By Eric Vandenbroeck and co-workers
China’s Economic Collision Course
China’s economy has
barely grown in the past two years. The immediate causes, including a decline in
property construction and ham-fisted “zero COVID” policies that tanked
private-sector investment, are well known. But the roots of the stagnation are
systemic, and firms and analysts inside China, as well as governments and
businesses around the world, have waited with anticipation for Beijing to
clarify its plans to put the country’s economy on a more stable track. Between
2010 and 2019—not long ago—China’s annual GDP growth averaged 7.7 percent, but
today the basic policy reforms necessary to support even three or four percent
growth are proving difficult for Beijing to achieve.
Domestic and foreign
observers pinned their hopes on the biggest policy event on China’s calendar,
the National People’s Congress (NPC), for signs of an overdue change in
direction. China has run an annual trade surplus for more than two
decades, but in 2022 and 2023, a slowdown in China’s domestic demand pushed the
country’s exports to exceed its imports by a shocking $1.7 trillion. A year
earlier, in 2021, President Xi Jinping had declared that China had become a
“moderately prosperous society”—a reference to a concept defined more than two
millennia ago in the Chinese poetry collection known as the Book of
Songs. In modern economic terms, Xi was taking credit for China’s rise to
middle-income status. This transition should come with a policy pivot. After
over two decades of strong investment-led growth, China now needs
consumption-led growth. Further investment will have diminishing returns unless
China can consume more at home. Yet over the past two years, the opposite has
happened. Unable to sell goods to domestic buyers, Chinese companies are
exporting their excess production abroad.
The United States,
the European Union, Japan, and other advanced and developing countries worry
that this trend will continue—that China is preparing to export its way out of
the economic slowdown. Beijing has declined to prioritize domestic demand and openly
denigrated consumer stimulus proposals, and it has promised to sustain support
for the very industries that are driving China’s export growth. These policies
will result in larger Chinese trade surpluses and foreign deficits,
undercutting competition abroad and threatening to put Western firms out of
business and their workers out of jobs.
The outcome of the
NPC, which concluded on March 11, will heighten rather than allay foreign
countries’ legitimate worries. Faced with an economic situation that calls for structural
reform to enhance productivity and bring domestic demand more in line with
production, China’s leaders have instead put forward a policy mix that will
delay necessary changes and deepen the economy’s reliance on foreign sources of
demand. To protect their own economies from the damage caused by inexpensive
Chinese exports, foreign governments will increasingly turn to antidumping
tools, which typically include tariffs on Chinese goods produced below cost.
Worsening trade
conflict is an inevitable outcome of current Chinese policies, and it will not
be limited to China’s relationships with advanced economies. Trade disputes are
already arising between Beijing and several other members of the multilateral forum
known as BRICS, for Brazil, Russia, India, China, and South Africa. Earlier
this month, Brazil initiated antidumping investigations into Chinese steel
imports. India has introduced more antidumping orders than any country in the
world in its efforts to restrict imports from China. South Africa’s trade
commission recently completed an assessment of Chinese imports and confirmed
that dumping was taking place. While developed and developing economies alike
push back against China’s high export volume, Beijing appears to be simply
ignoring the problem. And as Chinese overcapacity drives foreign governments
toward ever-harsher countermeasures, the resulting confrontation is something
neither the Chinese economy nor the global trade system can afford.
No Change On The Horizon
This is not the first
case of broad international objection to a single country’s trade practices.
Advanced economies also took issue with Japan’s refusal to address its trade
imbalances in the 1970s and 1980s. The United States intervened by holding direct
talks with Japan in 1984–85 to compel Tokyo to deal with the root
of the problem: structural policies that disadvantaged foreign products and
undervalued Japan’s currency. As a result, Japan agreed to “voluntary” export
restrictions. The Plaza Accord of 1985 and the Louvre Accord of 1987, both
signed by France, Germany, Japan, the United Kingdom, and the United States
(with Canada joining the latter agreement), codified further arrangements to
reduce trade imbalances by allowing exchange rate adjustments to strengthen the
yen against the dollar. These coordinated efforts to change Japanese economic
practices were controversial at the time, eliciting complaints that Washington
and its partners were being heavy-handed. But in the end, the measures did not
impede Japan’s economic development. In fact, by dealing with
legitimate concerns about trade imbalances, they laid a foundation of trust in
globalization that would benefit many countries—none more than China—in the
ensuing years.
