In spite of its economic success, China may face greater economic uncertainty today than at any time since Deng Xiaoping’s reform and opening in the 1980s. Not only is China’s pace of economic growth slowing, but the slowdown is structural and not merely cyclical. Also importantly, the slowdown has similar aspects to troubled transitions which other emerging economies failed to navigate, threatening to stall China in the ranks of middle-income countries.
At its heart, China’s economic challenge is to change the growth model it has so heavily relied upon since the 1990s. China’s remarkable economic sprint relied mostly on capital investments and export-led growth, fueled by the influx of rural-to-urban, inexpensive surplus labor as well as imported technology to increase efficiency Investment in capital stock helped to build the foundations of a modern, export-led, industrial economy: power plants, telecommunication networks, highways, railways, airports, harbours, and massive urban centers.
However, continuing the pace of economic growth based on this model has become more and more difficult with each passing year. China’s demographics are an immutably big reason for this as China’s growing number of elderly will need to be supported by a dwindling working-age population. China’s workforce population peaked in 2012 and has been in decline since, contributing to increasing labor costs. China’s aging population also foretells increasing long-term pressures on China’s savings rate and capital formation, human capital formation, and its welfare and pension systems as the country grows old before it grows rich. In addition, capital investments have reached a saturation point.
China’s future economic future needs to rely less on capital investment—which in the past was less concerned with efficient use of capital—and much more on extracting efficiencies and productivity from existing capital stock. That means gaining greater outputs per worker and unit of capital through such measures as technological innovation, allocating capital toward higher-yielding results, and shifting towards a greater consumption-led growth model.
However, according to the International Monetary Fund, China’s post-COVID-19 recovery relied very heavily on government financial support which only extended the burden of poorly-performing, capital-intensive state-owned enterprises (SOEs). On the whole, PRC SOEs operate about 20 per cent less productively than their private counterparts. But, because of their social, political, and economic significance within the Chinese system, SOEs still retain privileged access to resources such as capital and land while putting a disproportionate drag on the economy. State-sector reforms are much needed and should include the closure of loss-making firms, stricter budgetary controls on SOEs, and allowing the market to have a greater say in the allocation of resources. But for the current PRC leadership this appears to be too politically risky—if anything, state and Party intervention in the governance of SOEs and the private sector has increased.
Beijing needs to address these challenges in order to avoid what has been called the “middle income trap.” This situation arises when a country reaches middle-income levels, but then—owing to higher wage costs and diminishing productivity gains—fails to progress to high-income status. China’s gross national income (GNI) per capita now stands at about U.S.$11,000 which, according to the World Bank, makes China an “upper middle-income” country and on the cusp of reaching the lower rungs of the high-income ladder. However, as the World Bank reports, of the 101 middle-income economies in 1960, only 13 advanced to a high-income level by 2008.
In addition, it appears a successful transition to high-income status is highly correlated to “institutional quality”: greater political openness, good governance, and the rule of law. Of the 13 economies just noted, the vast majority of them—including PRC neighbors Japan, Singapore, South Korea and Taiwan—developed high-quality political and legal institutions while transiting beyond the middle-income trap. For Xi Jinping, avoiding this trap is imperative but it also carries economic and political risk. Nonetheless, one of China’s most acclaimed economists, former Minister of Finance Lou Jiwei, declared in 2015 that the country has a 50-50 chance of remaining in middle-income limbo if significant reforms were not taken.