The Current and Future State of the Chinese Economy

While the recent travails of the Chinese economy may have cost it some of its mystique, there are hopes that the worst of China’s recent economic slowdown may be over.  In fact, in many sectors of the Chinese economy, confidence levels appear to be rising, as fears over a hard landing for the Chinese economy appear to have not come to fruition, for the time being.  Nevertheless, a number of significant threats to the health of the Chinese economy remain in place and the potential for an even greater economic downturn for the world’s second-largest economy remains dangerously high.  Regardless, China’s role in the global economy is now so important that, whatever happens in China in the coming months and years, there will be major repercussions for the wider global economy, hence the great interest in the threats facing the Chinese economy.

Those who feared a hard landing for the Chinese economy were comforted by the fact that China’s official economic growth rate for the third quarter of this year was 6.7% on a year-on-year basis, exactly the same level of growth recorded in the first and second quarters of 2016.  As has been the case over the course of this year, this relatively strong growth in the third quarter was driven by the continued expansion of China’s consumer sector, with retail sales growth remaining above 10% in recent months.  In fact, consumer spending now makes up a larger share of Chinese economic growth that at any time in the country’s history. 

This high level of consumer spending helped to offset lower levels of fixed-asset investment in China, as well as the relatively sluggish performance of the country’s industrial sector that has been hit hard by the downturn in export revenues over the past two years.  Overall, the reorientation of the Chinese economy away from its dependence upon manufactured exports for much of its growth and towards a growing reliance upon Chinese consumer spending continued in the third quarter, and this trend appears set to continue for the foreseeable future. 

While China’s economy appears to have stabilized this year in the wake of the extreme volatility of 2015, the country faces some very real threats to its economic well-being that, if not handled properly, could lead to a serious economic slump.  Over the near-term, a growing threat to China’s stability is forming as debt levels continue to rise to dangerous new heights in China, driven by the recent expansion of credit that has been used to offset the decline in growth in other areas of the economy. 

Furthermore, demand in many of China’s key export markets is forecast to remain relatively weak over the near-term, holding back prospects for an export-driven recovery in China.  In addition, China’s volatile real estate market continues to be a serious threat to the country’s economic stability and could severely impact the consumer sector in China, the sector that is playing an increasingly important role in driving Chinese economic growth.  As such, the potential for a new round of extreme volatility in China over the near-term has not dissipated. 

China also faces a series of threats that could harm its ability to continue to expand at a healthy pace over the longer-term.  First and foremost, China’s economic competiveness is waning.  By many measures, China remains one of the most competitive economies in the world, with a huge labor force, low labor costs (in some areas of the country), relative stability, an improving infrastructure and huge economies-of-scale advantages. 

However, many of these competitive advantages are being eroded by emerging market (and some developed economy) competitors, particularly elsewhere in Asia.  Moreover, overcapacity continues to be a serious threat to many of the key sectors of the Chinese economy as years of over-investment have resulted in serious overcapacity issues that have worsened as demand levels have failed to meet expectations in many of China’s key export sectors.  Finally, China’s demographic situation poses a serious long-term threat to the health and competitiveness of the country’s economy, as China’s working- and consuming-age populations are forecast to decline significantly in the decades ahead. 

As such, it is clear that China faces a series of near-term and long-term threats to its economic well-being and managing these threats will be a major challenge for the country’s decision-makers in Beijing.  How China manages these threats will play a major role in determining the direction of the global economy in the coming years and decades, as China has emerged as the leading driver of growth for the global economy.  Thus, the threats to China’s economic future are also threats to the economic futures of most of the world’s leading economies.