation of sustained Chinese demand growth or encounter political
upheavals if it turns out they erred by deciding to align themselves with
Beijing.

Last but not least, a slower Chinese economy means the CCP will have
less room to maneuver at home. With less spending power, Chinese
leaders will have to worry more about social stability. Less fiscal capacity
means fewer resources for outbound investment and official development
assistance. Choices about public expenditure priorities will become more
difficult. Officially, in 2019, China’s $261 billion in military spending
represented 1.4 percent of GDP and was growing at around six percent
annually, but many observers think that spending is higher and growing
faster. Support for industrial policy, especially for technology deepening,
runs to hundreds of billions of dollars a year. These numbers pale in
comparison to the growing perennial expenditures on education, health
care, infrastructure, government salaries, government debt service, and
other obligations. Fiscal promises made assuming five percent or higher
GDP growth will have to be scaled back. Beijing can’t do everything it
hoped. The party has built authoritarian tools to suppress discontent, but
these have been tested only during the long period of high growth.

Presented with these headwinds, will Beijing concede its mistakes and
reorient policy back toward the marketization that delivered decades of
double-digit growth? Or will the CCP take the opposite course, deeper
into command-and-control statism? The past century has seen China go
both ways. One cannot be sure, even with Xi at the helm. But China
cannot have both today’s statism and yesterday’s strong growth rates: it
will have to choose. This reality is stoking debate and disagreement about
the way forward. In recent weeks, one camp of officials rolled out
promises to attend to investors while another insisted that growth was
fine, targets would be met, and no corrections would be taken. Slowing
growth will bring that fight to the fore.

HONESTY IS THE BEST POLICY

Washington should draw attention to the realities of economic problems
in a responsible manner. There are three rules to observe in doing so. First,
be objective. That means empowering U.S. officials by providing them
with accurate analyses of the nature of China’s economic challenges and
the spillovers that will ensue. U.S. leaders were too often playing catch-up
to understand the significance of China’s high-growth period; the
downshift to slower growth will be similarly profound, and it is crucial
that officials in the executive branch and Congress are prepared to
interpret and respond to it effectively.

Second, be intelligently self-interested. Some would leverage China’s

economic troubles to pursue maximum decoupling, closing down all trade
and investment flows. That would be ill-advised: economic divorce would
impose huge costs, worsen inflation, and serve no strategic purpose. The
self-interested response to a Chinese economic downturn is to maintain
as predictable a trade and investment policy stance as possible, adapting
over time to serve the welfare of all Americans and reduce newly arising
security concerns. This attitude is crucial because it maximizes American
welfare and preserves resources for solving real security dilemmas when
they emerge. It would also encourage alignment between Washington and
its allies and partners. Such alignment has been the most powerful
element of the Western response to Russian aggression, and it would be
decisive in the success of a reset with China. The consequences of China’s
slowdown should be a regular point of discussion at the G-7, the
Organization for Economic Cooperation and Development, the U.S.-EU
Trade and Technology Council, the Quadrilateral Security Dialogue, and
other multilateral forums.

Finally, Washington should take a sober and constructive tone in

discussing China’s economic problems: gloating would be
counterproductive. Slowing growth impairs the welfare of 1.4 billion
Chinese people and countless others around the world. It could lead
China further down illiberal social and political paths just as easily as it
could lead it toward reform. Officials in Washington and other Western
capitals have a legitimate interest in the fortunes of the world’s most
populous nation, and they have a responsibility to address the global
economic risks that could result from a Chinese downturn. The proper
messages are admiration for the Chinese people and the four decades of
exceptional, sustained development their leaders oversaw; humility that
advanced industrial democracies all went through periods of painful
adjustment in their development journeys, too; readiness to restore
channels of cooperation if requested by Beijing; and assurance that the
West does not seek to exploit China’s economic challenges but rather
wants to see them sustainably resolved. China does not have to lose in
order for the United States to win.

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