Abstract: The biggest challenge facing the Chinese economy in 2022 is to maintain growth. China’s economic growth has fallen from around 10% a decade ago to over 5% today, a decline that is a bit too sharp even considering the country’s natural course of development, changes in its domestic and international environment and the sudden outbreak of the COVID-19 pandemic. If China is to remain well on track toward economic recovery next year, it should focus on stabilizing growth within a proper range while pursuing high-quality development.
I. THE CHINESE ECONOMY IN 2021
In the year 2021, with local governments’ ongoing dedication to both COVID-19 control and social-economic development, market participants have gradually accommodated themselves to the changes in the economic environment and managed to overcome many challenges. The Chinese economy has remained well on track toward recovery, with a year-on-year (y-o-y) growth for the first three quarters of 9.8% and two-year average growth of 5.2%. This is no easy task given the global spread of the pandemic, the surge in global commodity price, the increasingly acute structural problems accumulated over the years, and the ongoing Covid outbreaks at home.
The Chinese economy in 2021 has shown several features:
First, there has been a balanced recovery of the three main industries. If the economic recovery in 2020 was driven by the secondary industry, it has been more balanced in 2021. During the first three quarters, the primary industry grew by 7.4% y-o-y, faster than previous years; the secondary industry grew an accumulated 10.6%, thanks to the strong rebound in the first two quarters despite the slowdown to 3.6% in Q3, reversing the continuous downfall in the share of manufacturing in the national economy over the previous years; and the accumulated growth of the tertiary industry has gone back to 9.5%, although Q3 growth stood at a lacklustre 5.4%.
Second, China’s domestic demand has picked up steadily, while external demand has increased rapidly. In the first three quarters, final consumption expenditure contributed to 78.8% of economic growth during Q3, with an accumulated contribution of 64.8%; the quarterly contribution of investment dipped to the negative territory at -0.6% during Q3, with an accumulated contribution of 15.6%; and net export recorded a quarterly contribution of 21.7% during Q3, and its accumulated contribution was 19.5%. Compared with Q3, 2020, final consumption’s contribution surged, the investment’s plunged, while that of net export remained notable.
Quickly bringing Covid under control, China has managed to stabilize its economic development with a boom in export when manufacturing elsewhere was almost paralyzed by the global spread of the virus. That has demonstrated the country’s resilient manufacturing capacity, adroit supporting facilities and strong competitiveness, and such resilience, as proved amid this unprecedented crisis, is underpinned by the wise strategies implemented by the Chinese leadership to boost the real economy. Without a strong and resilient manufacturing sector, the Chinese economy would never have gotten back on its feet so soon.
Third, China has maintained stable prices, employment and level of income, and people’s livelihood has been well protected. In the first three quarters, China’s CPI rose 0.6% y-o-y; its monthly growth in October was 1.5%, 0.8 percentage points on top of the previous month. The price surge in PPI has yet to infect consumer spending, leaving people’s livelihood unaffected. Given this, China will be able to realize its goal to contain an annual price hike within 3% or so.
Additionally, during January and October 2021, China recorded 11.33 million new urban jobs, meeting the annual target of 11 million ahead of schedule. The surveyed unemployment rate in the first three quarters was 5.2%, 0.5 percentage points lower than the same period last year; it dropped to 4.9% in October, staying within the acceptable range around the 5.5% target.
At the same time, during Q1-3, household income in China climbed up by 9.7%, with 8.7% growth in urban household income and 11.2% in rural. An elevation in rural household income that keeps outpacing urban household income growth can contribute to closing the wealth gap; however, given the larger proportion of urban households’ consumption in total national consumption, such income structure may turn out inhibiting the country’s consumption recovery.
Through a sectoral lens, China has not achieved a well-balanced recovery, though. Domestic demand seems too sluggish compared with external demand; upstream industries have done much better than downstream ones; large- and medium-sized businesses have far outperformed small- and micro-sized ones, and in 1H21 the secondary industry had a much better record than the service industry. But we don’t need to be too worried about such imbalance which is a natural outcome of the pandemic’s lingering blow amidst which the economy has yet to fully recover.
Timewise, economic recovery came to a new crossroads in Q3, when it slowed to the point that China had a quarterly growth of as low as 4.9% and a two-year average growth of, again, 4.9%. The quarterly figure for Q3 fell by 3 percentage points from Q2, and the two-year average declined by 0.6 percentage points. Of the 12 major sectors in the Chinese economy, 10 witnessed slower growth in Q3 than in Q2 except for finance and commercial services whose growth matched that a quarter ago, with real estate and construction even finding themselves in the negative growth territory.
