China’s Rapid Growth Might End Sooner Than Expected:

1. The Chinese economy may slow sooner than expected

Chinese government announced on October 18 that its real GDP year-to-year growth rate in the July–September quarter of 2021 was 4.9%.

Right after this announcement, I exchanged views with Chinese economic and other experts. Most of them agreed that the year-to-year growth rate will fall to around 4% in the October–December quarter.

When I asked about their outlook for the January–March quarter of 2022, some of them suggested that the rate may fall below 5% depending on how China deals with the power shortages and the pandemic for the Beijing Games.

Still, there is little doubt that the real growth rate for 2021 as a whole will reach the eight-percent mark.

As for the outlook for 2022 whole year growth rate, many economists predict 5.0–5.5%. Yet a few economists with a close association with the central government now hint at the possibility that the rate will dip below 5%.

For the past few years, I have predicted that China will see an end to the rapid growth age in the mid-2020s and began a transition toward stable growth age by the second half of the decade. A sustained real growth rate of 5% or more is a benchmark for rapid economic growth age.

In the autumn of 2019, I exchanged views on the long-term economic outlook with Chinese government officials involved in economic policy-making and Chinese renowned private-sector economists. I ascertained that my prediction was largely shared by many experts.

This generally agreed scenario, if expressed in rough figures, is that China’s real growth rate will hover around the 5%-plus range during the first half of the 2020s, drop below 5% around 2025, and dip during the second half of the decade before falling to about 3% around 2030.

In this scenario, I have predicted that the rate might fall below 5% in 2024 or 2025 at the earliest.

It was beyond my expectation that some economists began to predict the growth rate might sink below 5% in 2022 at the earliest. (The year 2020, when the rate stood at 2.3%, is considered an exception because of the COVID-19 pandemic.)

2. The adverse impact of the recent US-China rivalry has been smaller than expected

Before the pandemic, China posted a significant drop in the real growth rate, from 6.7% in 2018 to 6.0% in 2019.

This stemmed from growing economic uncertainties amid intensifying trade frictions between China and the United States under the administration of Donald Trump.

Such uncertainties decreased temporarily after the Trump administration moved toward reconciliation in the October–December quarter of 2019 in the face of the US private sector’s strong opposition to the administration’s policy of instigating trade frictions with China.

Until 2019, few expected that the serious US-China rivalry would last this long. Fortunately, however, its adverse impact remains smaller than expected.

In fact, the impact of the US-China rivalry has not been taken so seriously partly because the Trump administration’s hard-line stance toward China was somewhat relaxed from the autumn of 2019 onward.

After the second half of 2020, China businesses substituted production by companies in other countries that was suspended owing to the pandemic. As a result, China’s exports to the US surged and continued to grow rapidly until the July–September quarter of 2021.

Accordingly, the negative impact of the US-China rivalry has not come to the surface on the trade front.

In relation to technology frictions, the US government has made many items subject to the US government’s export restrictions toward China from the perspective of economic security.

In reality, however, the actual harm is not so serious as the US Department of Commerce allows US firms to continue their exports to China as an exception to the restrictions.

For example, US exports to two Chinese tech giants, totaling 103.3 billion dollars, or more than 11 trillion yen, were allowed as an exception for a period of about six months from November 2020 to April 2021. This includes 61.4 billion dollars for Huawei, accounting for 69.3% of all export applications; and 41.9 billion dollars for Semiconductor Manufacturing International Corporation or SMIC, a leading Chinese contract manufacturer of semiconductors, representing 91.3% of all export applications.

The total amount is equal to about 60% of Japan’s total exports to China for 2020, which stand at 176.1 billion dollars.

Nevertheless, the partial restrictions on the supply of semiconductors and other products remain in place. Yet the global short supply of semiconductors exerts a greater downward pressure on the Chinese economy.

3. Factors contributing to a slower growth for next year

For these reasons, the negative impact of the US-China rivalry on the Chinese economy has not been so serious up to now.

Rather, many other concerns of uncertainty have been raised about the growth outlook of the Chinese economy from 2022 onward.

The impact of the pandemic, which started in Wuhan in January 2020, has become so serious that its downward pressure on economic growth has not been dispelled around the world.

Moreover, there are other concerns for the Chinese economy in 2022 as shown below.

On the export front, if the pandemic is brought under control in other countries, China’s exports to Japan, the US, and Europe, which have been growing owing to production substitution by Chinese firms, will fall.

