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China's slowdown - Implications for the West

Last week I argued that China is set for continuing slow growth but probably no crisis. Data this week on industrial production, retail sales, unemployment and fixed asset investment have been soft, supporting the view. What are the implications for the West?

Let’s distinguish the short term and the longer term. Short term it is unambiguously good news for the US and Europe. The West’s problem right now is that inflation and economic growth are too strong. That’s why interest rates are going up. A slow China will keep the lid on energy and commodity prices as well as prices of manufactures. And it will be a mild restraining influence on economic growth generally. This should help to bring inflation in the West back to 2%, pointing to a lower path for US and European interest rates than if China bounced back.

Over the longer term, if domestically-driven Western growth is solid, a more slowly-growing China is again not a problem overall though it will have implications for some countries and sectors. Germany’s growth model has benefitted from exports of machinery to China. Japan and some other Asian countries will see slower demand too, though a good part of their exports are actually processed in China for re-export to the West, so this effect should not be exaggerated. It will also impact commodity producing countries such as Australia, Chile, Peru and Brazil which have all enjoyed rapid increases in sales to China so far this century. The expansion of outbound tourism from China may slow too, impacting tourist regions in Europe as well as countries like Thailand. But for the bulk of the West, the impact will be small, and could be easily offset with a slightly lower path for interest rates (good for markets).

Suppose domestically-driven Western growth turns out less than solid? After all, a big factor keeping it going recently has been the enormous fiscal stimulus during Covid which boosted personal savings. By early next year the accumulated ‘excess savings’ will be largely spent. If Western growth does falter, then weakness in China may be seen as a negative. Interest rates will be heading down to low levels again and people will be asking ‘where is the growth in the world going to come from?’. Fears of ‘secular stagnation’, as in the 2010’s, will re-emerge.

Two points on Western domestically-driven growth. First, the weakness in the 2010’s had a lot to do with the aftermath of the banking crisis. Banks were reluctant to lend and both households and businesses were cautious about borrowing. That’s what a financial crisis does. But today, balance sheets are much stronger and confidence is higher. Secondly, I can point to two strong reasons for expecting high domestic investment - the Green Transition and automation (AI and robotics). ‘Reshoring’ of industry could be another.

The fundamental point is that countries can’t really depend on other countries for growth.

After all, Chinese growth was quite strong in the 2010’s and that didn’t stop the West growing slowly. Moreover, technically one country only gets a lift in GDP if its exports grow faster than its imports, which doesn’t last for long, especially for big Western economies.

Broader issues

Slower Chinese growth will restrain the growth of China’s CO2 emissions in coming years which would be a very good thing for the world. China’s emissions have more than quadrupled this century and are now 35% of the world total. Much of this is due to electricity generation using coal, together with cement and steel production to support China’s massive building and infrastructure boom. In time, improved energy technology should bring renewables costs decisively lower than fossil fuel costs. China is already building out renewables rapidly but, as long as economic growth was strong and renewables costs were high, it needed to expand coal-fired power stations too. So, a slowdown in China’s industrialisation could help with climate change.

Another issue to watch is whether the ‘China model’ of state-led growth becomes tarnished. After 2008, the Western policy failures which led to the Global Financial Crisis and the slow recovery afterwards stood in contrast to China’s rapid rebound. This caused a shift in favoured economic models away from the liberalising, free market Western approach towards more interventionism, characterised by industrial policies. That trend is still unfolding in the West, with Covid encouraging greater government interventionism. But if China is struggling, perhaps this model will fade. One to watch. I certainly hope so!

Meanwhile expectations for the Chinese economy to soon surpass the US in size will have to be put back. If the US averages 2% growth and China 3-4%, China will catch up only slowly (and might not even manage that rate of growth especially as the population decline accelerates). This suggests that the balance of international power will not shift so quickly away from the US and the West.

Does slower growth threaten China’s political stability? Many middle-income countries see political instability which leads to poor policy. Think of Thailand, Argentina, Brazil and Mexico, all of which grow much more slowly than they could, as they lurch between cronyism and socialism. China could face some sudden political changes in coming years. The succession to Xi Jinping, now 70, will be interesting to watch, though it is probably some way off.

Slower growth does not necessarily point to early regime change. Plenty of countries reach China’s level of development and fall into the ‘Middle Income Trap’. Only some of them see political transformation too. And its worth remembering that one of the most consequential revolutions of the last century came in Iran in the 1970’s, at a time when its economic growth was rapid.

For the CCP the lesson of Iran, as well as the collapse of the Soviet Union, is that economic opening is more risky for a government than slow growth. But that means slow growth will become the norm. Unless the government does move ahead with liberalising reforms, (the source of the last 40 years of success), growth won’t improve very much.

Overall then, slower Chinese growth is a mixed bag for the rest of the world. It doesn’t mean the West cannot grow healthily. Much depends on technology for that. And China may help there. Its focus on research into new technology, as well as the competition it is engendering from the West could see a new drive to produce and adopt technology which would be good for everyone in the long run.

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