Structurally, the fall in general economic growth in China was mainly driven by a slower recovery in the tertiary and manufacturing industry. In Q3, the growth of the tertiary industry was 2.9 percentage points lower than in Q2, and that of manufacturing, almost 5 percentage points. The decline in manufacturing growth was mainly contributed by the large slowdown in September: the monthly growth of manufacturing was 2.4%, a sharp slide from the August height at 5.5%. Most of the 30 manufacturing subsectors in China recorded slower growth in September than in August; the same was with growth in their outputs of manufactured goods.
In October, China’s industrial added value increased 3.5% y-o-y, 0.4 percentage points higher than in September, mostly driven by the growth in the mining of 6% and that in electricity, thermal power, natural gas and water of 11.1% (mainly electricity). Growth in manufacturing in the month was 2.5%, only 0.1 percentage point higher than in September. Thus, the level of industrial recovery in China remains to be seen.
The slowdown in recovery in Q3, especially the decline in manufacturing in September, is a result of an array of factors – in my view, mostly a result of three constraints:
First is the sluggish real estate investment which has pushed construction and the real estate sector into negative growth – which is rarely seen in history. With a weak market and sliding investment, the real estate sector suffered a cash crunch, unable to buy or store lands, which in turn has pared down government receipts from land sales and dragged local infrastructure investment. This year, real estate investment as part of fixed-asset investment has been growing at a slower pace month by month, and in July, the new construction area began to experience a negative increase. The deep-seated reason behind this is that the traditional house price-led growth model, a triangle cycle among real estate, finance and local government infrastructure investment, needs to transform. This is a long-term issue mirrored in the near-term lens.
Second is the shortage in coal and electricity supply which has slowed manufacturing growth. China’s new raw coal mining capacity peaked during 2010 and 2014, with an annual increment of around 400 million tons. By 2018 and 2019, annual new capacity had come down to around 100 million tons; coupled with the state-led cut in outdated capacity, China doesn’t have much coal mining capacity in-store at the moment. Since March 2021, under several regulatory factors combined, growth in monthly coal production fell, with widened scissors with the growth of thermal power. The accelerated growth of thermal power and the slowed growth of coal production have resulted in a coal crunch, significantly pushing up the price of coal. At the same time, many of the local jurisdictions which had failed to meet the goals for the control of aggregate energy consumption and its intensity in the first half of the year began to implement related plans in August and stepped up these efforts in September. Some of the places have had power cuts; and many coal-fired power plants did not turn out unhappy about the outage given the coal price surge and the congested transmission of such price, which further aggravated the electricity supply strain. As a result, September witnessed a slash from August in thermal power generation across the country except for Fujian and Guizhou, with the sharpest fall by as much as nearly 10 gigawatt-hours of power generation in one single province. Thus, undersupply of coal and the rise in coal prices are among the reasons behind the power shortage in China, which has been further aggravated by the administrative restrictions on the power supply.
The third is the Covid resurgences across the country that have slowed the recovery of the service sector. The outbreak in some of the places in August took a bite out of the monthly growth in total retail sales of consumer goods which were as low as 2.5%, 6 percentage points down from 8.5% in July. It returned to 4.4% in September and 4.9% in October, but was still quite low. The consumption rate has fallen back to the level a year ago, that is, the share of per-capita spending in household disposal income reduced to 65.9% of the last year’s number. As a result, growth of the accommodation and catering sector slowed to 5.7% in Q3 from 17.1% in Q2; that of transportation, from 12.7% to 5.9%. In total, these have pared down the growth of the tertiary industry from 8.3% in Q2 to 5.4% in Q3, down by 2.9 percentage points.
II. MAIN CHALLENGES FACING THE CHINESE ECONOMY IN 2022
The first and biggest challenge is economic growth. China recorded a GDP growth in Q1, 2021 of 18.3%, a base figure large enough to put great pressure on Q1, 2022. Economic growth in 2021 will exceed the 6% target, but would still give a two-year average of 5% plus, lower than 6.1% back in 2019, falling below the 6% threshold into the 5% plateau. Despite the changes in the internal and external environment and the COVID-19 pandemic, and despite that this is a natural outcome when China turns to focus more on high-quality growth rather than placing too much emphasis on quantity of growth, this decline in GDP growth from 10% a decade ago to the current 5% plus, in retrospect, is still a bit too drastic.
Therefore, in 2022, to ensure that the economy remains well on track toward recovery, Chinese policymakers should focus on stabilizing economic growth within a reasonable range despite the pursuit of high-quality development. It would be very hard for businesses to play their role in promoting development without proper support and guidance from the government. Thus, the government must step up support to drive the business sector’s development. The target of regulation is to enable businesses to grow healthily, not to hinder their growth.
The second challenge is COVID-19. The pandemic is far from gone, and in 2022 it remains important to balance between Covid control and socio-economic development. More Covid resurgences would only put the economy to a halt again with a higher price to pay; but with timely and targeted control measures in place to minimize new outbreaks’ impacts on the people and economic activities, the blows to economic growth would be smaller.