Today, the question
is whether Beijing will agree to correct its policies, as Japan did,
forestalling a campaign by G-7 countries to impose more aggressive restrictions
on the growing volume of Chinese exports. But trade policies would be only a
temporary expedient. China’s trade surplus will persist until its domestic
demand meaningfully grows or investment growth slows significantly. To
alleviate the problem in the short term, Beijing would need a strong fiscal
stimulus. And to fix it in the long term, China must transfer resources from
the state to households—either directly through cash payments or shares in
state-owned enterprises, or indirectly through changes in tax policies or
subsidies for housing, retirement, medical care, and other services.
If China had such
steps in mind, its intentions would have been apparent in the policy messaging
that came out of the NPC. But no such evidence has emerged. In fact, Beijing’s
economic targets show not only that it remains committed to its old export- and
investment-led development model but also that it may even be planning to
expand Chinese manufacturing capacity to further increase exports.
Consider that
Beijing’s new fiscal policy package includes no direct support for household
consumption or incomes. China’s formal budget deficit target of
three percent of GDP in 2024 is largely in line with its 2023 target, which,
taking into account the current combination of government spending and bond
issuance, means that Beijing will not be implementing the kinds of fiscal
policies that spur domestic growth. Most important, China continues to channel
credit and fiscal resources into local investment rather than making direct
transfers to households to boost their spending. In the past, Xi has derided
such payments as “welfarism,” but China cannot sustainably expand household
consumption as a share of the economy only using supply-side measures. Eventually,
fiscal resources must move from the state to the household sector, and there
are no signs now of that transfer taking place.
This industrial
policy is particularly unwelcome to the rest of the world. China’s official
government work report for 2024 identifies the electric vehicle, battery, and
solar cell industries among the “new productive forces” that will boost the
country’s overall productivity growth. An entire section of the report
describes how the government “will actively foster emerging industries and
future-oriented industries” with an aim to “consolidate and enhance [China’s]
leading position” in several of them. But the industries China seeks to
champion are exactly the ones that are threatening to undermine competitors in
developed and developing economies.
China’s fiscal
revenue targets, too, imply that it is aiming for stronger export-led growth.
These figures include various types of collected taxes as well as rebates on
export taxes. Although the Ministry of Finance projects that overall fiscal
revenue will rise by just 3.3 percent this year, it expects that spending on
export tax rebates will increase by 9.9 percent. Meanwhile, the ministry
expects that the taxes China collects on imports will rise by only 4.1 percent.
These forecasts do not necessarily indicate an explicit intention to boost
exports, but at the very least they show Beijing does not anticipate any
reduction of its trade surplus in 2024.
Defense spending is
also set to rise much faster than overall government spending or revenue
generation. China has planned for only a 4.0 percent increase in total
expenditures, but it has mapped out a 7.2 percent expansion of the defense
budget. The signal to the rest of the world is that Beijing is prepared to
prioritize its military over investments in sustainable household development
or human capital.
Before China unveiled
any of these policies, European officials engaged in extensive outreach to urge
Beijing to consider the threat its exports posed to European industries and
employment—and the risk of spoiling a European political environment that had
long been favorable to trade with China. On a visit to Beijing in early
February, officials from the U.S. Treasury Department delivered a similar
message. But the NPC's plans show no signs of China taking these requests from
Western governments into account.
