CHINA HAS this year freed its economy from the lockdowns, quarantines and other restrictions of its “zero-covid” regime. But it has not freed itself from concerns about longer-term growth prospects. The population is shrinking. The epic housing boom is over. Thanks to a regulatory crackdown on e-commerce companies, the Communist Party has intimidated the tech billionaires it once courted. Jack Ma, a former teacher who became one of China’s most celebrated entrepreneurs, has returned to teaching – in Japan.
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The Communist Party now values security over prosperity, greatness over growth, solid self-sufficiency over the filigree interdependence that distinguished China’s economic success in the past. Foreign investors are more wary and are trying to move or at least diversify their supply chains. And America is eager to limit China’s access to some “fundamental technologies”. The economy of mutual benefit has given way to the geopolitics of mutual suspicion.
All of this has led many analysts to cut their long-term growth forecasts for China, even as they raise forecasts for this year. Some wonder how much longer China’s economy can grow faster than America’s. The answer will affect much more than factory orders or personal incomes. It will shape the world order.
The previous consensus, both inside and outside China, was that its economy would soon eclipse America’s. That, in turn, would enable China to become the world’s preeminent military power, displacing America as the world’s most powerful country. This remains a common view. Yao Yang, a respected economist at Peking University, believes China’s GDP could overtake America’s by 2029.
But others believe China’s economic clout relative to its rivals is nearing a peak. Hal Brands and Michael Beckley, two American political scientists, argue that China’s rise is already stalling. The era of “Peak China”, as they call it, is upon us – and it is much less of an Olympic summit than most predicted.
In 2011, Goldman Sachs predicted China’s GDP would surpass America’s by 2026, growing more than 50% by the middle of the century. There was no peak in sight. At the end of last year, the bank revised its calculations. It now thinks China’s economy will not catch up with America’s until 2035 and will be only 14% larger at peak (see chart).
The spike in China seems similar in an influential prediction made last year by Roland Rajah and Alyssa Leng of the Lowy Institute, an Australian think tank. Others see an even lower top. Capital Economics, a research firm, argues that China’s economy will never be number one. It will reach 90% the size of America by 2035 and then lose ground. As far as the Peak China theorem can be summed up in a single projection, this is it.
What explains the lower expectations for the Chinese economy? And how much discount is justified? The answers depend on three variables: population, productivity and prices. Start with the population. According to official statistics, China’s workforce has already peaked. It has 4.5 times as many 15 to 64 year olds as America. By the middle of the century it will be only 3.4 times as many, according to the UN’s ‘median’ forecast. By the end of the century, the ratio will drop to 1.7.
But China’s demographic outlook hasn’t changed much over the past decade, even as economic growth forecasts have shrunk. In fact, Goldman Sachs’ new forecasts assume a softer decline in China’s labor force than the old one, as health improvements could keep older workers in work longer. The bank expects labor supply in China to decline by about 7% between 2025 and 2050.
The biggest swing in sentiment is not about population, but about productivity. In 2011, Goldman Sachs projected that labor productivity would grow at an average annual rate of about 4.8% over the next 20 years. Now the bank expects to grow about 3%. Mark Williams of Capital Economics takes a similar view. China will “fall off the path of an Asian outperformer and onto the path of a decently respectable emerging economy,” he says.
There are good reasons to be gloomy about the productivity of Chinese workers. As China ages, it will have to devote more of its economic energy to serving the elderly, reducing the need for investment in new equipment and capacity. In fact, after decades of rapid capital accumulation, returns on new investments are declining. A new high-speed rail line through mountainous Tibet delivers much smaller benefits at a much higher cost than connecting Beijing and Shanghai, for example.
China’s rulers are trying to impose more discipline on local governments, which build much of China’s questionable infrastructure. Unfortunately, they seem equally eager to impose their will on Chinese private companies. In China, unlike elsewhere, companies earn a smaller return on their assets as they grow in size, Capital Economics points out: “When they reach a certain size, companies must pay as much attention to meeting the needs of officials as they do to those of consumers.”
It is not just their own government that hinders Chinese companies. In October, America imposed controls on the sale of advanced computer chips to China. This will hurt Chinese companies that make products such as mobile phones, medical equipment and cars. Goldman Sachs has not factored this damage into its long-term forecasts, but estimates that China’s GDP could be about 2% smaller than it otherwise would be by the end of this decade.
The tech war could continue. The IMF’s Diego Cerdeiro and his co-authors have explored a scenario in which America restricts its own technology trade with China, persuades other OECD members to follow suit, and forces countries outside the club to take sides in the fray. In this extreme scenario, China’s economy could be about 9% smaller than it would otherwise be in a decade. In other words, the idea that productivity growth in China could be closer to 3% than 5% is not far-fetched.
All predictions about the economic future should of course be taken with a grain of salt. Predictions are often disappointing. Small differences in productivity or population trends, when combined and compounded over many years, can produce vastly different results.
Forecasts are also sensitive to prices, especially the relative price of currencies. Unexpected shifts in exchange rates can mock predictions of relative economic weight. Right now, a basket of goods and services that costs $100 in America costs only about $60 in China. That suggests that the currency, the yuan, is undervalued. Capital Economics believes this undervaluation will continue. Goldman Sachs, on the other hand, thinks it will narrow, either because the yuan strengthens or because prices rise faster in China than in America. This process, according to Goldman, will add about 20% to China’s GDP by the middle of the century.
If China’s prices or exchange rate don’t rise as Goldman Sachs expects, China’s GDP may never catch up with America’s. If China’s labor productivity grows just half a percentage point slower than Goldman Sachs expects, GDP, everything else constant, will never exceed America’s either (see chart). The same is true if America grows half a point faster (as Capital Economic projects). If China’s fertility rate falls further (to 0.85 children per woman by the middle of the century), it could take a lead in the 2030s only to lose it again in the 2050s. Even if China’s economy becomes the largest in the world, the lead is likely to remain small. It is unlikely to gain a lead over America equivalent to the 40% lead America now has, argue Mr Rajah and Ms Leng.
It also seems safe to say that China and America will remain in a position of near parity for decades. In the Goldman Sachs scenario, China has maintained a small but sustained lead over America for more than 40 years. Even in Capital Economics’ projection, China’s GDP will still exceed 80% of America’s by 2050. China will remain a geopolitical rival to be reckoned with. That’s crucial: if China’s summit is more Table Mountain than K2, the leaders will have little reason to confront before the decline sets in. ■
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