Three reasons China’s economy is strong but not invincible

China’s economy is surging while the rest of the world struggles with the pandemic, bringing the day it surpasses the US as the leading economy ever closer
Even so, China’s demographic time bomb, an only partially liberal financial market and systemic weakness in frontier science and technologies threaten its rise

Shirley Ze Yu

Published: 3:30am, 10 Feb 2021

Why you can trust SCMP

Where there is strength, fragility arises. The Chinese economy appears invincible following a pandemic that has destroyed the global economy. It grew 2.3 per cent in 2020, beating Beijing’s own expectations.

Aided by an appreciating yuan, the Chinese economy nearly surpassed that of the entire European Union in 2020 and reached almost 75 per cent of the United States’. The last nation to come this close to the US’ economic might was Japan.

China has devised a strategy to double the size of its economy again between 2020 and 2035, suggesting a 4.7 per cent average annual growth rate. The timetable for China to reach economic parity with the US has been brought forward to as early as 2026. This could fall in US President Joe Biden’s second term of office, leaving him the dubious honour of presiding over the cessation of the American century.

The Chinese economy is strong, but not invincible. Three economic forces can trap China’s growth: its demographic time bomb, a shallow and partially liberal financial market, and a systemic weakness in frontier science and technologies.

China’s population could begin to shrink before 2025. In 2022, China is expected to become an aged society, marked by 14 per cent of the population being 65 or older. When the US and Japan were this old, citizens were 2.4 times richer than China’s. In 2050, the median age in China will be 51, in the US, it will be 43 and in the EU, 47. By 2060, one-third of Chinese will be older than 65, making China the most aged country in the world.

Nobel laureate Edmund Phelps told me that if you strand many Robinson Crusoes on an island, a lot of them will innovate. Labour force matters in the innovation era.

Ageing directly raises labour costs. China is losing its labour premium as the world’s factory because of both rising wage costs and a lower labour supply. Ageing also diminishes Chinese people’s savings, reduces the demand for housing and commands larger fiscal deficits to finance rising social welfare costs.

A demographic Japanisation of China seems inevitable. Will China become trapped in its own “lost decades”? Financial liberalisation and tech innovation can provide a remedy.

China cannot finance its massive drive for innovation without turning its financial markets into a global capital magnet, both for foreign investors and its own citizens. China’s gross savings rate today lingers at 45 per cent. Government policies are driving US$13.9 trillion in individual savings out of people’s accounts.

01:31

China faces demographic challenge as birth rate drops despite government efforts

Savings can fulfil the competing roles of fuelling China’s domestic consumption growth and funding China’s equity market rise to provide direct financing to its technology companies.

China’s stock market allure has been apparent in the absence of further major Covid-19 outbreaks since the second quarter of 2020. The Shanghai Stock Exchange’s market capitalisation surpassed Tokyo’s in 2020, making it the world’s third-largest exchange. Foreign investors hold less than 5 per cent of China’s domestic stocks.

Yet, interest rates are still partially set by the government, distorting market signals. People-to-people lending rates have been artificially capped at four times the loan prime rate by the People’s Bank of China, depressing a risky yet complementary high-yield lending sector.

China adopts a managed floating exchange rate regime, which is susceptible to government exchange rate fixation. China still keeps a closed capital account, restricting capital from freely flowing in and out of the country. Four decades on, the difficult decisions are still to be made in China’s reform agenda.

01:33

China’s economy accelerated at end of 2020, but virus-hit annual growth lowest in 45 years

Dozens of chip companies were set up each day across China in 2020. Speculative capital rushed in to the lower-end chip supply chains, causing overinvestment in fixed assets and warehousing.

Capital also moved into high-end chip-making. Financial defaults ensued, highlighted by state-owned Tsinghua Unigroup and leading Wuhan chip maker HSMC.

China’s drive for chip independence, mandated by the State Council according to the “Made in China 2025” plan, is a top priority. Yao Yang, dean of the School of National Development at Peking University, has warned of politicising technology in China and mirroring the economic instincts of the US.

Some believe it is possible for China to produce 70 per cent of the desired chip volume by 2025. Fanned by the ubiquity of the internet of things, cars, appliances, machinery and cities can be wired up using chips. Demand for chips can be stimulated by policies focusing on the lower-precision end. China will just not have the top-end capabilities that Huawei needs.

“America is still the beacon of global technology,” Huawei’s Ren Zhengfei said in January, cautioning against a single-minded emotional movement towards technological self-reliance. Ren said the core of US-China competition is fundamentally based on education. Talent is not bred overnight.

Will China position itself at the global economic helm? It needs to develop Industry 4.0 to ensure it can leapfrog the three traps in demographics, finance and technology in the next decade.

It is easy for China, as the biggest beneficiary of globalisation, to lecture the US on openness and inclusion. Unseating the global economic incumbent of the past century will not be easy and will elicit nothing short of self-defence from the Biden administration.

“We only have to do our own things right,” President Xi Jinping told the Central Party School on January 11. China’s rise depends less on US policies towards China and more on China’s own resolve to complete its four decades of reform.

Dr Shirley Ze Yu is a political economist, an Asia fellow at the Ash Centre for Democratic Governance and Innovation and a former Chinese national television (CCTV) news anchor