Speaking in Davos, Switzerland, this week, Vice Premier Liu He said that the Chinese economy would return to fast growth sooner than expected. Liu offered confidence “that in 2023
China’s
growth will most likely return to its normal trend. The Chinese economy will see a significant improvement.”
Liu is blowing hot air: The Chinese economy is embedded in the
middle-income trap.
CHINA’S POPULATION FALLS FOR THE FIRST TIME IN 60 YEARS
In China, the growth potential of a large pool of low-cost labor to produce low-skill manufacturing is exhausted. China’s labor force is declining. Its working-age population peaked a decade ago. Chinese labor is now expensive
relative to
its economic competitors: Vietnam and Mexico, for example. Equally important, China’s overall population is declining. A country with a shrinking population faces extraordinary growth challenges.
Indeed, China has entered the demographic doom loop. Michael Beckley notes that over the next decade, China
will lose
70 million working-age adults while gaining 130 million senior citizens. China’s dependency ratio will collapse to 2 to 1. At the same time, productivity in the Chinese economy is falling. Productivity growth in China slowed from 3.1% per year in the 2000–09 period
to 1.1%
in the 2010–19 period. Capital efficiency has declined for two major reasons: too much investment in infrastructure and housing and the
misallocation
of capital toward state-owned enterprises from the more dynamic private sector.
On average, state-owned enterprises are 30% less productive than private firms competing in the same economic sector. Capital efficiency is 50% lower for state-owned enterprises, and labor efficiency is 6% lower. And while Liu says that China will open up to the private sector and foreign investment, he’s lying. China prefers social and economic stability to the dynamism of creative destruction.
China’s focus is on employment, especially the employment of young college graduates, whose unemployment rate now approaches 20%. China’s allocation of capital does not focus on research and development. Capital
does not flow to productive investment
in industrial equipment. Capital is instead allocated on the basis of increasing employment.
Compounding China’s policy mistakes, the country relies on the reckless use of debt to fuel the illusion of growth. Last year, China’s debt-to-GDP ratio reached 270%, up from 247% in 2021. At the margin, low-scale manufacturing will exit China and migrate to other countries in Asia as well as to Mexico. Increasingly, higher-skilled manufacturing will exit China and return to the United States or to other wealthy countries that are aligned with Western interests.
Even in the economic sectors of technology and biotechnology, China lags behind the U.S. and other advanced economies. Semiconductors are the oil of this century. China lacks the intellectual property necessary to develop the most advanced semiconductors, 5 nanometers or below. China is
decades behind
in manufacturing the most advanced semiconductor fabrication machines. As for biotechnology, China’s failure to develop an effective COVID-19 vaccine speaks for itself.
The central problem complicating Liu’s olive branch to Davos? There is no rule of law in China and thus no foundation for long-term confidence. Investors know that where it matters, Chinese leader Xi Jinping pursues policies that support one paramount goal: the supremacy of the Communist Party.