The third challenge is the real estate sector. Real estate-related risks are no short-term ones. They would erupt sooner or later even if there had not been a pandemic. The underlying logic is that the triangle cycle among the real estate sector, finance and infrastructure investment by local governments no longer works. Even if we exclude the factor of administrative control, the house price hike is already reaching a plateau with weakened momentum.
The most deep-seated cause for this is the unbalance between slowed population growth and increasing concentration of population and economic activities. Such imbalance is a natural outcome of economic development in China, but the country’s administrative system has also played a part. For example, municipalities directly under the central government, provincial capitals and cities specifically designated in China’s state-level plan enjoy natural advantages over other types of cities in attracting production factors, and that’s why over the past decade these cities have had over 70 million new dwellers, equal to total population growth nationwide. This means that all newly added population in China has concentrated in these three types of cities. Behind the concentration of people is that of economic activities.
Houses in some of the cities today are just unaffordable to middle-income groups, and that would stem manufacturing growth and innovation, especially population growth over the long run. Worse still, lower population growth would hinder long-term development. Thus, it’s important to implement the decisions made at the 19th National Congress of the Communist Party of China (CPC) and the 6th Plenary Session of the 19th CPC Central Committee following the new population and economic situations today, and step up building a sound housing system with multiple types of suppliers and support channels that encourages both renting and buying with a series of reform measures.
The fourth challenge is energy and the structure of the energy sector. The lack of coal, lack of electricity, and power constraints indicate that China’s mindset, institution, technology, and policy are not fully prepared for the so-called “dual carbon” goal. The State Council recently released two regulation documents on “dual carbon”, along with some policy arrangements, such as increasing coal production, which could improve the decline in the manufacturing industry caused by a scarcity of coal and electricity this year.
The fifth challenge is household consumption, which is a long-term issue but also a run-up for sustained growth. Household consumption has always been the greatest shortfall in China’s economic growth. An increase in final consumption does not necessarily mean an increase in household consumption; it may well be government consumption increases, and the increases could be much higher. For example, China’s total consumption increased in 2020 due to COVID-19, but household consumption declined, while government consumption climbed by more than 400 billion yuan.
Fundamentally, low consumption results from low income. This is why China needs a bigger share of household income in its total national income as well as a fair balance between labour rewards and rewards on other factors. This is a must-answer question for China to achieve common prosperity and long-term growth. Therefore, the 2022 pandemic combat and economic growth should rely more on the expansion of household consumption, as it relates both to the present and to the future.
Ⅲ. THE RATIONALE OF THE 14TH FIVE-YEAR PLAN
China’s 14th Five-Year Plan begins in 2021, with the rationale of "new" – a new stage, a new concept, and a new pattern. The new stage signals the start of the comprehensive construction of a modern socialist country. The new thinking incorporates innovation, coordination, sustainability, openness, and sharing. The new pattern encourages both domestic and international circulation.
The three fundamental pursuits determine many subordinate norms, such as common prosperity – the nature of socialism. China was unable to achieve such ambition when building a moderately prosperous society, but with the country entering a new stage, it must be addressed, because common prosperity is a feature of Chinese modernization. It is also essential in the new pattern for consistent growth driven by household consumption. As we strive for the prosperity of all, the priority should always be development rather than distribution. High-quality development lays the groundwork for widespread prosperity.
In addition, the 14th Five-Year Plan contains many new references to the next five years, implying new duties and goals, all of which are dictated by fundamental thinking. For example, due to the unprecedented changes we are experiencing, security must be assured in the course of development; to be “systematic” is to optimize despite the constraints of multiple objectives, as is required in dealing with development and carbon reduction. The underlying logic also necessitates self-reliance on sci-tech, a stable share of the manufacturing industry, as well as the balanced development of finance, real estate, and the real economy.
I will focus on the new pattern, which includes, but is not limited to, the following tasks.
First, establish a comprehensive domestic demand system and improve the resilience of the supply and demand system. China's total supply and demand are balanced, but total domestic demand is less than total domestic supply, thus the supply and demand pattern must be optimized. The emphasis is not on the proportion of domestic demand. Since the global financial crisis, China's domestic demand has grown dramatically as a share of total demand. As a large economic country, however, China’s resources cannot support 100-trillion GDP and a good life for 1.4 billion people. The findings of empirical evaluations of domestic and foreign demand in other countries cannot be used to formulate China’s policies on the share of domestic or external demand. The proportion of domestic or external demand is, in fact, dynamic.
Therefore, a new pattern should focus on enhancing the resilience of the supply and demand system. When the international environment is favourable, there could be more exports and accordingly more imports, raising the share of external demand, as was the case last year and this year. In such cases, there is no need to limit exports for the share of domestic demand. Conversely, when exports slow, domestic demand should be able to fill the gap left by exports, as was the case in 2018 and 2019, but domestic demand was not resilient enough to fill such a gap, resulting in a decline in growth.