The optics at the NPC
did not help. Typically, at the conclusion of the congress, China’s premier
gives a press conference. This year the event was canceled—not only for 2024
but for future years, as well. The press conference was always a staged affair,
with questions submitted in advance and answers prepared. But by calling off
the event, China’s leadership is showing that it now sees convergence with the
practices of developed economies as unimportant, or at least not as important
as whatever backstage politics were behind the cancellation.
Doubling Down
Not only does Beijing
appear unwilling to address domestic economic imbalances, but it may also lack
the capacity to do so. This is especially concerning. For decades, economists
have called for China to shift toward domestic consumption by addressing
constraints on individual spending, which include insufficient household
income. To both rebalance the domestic economy and reduce the country’s trade
surplus, Beijing must encourage consumption in addition to slowing investment
in property and infrastructure.
But China is now
poorly positioned to engineer such a shift. The state collects only around 14
percent of GDP in tax revenues, far below the Organization for Economic
Cooperation and Development average of 34 percent. More important, a large part
of those revenues comes from value-added taxes on manufacturing and
other taxes on businesses, rather than from taxes on individual income and
domestic consumption. Under the current tax system, therefore, a transition to
a consumption-led economy would result in a dramatic decline in tax revenues,
undercutting Beijing’s ability to execute policy.
The need for tax
reform is clear; Xi himself acknowledged the problem in his policy agenda
announced in 2013. The fact that no such reform is in sight is thus additional
evidence that Beijing is doubling down on its antiquated growth model. Every
year, as it does with all countries, the International Monetary Fund consults
with Chinese officials on economic policy, makes recommendations, and then
reports on Beijing’s view of the proposed changes. In previous years, Chinese
officials agreed with the IMF on the need for fiscal reform. But this year,
Beijing told the IMF that a suitable tax system “has been basically
established” and that Beijing’s goals would focus on high-quality development
“rather than directly increasing fiscal revenue.” China is rejecting not only
the specific reforms that would facilitate a more sustainable trade
relationship with the rest of the world but the need for any reform at all.
China faces limits
when it comes to updating its industrial policies, too. Even if Beijing were to
yield to foreign pressure and make concerted efforts to restrict investments in
electric vehicles and batteries, solar cells, and other industries, the companies
and manufacturing facilities that benefited from earlier government subsidies
would not disappear. A central government campaign, moreover, is unlikely to
change lending decisions on the ground, given that local officials face
mandates to maintain employment levels and ensure financial stability.
It would be difficult
for China to quickly reduce its widening trade surplus, and no one expects the
country’s leadership to deliver a fix overnight. But it is alarming that
Beijing seems to have made no meaningful effort to right this imbalance. By
idly allowing policies to remain as they are, China is setting itself up for
confrontation with developed and developing economies alike.
Beijing should
recognize foreign countries’ valid reasons for introducing protective trade
policies, at least until China achieves structural reform at home. Instead,
Chinese officials have described U.S. trade measures as “reaching bewildering
levels of unfathomable absurdity.” If Beijing is unable to acknowledge the real
economic harms that these policies seek to avoid, there is no starting point
for a discussion with the leaders of advanced economies. G-7 countries will end
up formulating solutions among themselves, rather than working with China.
Chinese officials
often say that Beijing does not deliberately seek a trade surplus. Deliberate
or not, China’s trade imbalances are not sustainable for the rest of the world,
and China should not be surprised if foreign governments start to respond more
aggressively. Beijing is likely to reject measures similar to those the United
States and its partners adopted in the 1980s to address Japan’s trade
imbalances, such as an exchange rate arrangement resembling the Plaza Accords
or Louvre Accords. Tariff hikes on Chinese imports, another policy available to
foreign governments, may only provide temporary relief; when the Trump
administration imposed such levies, many Chinese suppliers were able to skirt
these regulations by shipping goods through third countries before they reached
their final destinations in the United States. With few effective policy
options and an unwilling negotiator in Beijing, Western governments in
particular will consider increasingly draconian restrictions on Chinese trade.
That shock may be what is necessary for China to take structural reforms
seriously, for the sake of its economic health and in the hope of avoiding an
irreparable split in global trade.
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