Can China’s policies restore its economic growth?

China’s slowing economic growth challenges the world’s economic recovery. According to recent data from the National Bureau of Statistics (NBS), China’s Q3 economic growth rate is 4.9%, which slowed down from the 7.9% growth in Q2. In particular, the manufacturing Purchasing Managers’ Index in October was at 49.2, down from 49.6 in September, indicating that factory activities are shrinking.

Meanwhile, the producer price index (PPI) hit a record high, rising 10.7% year-on-year in September, reflecting that industries face a higher cost in making products. It raises the pressure to pass on higher costs to consumers, which may lead to worldwide inflation.

China has been viewed as one of the engines for global recovery. However, the above data, along with several recent challenges such as power crunch, Evergrande Group debt crisis, supply chain bottleneck and more disruptive pandemic restrictions, could hinder the recovery. Do these challenges bring in any market systematic risks? Can China’s policies restore economic growth? Should the other countries be alarmed by China’s economic slowdown?

The answer may be found in China’s aggregate demand and aggregate supply.

1. Aggregate Demand

Aggregate demand is a measurement of the total amount of demand for all final goods and services produced in an economy. Consumption, investments and net exports are three important factors to determine the total demand.

Weak consumption has been a persistent problem in China, slowing the recovery of its economic growth. In 2020, China’s per capita consumption spending experienced a real decrease of 4% after deducting price factors.

Despite the rebound in the first three quarters of this year, the August retail data is very disappointing, growing only 2.5% from a year ago which is well below the 7% growth expectation. This is a result of China’s “zero tolerance” policy for COVID-19 cases and local lockdowns imposed in order to control the highly contagious Delta variant. The policies disrupted retail sales from returning to pre-COVID levels.

Before the emergence of the Delta variant, China successfully brought the number of infections to zero. Retail, tourism and manufacturing industries quickly resumed pre-COVID levels. But the highly contagious Delta variant broke the peaceful equilibrium. Since July, infections appeared in several cities. The cities halted all trains and flights, closed the local highways, conducted mass testing and imposed lockdowns.

There is no signal that these measures will be eased in the near term. The intermittent COVID-19 outbreaks together with the “zero tolerance” policy pose an economic threat and uncertainty. On one hand, residents would have to stay at home, which decreases the demand for some consumer goods. On the other hand, some small businesses, such as retail stores, restaurants and travelling agencies, incurred higher operating costs due to the uncertainty. Some workers would have to face lower income or even unemployment. This further dampens domestic consumption.

China’s recent property crackdown policies cast another shadow over the economy. The authorities have decided to cut the country’s reliance on real estate, which has been a driver of GDP growth in the past. Housing activity has contributed 30% of China’s GDP, far above the 10-20% typical of most developed nations, according to The Guardian.

Frantic real estate developers have loaded up on debt, bringing a crisis to the whole economy. The Evergrande Group, one of the largest property developers in China, racked up more than US$300 billion in debt because of the crackdown on property developers’ reckless borrowing and a sluggish property market. Whether the authorities will step in with a rescue is uncertain.

Panic among investors and homebuyers will affect property sentiment. People with shrinking assets are likely to reduce their consumption and investment, affecting the aggregate demand even more.

Fortunately, China’s export sector has outperformed since the effective containment of the virus in early 2020. The outbreak of COVID-19 in developing countries, such as India, Thailand and Vietnam, has fuelled global demand for China-made products. China’s export in September is unexpectedly robust, rising 28.1% from a year earlier year-on-year. It reflects the solid global demand for Chinese products.

2. Aggregate supply

Will there be always enough supply to meet the global demand for Chinese products? To have sufficient supply, producers must have sufficient raw material and labour at reasonable prices. Unfortunately, China is struggling with severe energy and labour shortages.

Recently some local authorities in China have announced plans for power cuts in the coming months. This is because the country fails to balance electricity demand with supply.

Factories need more power to meet surging demand for Chinese goods. But many coal mines have been shut down in recent years due to China’s push for a greener electricity supply. The reduction of coal mines and a higher demand for electricity pushed up coal prices naturally.

For electricity providers, their production costs have gone up. But they could not increase electricity prices accordingly because the government-controlled the electricity prices. This led some electricity providers to reduce production, causing a shortage of electricity.

The power shortages have affected as much as 44% of the country’s industrial activity, according to Goldman Sachs’ estimation. Many factories would have to either cut production or pass on the higher cost of production to consumers. That will lead to inflation both domestically and globally.

At the same time, Chinese factories are facing a shortage in labour. The younger generation disdains factory work, which they perceive as dull and back-breaking. Even though many factory owners upped salaries and working conditions, it is still hard to find workers.

What’s more, China’s working-age population, referring to those between 15 and 59 years old, is shrinking. It was down from 70% of the total population in 2010 to 63% in 2020, according to a Wall Street Journal report.

Wages have been rising but the jobs are still unfilled. Many factories refused orders from overseas and scaled-down their production. This capacity limitation is undoubtedly slowing down economic growth.

3. Government policies

China is restructuring its economy, shifting the manufacturing sector to higher value-add areas, and reducing high debt levels to avoid a debt crisis. It will definitely experience a pain in the short term, presenting a lower-than-expected economic growth.

Currently, Chinese regulators are making every effort to deal with the default of property developers and trying to reduce the systematic risk. If the debt crisis brought by the Evergrande Group cannot be resolved effectively, it will affect the GDP growth in the fourth quarter, as well as affect overseas financial markets negatively.

Last month, China loosened its pricing control on electricity, allowing energy firms to set prices in the open market. While this would push up the prices of electricity, it would also incentivise firms to supply more.

Earlier this year, China has announced that it will allow couples to have up to three children. Subsequently, the government decided to regulate the private tutoring industry to alleviate the financial burdens of young couples, with the hope that it would encourage them to have more children. The policy may not have a positive impact on economic growth in the short term. But in the long run, with more people responding to the policy, families may have more children, filling the labour gap.

China views boosting domestic consumption as a priority in its five-year plan from 2021 to 2025. To achieve this goal, many provinces and municipalities adjust minimum wages to increase household income. However, due to the recent inflation in food prices, the rising wages may not be enough to outpace inflation.

Another factor affecting economic prospects is China-Taiwan military tension. It is described as “the worst in 40 years”. At the moment, the odds of war happening between China and Taiwan in the near future are still very low. But if such a black swan event happens, it will have an unpredictable impact on China’s economic growth.

The article is an abridged version of the one first published in ThinkChina.