In my recent interview with Steven Budgen on the Achieving Alpha Podcast (see the podcast below), we delved into some pressing economic issues, particularly focusing on China’s economic trajectory and its implications for the global economy.
Here are my key insights and reflections from that discussion, as well as references to my 2014 blog post, “China might never be the largest economy in the world.”
Demographic Challenges in China
China faces significant demographic headwinds. The country’s labour force has been shrinking for more than a decade, and this trend is expected to continue in the coming decades. This demographic shift mirrors what Japan experienced, leading to a continuous slowdown in growth. As the labour force declines, so does the potential for sustained economic growth. Without a reversal or mitigation of these demographic trends, China’s growth will continue to slow.
Investment Imbalances
For years, China has maintained extraordinarily high investment ratios, often exceeding 40% of GDP. While investment is typically seen as a positive driver of growth, in China’s case, it has led to overinvestment and malinvestment, particularly in the real estate sector. A significant portion of this investment has been driven by government subsidies and easy credit, resulting in unsustainable growth patterns. Moving forward, China needs to shift from an investment-led growth model to one that is consumption-led to ensure economic stability and health.
Policy and Governance Issues
Since President Xi Jinping took power, China’s economic policies have become increasingly less market-friendly. The shift towards more totalitarian governance and aggressive foreign policy has scared off international investors. This change, coupled with a lack of substantial economic reforms, has stifled productivity growth and innovation. Total factor productivity, which is crucial for sustainable long-term growth, has been negatively impacted by these policy shifts.
Future Projections for China’s Economy
Given the demographic pressures and the need to normalise investment levels, I predict that China’s real GDP growth trend will continue to decline, potentially nearing zero within the next decade or so. The government’s attempts to stimulate the economy through demand-side measures, such as fiscal stimulus and credit policies, are unlikely to be sufficient without significant supply-side reforms.
In my 2014 blog post, “China might never be the largest economy in the world,” I argued that China’s growth would slow dramatically due to demographic challenges, overinvestment, and the diminishing returns of the catch-up process. These factors remain relevant today and continue to support the view that China’s growth will decelerate significantly.
Political Constraints
The Chinese Communist Party’s reluctance to liberalise politically limits economic freedom and innovation, further constraining economic growth. The lack of supply-side reforms means that the slowdown in trend growth is likely to continue. China could do a lot to open up its economy, develop financial markets, and liberalise its political and economic systems, but these steps seem unlikely under the current political regime.
Global Impact and Comparisons
There are notable parallels between China’s current situation and Japan’s economic stagnation. However, Japan managed to navigate its crisis without major political upheaval due to its democratic governance structure. In contrast, China faces greater challenges due to its lower per capita income and political structure.
Impact of AI and Technology
I’m optimistic about the potential of AI to drive productivity growth globally, particularly in high-income countries. However, China, being a manufacturing-focused economy, may not benefit as much from AI-driven productivity gains as high-income countries. AI is likely to introduce significant productivity gains in sectors like finance, healthcare, and retail, which are more prevalent in developed economies.
US Economic Prospects
Despite the challenges faced by China, I’m very optimistic about the US economy. Several factors contribute to this optimism: the potential of AI, the impact of anti-obesity drugs, and strong immigration trends. These elements could lead to significant productivity gains and robust economic growth in the US, contrasting sharply with the challenges faced by China.
Policy Recommendations
For China to regain robust economic growth, it needs to implement significant supply-side reforms, including opening up its economy, developing financial markets, and liberalising political and economic systems. Additionally, central banks, particularly the Federal Reserve, should focus on nominal GDP growth targets rather than strict inflation targets to better manage the economy in the face of productivity shocks from technological advancements.
Concluding Thoughts
Economic freedom and innovation are essential for sustained economic growth. Historical perspectives and current global economic trends underscore the importance of policies that enhance productivity and economic flexibility. As we look to the future, it is crucial for policymakers to focus on these areas to navigate the challenges ahead.
These are some of the critical points Steven Budgen and I discussed on the Achieving Alpha Podcast. I believe understanding these dynamics is essential for anyone interested in the future of the global economy. You can read more about my earlier predictions in my 2014 blog post, “China might never be the largest economy in the world.”