On the investment front, capital investment by manufacturers will likely slow on the back of a falling corporate rates of return due to rising material costs as well as a falling rate of operation due to falling exports.

In addition, production curbs to be introduced in steel, petrochemical and other energy-intensive industries as part of efforts to reach a carbon peak by 2030 are also expected to constitute downward pressure.

As for investment in real estate development, expectations for higher prices of real estate are rapidly shrinking and speculative demand is decreasing substantially on the back of the recent liquidity crisis of the China Evergrande Group as well as the Chinese government’s tighter grip on the real estate market.

This will likely slow the growth of investment in real estate development.

With regard to infrastructure construction investment, the central government will remain prudent in appraising infrastructure construction projects by local governments for authorization. Therefore, financing for inefficient projects for which substantial economic benefits are not expected will continue to be held in check.

Some say, however, that for fear of an economic slowdown, the central government will lower appraisal standards to shore up the economy and ease restrictions on fund-raising by local governments.

Even if that is the case, investment as a whole will likely continue to be sluggish.

Sporadic COVID-19 clusters, though on a small scale, are continuing to drag down consumption.

A slowdown in demand for travel, transportation, food and drink, and apparel for outings is inevitable. This is because if the Chinese government, under its zero-COVID strategy, finds new infection cases, even though they are small in number, it will impose strict travel and other restrictions in the areas concerned.

In addition, sluggish housing sales on the back of a flagging real estate market and concerns about business failure risks of developers are pressing down the demand for consumer electronics, furniture, interior decorations, and the like.

As described above, China’s economic outlook for 2022 is not bright as it lacks positive factors in all demand aspects, including exports, investment, and consumption.

4. A pessimistic longer-term outlook and its unexpected efficacy

If this state of affairs continues, China’s real growth rate might fall below 5% in 2022. From 2023 onward, the country’s economy might be fettered by a number of possible factors. They include (1) sluggish real estate demand due to the introduction of a real estate tax as well as the central government’s continued tight grip on the real estate market; (2) curbs on infrastructure construction investment; (3) environmental policies designed to achieve a carbon peak; (4) a resultant sluggish growth in capital investment by manufacturers; and (5) the risk of the US-China rivalry becoming more serious.

If these concerns become a reality, the worst-case scenario might be that Chinese economy will continue to post a growth rate below 5% from 2022 onward. This would mean that the real GDP growth rate will fall below 5% two to three years earlier than generally predicted. This is a nightmare scenario for China.

Surprisingly, however, this could be a favorable scenario from the perspective of macroeconomic stability.

According to the conventional outlook, the growth rate will drop by as much as 2% over a five-year period between 2025 and 2030.

In this scenario, it is extremely difficult to keep a macroeconomic balance, raising serious concerns about economic destabilization.

A more favorable scenario might be that the growth rate will begin to enter the range of less than 5% in 2022 and fall gradually over a period of eight to nine years to around 3% in 2030.

Such a slow decline in the economic growth rate means a smaller risk of economic destabilization.

If the economic growth rate falls over a longer term, a major risk associated with economic policy management is a rapid change in expectations for the economic outlook.

Such a rapid change will discourage corporate capital investment and consumer spending quickly, which in turn will result in a severe recession immediately.

Stable control of such changes in expectations is key to ensuring economic stability.

What approach should the government take to avoid a rapid deterioration in corporate and consumer sentiment as well as resultant economic instability? It can be argued that such a soft landing will be better achieved by a gradual decline in the growth rate over a longer period of time starting in 2022 than by a sudden stall in the second half of the 2020s.

In that case, the Chinese government, which has won public confidence by achieving high economic growth, needs to demonstrate clear outcomes in improving social and economic quality if it wants to continue winning public confidence.

Specific agenda items include (1) controlling fiscal and financial risks, especially the risk of an economic bubble; (2) introducing a real estate tax and an inheritance tax; (3) reducing the wealth gap in a conspicuous manner by scaling up social security, for example; and (4) creating a society where people can live with peace of mind in terms of education, health care, nursing care, the environment, public safety, and disaster risk reduction.

Socioeconomic stability in China is critically important for the global economy, especially for the Japanese economy.

I will continue to watch the Chinese economy and its policy trends while maintaining high expectations for the Chinese government’s policy management capacity.