“East is rising, west is falling,” according to the Chinese Communist Party (CCP) story. Many outside of China take his “inevitable rise” as read. On its way to become a “modern socialist country” by 2035 and to become rich, powerful and dominant by 2049, the centenary of the People’s Republic, China wants to boast as its GDP exceeds that of the United States, and its power-based its growing economic weight.
However, there is a critical flaw in this story. The Chinese economy may not be able to catch up with the US as it succumbs to the proverbial middle-income trap. This is where countries’ relative development progress against wealthier countries stalls, and is normally characterized by difficult economic adjustments and often unpredictable political consequences.
Historically, China’s miracle of growth has been remarkable. In the 30 years to 1990. Money GDP (the market value of goods and services produced in an economy) for China and the US in US dollars grew more or less simultaneously at just over 6% and 8% per year, respectively. . But over the next three decades, China’s GDP growth doubled to more than 13%, while America’s halved to 4.5%. That pushed China’s GDP up from 5% of US GDP to 66%.
Yet China’s growth spurt is now over and the huge gap in GDP growth has been eliminated. In recent quarters, China’s GDP has grown at half the rate of the US. While that discrepancy is likely untenable, America’s $9 trillion GDP margin versus China means similar GDP growth rates will support and even extend the margin going forward. A Japanese think tank recently extended the date it expects China to overtake the US from 2029 to 2033. This kind of delay is now a possibility, and more will come.
However, the problem is less about the math and more about why China is at a turning point.
Remember we have been here before. In the 1930s, Germany would dominate Europe, if not the world. In the 1960s and 1980s, the Soviet Union — which had already stolen a march to the US in space technology — and later Japan, which was the emerging economic force on the planet, would overtake America within 10 to 20 years to achieve the dominant economic and technological power.
History was not kind to the consensus. There is a serial tendency dating back to the 1920s to underestimate the self-correcting capacity of American institutions and corporations. Similarly, the Soviet Union and Japan both pursued similar models of development, based on distortions that emphasized unsustainable and excessively high savings, high investment, and ultimately high debt. Their development models cracked with spectacular consequences due to chronic failure of institutions and governance.
China is our 21st century version of this phenomenon. The investment rate is over 10 percentage points of GDP higher than at its peak in the USSR and Japan, and is strongly associated with capital misallocation and inefficiency, and widespread debt service problems.
Zero Covid policies could maintain barriers between China and the global economy until 2023 or even beyond, but that aside, a prolonged slowdown in trend growth exacerbated by over-indebtedness and the tipping point now in real estate, as illustrated by the crumbling development giant Evergrande, is already underway. China’s $60 trillion real estate sector is four times the size of its GDP and accounts for a quarter to a third of its annual growth. It faces years of tricky adjustment, not least as developers deleverage, buy the age cohort contracts for the first time and probably as real estate prices fall.
Moreover, China’s economic structure is unbalanced. It has a per capita income equal to Mexico, but its per capita consumption is no higher than Peru. Consumer spending represents about 37% of GDP, slightly higher than in 2010 and much lower than in 2000. Productivity growth, closely linked to liberalizing reforms, has stalled.
China’s development model urgently needs a makeover to avoid the middle-income trap. The longer it is delayed, the greater the cost. Chinese leaders recognize the need for change, and Xi Jinping recently revived the slogan of “common prosperity” to mobilize the Communist Party and citizens around a strategy to reduce income and regional inequality and improve living standards.
Yet these political goals require exactly the kind of liberalizing, progressive and redistributive reforms of the economy that Xi Jinping opposes. He has pursued an increasingly ideological and totalitarian style of government in which the already dominant position of the party and state in the economy has been further strengthened.
He has perversely created a contradiction in which even the CCP’s expertise in dialectical argumentation may be of little help. The recent deluge of new laws and regulations targeting private companies and entrepreneurs, for example, aims to push back party control and elevate the private sector to a political level. This is hardly compatible with the productivity growth and innovation on which China’s lofty economic ambition depends.
Catching up with the United States takes a lot more than just a story. It requires policies that Xi’s China opposes, and it could just remain a mirage. The consequences for China and the rest of the world have not been well thought out.