Without critical reforms China’s economic growth is unsustainable

What is going on in China? While it can seem superficially that the Chinese economy is in crisis, the realities are more nuanced.

First are concerns over deflation. This has been looming over China since 2023 and appears to be intensifying. It poses significant risks to the world’s second-largest economy, prompting calls for immediate policy intervention.

According to data released on Monday, apart from food costs, consumer price growth in China has largely stagnated, coinciding with declining income levels. A key economic measure, the gross domestic product (GDP) deflator, which tracks economy-wide price changes, has been declining for five consecutive quarters. Analysts from Bloomberg Economics and BNP Paribas project that this downward trend could continue into 2025, marking China’s longest deflationary streak since such records began in 1993.

The concern for China is that deflation could worsen by encouraging households reeling from falling wages to cut back on spending, or delay purchases because they expect prices to fall further. 

Such is the danger of a deflationary spiral, as experienced in Japan in the 1990s. Lower prices hurt firm profitability, which results in either job cuts or lower wages or both. This leads to lower aggregate demand as households delay spending, which once again feeds back into firms being forced to discount more aggressively.

However, despite these challenges, the reality on the ground in China is more complex. As Columbia University economist Adam Tooze notes, cities such as Shanghai are simply awe-inspiringly advanced and sophisticated. “On the streets and the highways around Shanghai it’s just one fancy EV after another, stuff you’ve never seen before… EVs with gull-wings, it’s so futuristic.”

China’s growth rates, though potentially overstated in some official reports, remain higher than those of Europe and Japan, and in certain areas, competitive with the US. This ongoing innovation and affluence creation, particularly in major urban centres, contrasts sharply with the notion of a stagnant economy.

That said, the sense of unease is palpable. The real estate sector, once a pillar of China’s rapid growth, is crashing. The government’s policies appear increasingly hostile to the kind of wealth accumulation that fuelled earlier economic booms. The education system, known for its intensely competitive exams, continues to place immense pressure on young people and their families, contributing to broader societal strain. Moreover, the transition from an era of 7% to 8% annual growth to a more modest 3% to 4% – though still respectable – hurts. According to a recent analysis by Matt Klein, consumer demand remains tepid, regardless of how the data is parsed.

A general consensus outside China suggests that the solution to its economic challenges lies in stimulating domestic investment and boosting consumer demand. Yet even within China, economist Zichen Wang highlights the perspectives of 11 prominent Chinese economic officials, including those at the vice-ministerial level, who advocate for policies that would promote domestic consumption. These proposals range from improving housing conditions for rural-to-urban migrants, to implementing tax reforms that benefit households. There are also calls for expanding welfare programmes to support consumer demand and enhance the quality of public services. Such reforms could play a crucial role in addressing the stark inequalities between China’s highly developed urban centres and its vast, underdeveloped hinterlands, where hundreds of millions of people still lack access to basic services like quality education.

Yet, despite the apparent consensus among experts, other than rhetoric about a “dual circulation model” these reforms are not being implemented. The reasons for this are not clear. Some suggest that ideological factors may be at play, such as a belief in self-reliance and a reluctance to create a culture of welfare dependence. This mindset may be similar to the fiscal conservatism seen in countries like Germany, where saving is prioritised and deficit spending, even in times of economic need, is viewed with suspicion.

Another argument is that there may be political reasons for the reluctance to expand the welfare state. A broader middle class emerging outside of the main industrial hubs could potentially challenge the autocratic political system. If Chinese citizens begin to experience the benefits of a welfare state, might they not demand greater political agency, as has been the case in Western democracies?

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China’s economic trajectory matters for South Africa. The Asian hegemon is South Africa’s largest trading partner, accounting for nearly 11% of exports. A prolonged deflationary period in China, coupled with slowing economic growth, would hurt South Africa. Iron ore prices, down 31% year to date, are a harbinger of things to come. 

China’s internal policy decisions are not just a matter of domestic concern but carry significant weight for South Africa and other developing nations. While it is difficult to pinpoint the exact reasons for the government’s hesitation to enact the critical measures needed, the consequences of this vacillation are clear. China’s economic status quo is unsustainable. DM