China’s Difficult Challenge to Reach the Middle (Or why China won't surpass US GDP)

Growth dreams deferred. 

China’s per capita income of $21,400 places it just above the 60th percentile of the global income distribution.

By Enda Curran

October 23, 2023

An unlikely geopolitical subplot of 2023 is the emerging view that China’s economy isn’t going to overtake the US after all.

The latest entry into the debate came from researchers at the Federal Reserve Bank of New York, who last week published a blog post titled, “Can China Catch Up With Greece?”

If that question had been asked a decade ago, China watchers would’ve responded with an emphatic yes. But sentiment has turned, even amid evidence that this year’s cyclical slowdown has been exaggerated.

The authors Hunter L. Clark and Matthew Higgins lay out China’s strengths that include a well-educated workforce (with half the world’s trained engineers), world-class infrastructure and big leads in areas such as battery production and electric vehicles. Yet they say those attributes alone won’t be enough for China to achieve the status of being “a mid-level developed country by 2035,” as set out by President Xi Jinping.

The reasons are well-known: an aging population, diminishing returns from China’s famed investment-driven growth model, heavy-handed state intervention, limitations to technological know-how and a real estate bust that has yet to be worked through.

The arithmetic isn’t in China’s favor. The Fed researchers used a working assumption that Xi’s income goal is benchmarked by “Advanced Economies” as classified by the International Monetary Fund. This group of 32 economies had 2022 per capita incomes ranging from $36,900 at the bottom (Greece) to $127,600 at the top (Singapore), measured at purchasing power parity.

The researchers used “mid-level” as beginning at the 25th percentile of this group, which equates to a per capita income of $49,300. China’s per capita income of $21,400 places it just above the 60th percentile of the global income distribution, but, as calculated by Clark and Higgins, the world’s No. 2 economy is a long way off meeting their middle income threshold. They say per capita income would need to rise by a factor of 2.3, corresponding to an average growth rate of 6.6% to reach the threshold by 2035. Annual income growth would have to be 4.3% to match the current level in Greece by that year.

Although the Fed researchers acknowledge there’s an optimistic case for China’s growth, they also cite lessons from economic history to show why this challenge is a tall order. “Of the forty-three countries that had reached China’s current income level by 2009,” they wrote, “not one managed to achieve the growth rate needed to push China to the Advanced Economy 25th percentile over the subsequent thirteen years.”

The Fed isn’t alone is reappraising the long-term outlook. Bloomberg Economics in September downshifted its view on China’s growth potential and cautioned that it’s no longer likely to become the world’s biggest economy soon, or ever on any consistent basis. Confirmation of the contrasting fortunes between the world’s big two economies should come this week. Official gross domestic product data due on Thursday is expected to show the US economy is booming, growing by 4.3% in the third quarter, a long way away from the recession that most observers had expected by now.

While the US bragging rights may not last for long (a recession is still a threat for 2024), the divergence now is stark, making China’s ambitions all the harder. “China could surprise us and achieve Xi’s lofty income growth target,” the Clark and Higgins wrote. “But that bet comes with stiff odds.” —Enda Curran, Bloomberg News

U.S. and Chinese GDP levels of $25.5 trillion and $17.9 trillion in 2022, with 2% U.S. and 2% Chinese real growth, U.S. GDP would be still 42% larger than Chinese GDP in 2050, 

From: Why do China's Growth Projections differ so much?

Some factors, like demographic change, are reasonably predictable

A 1.7% annual growth in China’s working-age population between 1980 and 2010 will turn into a 0.9% annual decline from now to 2050. 

the most likely outcome is a deceleration to 2%-3% average annual growth in real Chinese GDP through 2050, but doesn’t rule out rates of up to 5%. 

China is in a deep real estate crisis. Sales, construction starts, and investments are plummeting, and few major developers will survive without massive bailouts. A large bubble — based on decades of investments chasing fast growth and price rises — is deflating, partly as a result of government policy, and leaves behind stunning examples of overbuilding. And China’s real estate sector is huge, with estimates ranging up to 29% of GDP.

Real estate prices have been artificially supported by the government, and when they eventually fall more losses will need to be recognized.

Since 70% of China’s household wealth is held in real estate, it will take years to rebuild consumer confidence and lost purchasing power. 

Severe as this debt crisis is, the government is likely to contain it without threatening the Chinese financial system. The system is built around the world’s four largest banks, holding assets nearly equal to U.S. GDP. All are state-owned, have access to government capital, and operate under state directives. The state ultimately controls the resources and rules needed to restructure distressed companies and allocate losses — and keeps a close eye on financial stability.

State-led crisis management is already underway in both real estate and local government finances. For example, Evergrande’s CEO and other top executives have been removed, but the company continues to get money to complete pre-sold but unfinished projects. The government can also mobilize fiscal support quickly, as illustrated by a new package.

China is investing too much in unproductive projects and consuming too little. This is a legacy of extraordinary 10.5% annual growth between 1990-2010, which would not have been possible without very high rates of investment. The problem has been long recognized, but investment today is still 43% of GDP while growth is projected to fall to 3.9% annually over the next five years 

China’s growth will not rebound enough to justify high investments; the economy is slowing for fundamental reasons including an aging population, less rural-to-urban migration, and the shift in demand toward services.

if the property sector, estimated to be 29% of GDP above, were to decline by one-third, about 10% of the Chinese production would have to be disrupted and replaced by new activities.

in the early 2010s, many new industries were also appearing, serving middle-income consumers, and creating new investment opportunities. The list is familiar: solar power, traditional and electric vehicles, innovative electronic devices, and state-of-the-art online services in commerce, leisure, transport, and education. A powerful ecosystem was emerging to support entrepreneurs, including venture capital markets with few rivals except in the United States. These were the new foundations of long-term growth.

By the end of the 2010s, however, the political climate had changed, often at the expense of China’s new industries. In speeches starting in 2015, President Xi Jinping revived an ideological approach to economic policy, focusing first on income inequality, but soon prioritizing technological self-sufficiency, national security, and the primacy of the Chinese Communist Party and its leadership.

In preparing for the 2023 National People’s Congress, Xi reined in decisionmaking and unveiled a wide, control-centered agenda. The share of state-owned enterprises in bank lending rose from 36% to 83% between 2010 and 2016, and the party tightened its oversight of private enterprises and intimidated foreign firms. Business decisions, from products to finance and leadership, slipped from private to party hands. As a result, domestic and foreign business confidence in China fell and China is now recording the largest capital outflows since 2015.

China’s recent strategies inhibit business investment and productivity advances and are already slowing economic growth. 

But China could grow faster. Three decades is a long time, and Chinese pragmatism could return — underperformance might even make this likely. Forecasts that leave room for a rebound in private initiatives and investments would raise China’s growth outlook at least into the middle part of the Lowy range.

For now, China’s plausible long-term growth projections agree on several factors that imply significant deceleration, but disagree on distant, future policies. These commonalities and differences explain a 2%-5% range in GDP growth rates to 2050.