China ready to support growth by investing more in domestic technology and redistributing income
For decades, China has been the engine behind global growth. In fact, from the Great Financial Crisis (GFC) of 2007-09, including the period before and after the pandemic, China was responsible for 37% of total global economic expansion. In the past year alone, China’s growth has added to the world an amount equal to the combined GDP of France, or more than $2.8 trillion. It is important to note that China’s overall demand expansion has a high multiplier effect, which often spills over into commodity prices, emerging markets and other open economies.
In recent quarters, however, internal factors have contributed to a sharp economic slowdown in China. This slowdown is due to the “zero covid” policy, which has led to a shutdown in China’s Tier 1 cities, restrictions on bank lending to the indebted real estate sector and aggressive regulatory measures across all sectors. As a result, China’s growth in the second quarter stagnated and the worst economic performance in decades contributed only 4% to overall global growth in the period.
China’s contribution to global GDP growth
(nominal USD, total contribution for the period in %)
Sources: Haver, IMF, QNB analysis
Given China’s importance to global growth, as well as the country’s recent economic slowdown, it is no surprise that investors, economists and policymakers have been watching the National Congress closely. The Chinese Communist Party (CCP), which meets twice a year, to find clues about what the future of the Asian giant will be. The CPC National Congress has secured President Xi Jinping a third five-year term as leader of China. It also gave a new generation of officials access to key positions within the CCP.
In our view, Congress has yet to ratify China’s 14th Five-Year Plan, approved two years ago in 2020. This plan, which is based on the idea of ”dual circulation”, emphasizes the growth of exports (international circulation) and expansion of domestic demand, primarily driven by the increase in consumption (internal circulation). The idea is that the “dual circulation” will support, boost and strengthen the country’s manufacturing base, which is the engine of successful future development, according to Chinese leaders.
Estimated development of nominal GDP in the United States compared to that of China
(US$ trillion, 2000-2027)
Sources: Haver, IMF, QNB analysis
Correct execution of the “dual circulation” program is essential for China to maintain high growth rates – above 4% – and overtake the US as the world’s largest economy within the next decade. Congress therefore decided to focus on two major areas to implement the “dual circulation” program, which, however, requires significant political and fiscal commitments.
First, China will need to invest heavily in domestic science, technology, research and development to increase self-reliance and self-improvement. This point has become particularly important and urgent after recent geopolitical events in recent years. Since the trade war between the United States and China, the tightening of export controls on American technologies and the sanctions imposed on Russia after the invasion of Ukraine, China has had difficulty importing the technological advances. A complete reorganization of the high value chain and the Chinese technology industry may be necessary. Innovation-heavy segments such as artificial intelligence (AI), quantum computing, semiconductors, health sciences and the space industry should be preferred. This, of course, will allow China to remain competitive abroad and continue to strengthen demand for its goods and services abroad.
Second, to achieve the “internal circulation” part of the “dual circulation” equation, China will need to further promote the redistribution of domestic income. The absence of more mature social protection structures encourages Chinese households to be cautious and to save more than spend, making it even more difficult to significantly increase domestic consumption. The only way to break this cycle is to change the incentive structure in the country. More direct transfers and social benefits would reassure Chinese households and make them more willing to spend a larger share of their income and savings. This will promote growth in personal consumption. This requires a change in the composition of public sector resource allocation, investing less in real estate or physical infrastructure and increasing tax transfers to social security programs.
Overall, the lineup of new senior officials from the CPC National Congress under President Xi Jinping reinforces recent economic policy changes, including technological autonomy and income redistribution. We believe that China will successfully transition to a dynamic “dual circulation” growth model. This should make it possible to maintain a growth rate in GDP above 4% over the next few years.