Furthermore, China's supply system should be able to respond to rapid changes in domestic and external demand; when there are export orders, the supply system should be able to fulfil export demand; and when exports weaken, the supply system should be able to quickly shift to meet the domestic need. According to the circumstances last year and this year, China's supply chain is more resilient and can swiftly satisfy the significant increase in international market demand despite the global spreading of the coronavirus. There is, of course, still room for improvement.
Second, expand household consumption and create a domestic demand pattern that features household consumption. To cope with the 2008 global financial crisis, China adopted a strategy to expand domestic demand, which took good effect. When compared to 2007, the proportion of exports in 2018 decreased by 12 percentage points while domestic demand climbed by 12 percentage points; in terms of domestic demand, the share of investment increased by 6 percentage points, government spending 3, and family consumption 3. In terms of final consumption, since 2002, the share of government consumption has increased by 3.2 percentage points, while household consumption has declined by 3.2 points. Although local demand has been able to drive China's economy, home consumption accounts for a minor portion of it. The issue is one of distribution. The problem lies in distribution.
Third, boost household income and its share in the national income distribution. In terms of primary distribution and redistribution, China's household income accounts for roughly 60%, which is 10 percentage points lower than that of major countries. In 2018, the share of labour remuneration in national revenue increased by 11 percentage points as compared to 2007. However, the fees of public health care and medicine, as well as employer-provided social insurance and housing provident funds climbed at a quicker rate. They are part of work rewards but do not contribute to disposable household income over the same period.
Therefore, promoting common prosperity on top of economic development requires a bigger share of household income in national income. The distribution structure determines that of domestic demand. A higher share of government and corporate income and a lower share of household income ultimately lead to a demand structure with high investment and government consumption. Determined by the demand structure, the production structure may encounter similar situations.
Fourth, strengthen sci-tech self-reliance and increase the share of independent technology in technological progress. One of the connotations of the new pattern is to protect the supply and industrial chain. The key is the intermediate inputs. If intermediate inputs are mainly made domestically, the industrial chain is highly secure, whereas reliance on imports makes the chain more vulnerable.
The industries that rely heavily on imports for intermediate inputs can be grouped into two main categories: resource-based products (oil, iron ore, soybeans, etc.) and high-tech products (communications equipment, computers, instrumentation, public utilities, etc.). The net import rate of electronic components can reach 37%, posing threats to the industry chain. The paucity of chips that has impacted China’s manufacturing industry this year indicates China’s inability in sci-tech innovation. It is time to fortify the core technologies.
However, sci-tech independence does not mean that we should do everything; imports are still necessary. We must adhere to a high-level opening, giving full play to the advantages of a large market, so that technological progress could be gained both by ourselves and through introduction, absorption, and reinvention.
Fifth, enhance supply-side reforms and improve the match of the supply system and demand structure. The production follows the pattern of demand, and production also reacts to demand, impacting the volume and structure of demand. Supply creates demand only in areas where supply determines demand. For example, if there is no product innovation, there will be no need for such products; however, if material products are made on a huge scale, demand may lead to supply.
As a result, to strengthen the structural reform on the supply side, we need to unblock the flow of production/supply, distribution, and demand. In production, the proportion of manufacturing industries should be kept stable; high-tech, consumer goods, and service industries, which are undersupplied domestically, should be enhanced to fulfil upgraded consumption. In distribution, we could change the national income distribution by moderately increasing the proportion of labour rewards and residents' income to national income. In demand, some measures should be taken to lessen the burden on households for consumption to stabilize the consumption rate.
Sixth, improve the high-level opening and smooth the dual circulation. With China’s economy integrated into the global economy, the international and domestic circulations are inextricably linked, which remains true even amid the pandemic. China’s production is inseparable from imports, as 70% of total imports are used as intermediate inputs. In 2018, all 42 categorized sectors of China’s national economy required imports for production. The vast majority of the 42 categories have exports, with only five purely domestically circulated, namely water and gas production and supply, real estate, technical services, and education. In terms of exports and imports in the 42 sectors, the majority of industries in China are involved in both circulations.
In the face of a complicated and changing international environment, we need to promote domestic demand and sci-tech self-reliance, but it cannot be a one-sided endeavour. The dual circulation cannot be measured by the "troika" of demand, nor can rapid economic growth be sustained without foreign markets. As a "world factory" and a "world market," China needs both domestic demand and opening up. The two sides are mutually reinforcing. We should learn to open up in a complex and grave international environment.
This is the speech made by the author on December 2 at the Sina Finance 2021 Annual Conference. The views expressed herein are the author’s own and do not represent those of CF40 or other organizations.
