Why China’s best days are already behind it

China father and daughter with Chinese flag - AP Photo/Mark Schiefelbein, File
China father and daughter with Chinese flag - AP Photo/Mark Schiefelbein, File

For decades, China’s growth stunned the world. The country’s transformation into the “workshop of the world” unlocked what has been dubbed an economic miracle.

Now, however, the clouds are gathering over the world’s second-largest economy.

For the first time in more than 60 years, China’s population is shrinking. Growth is slowing. Western investors, for years a source of capital for growth-hungry Chinese businesses, are shunning the country. China’s lucrative tech sector is stumbling. And a slow motion implosion is playing out in the country's debt fuelled property sector, triggering billions in losses across the financial sector.

“I think people have to get used to the idea that in the next five to 10 years China's growth rate will be quite pedestrian,” says George Magnus, an economist at the China Centre at Oxford University. “It won't be the force in the world economy that it has been in the last 10 or 20 years.”

The evidence suggests China has passed its peak economically, according to Magnus, the author of “Red Flags: why Xi’s China is in Jeopardy”.

GDP expansion has come to a juddering halt after a year of zero-Covid policies followed by an explosive outbreak of the virus.

While 2023 will be a year of post-Covid recovery, with normal life resuming and consumers spending money again, the country will struggle to get back to the dynamism it enjoyed in the early part of this century. Growth stalled to 3pc in 2022, dropping from 8.4pc a year earlier.

Compared with many Western countries, 3pc is high. For China, however, it is the lowest growth in 46 years, barring the height of the pandemic in 2020.

The era of double-digit growth is “all finished now”,  Magnus says.

“That ended really in the 2000s. The growth rate in China has been halving each decade. So it halved from about 10pc to 5pc between the 2000s and the 2010s. And it's going to halve again in my view from about 5pc to about 2.5pc between the 2010s and the 2020s.”

Capital Economics, a research business, predicts the Chinese economy will grow 5.5pc this year. The conditions are ripe for a short-term growth spurt according to chief Asia economist Mark Williams. But like Magnus, he warns that looming structural issues will resurface before long.

“Everything is aligning for near-term strength,” he says. “But the structural challenges that China faces haven’t gone away.

“Its population is shrinking. The economy still runs on debt-funded investment, in property and infrastructure, that no longer delivers rapid long-run growth. The advanced economies are restricting China’s access to cutting-edge technology.

“China’s economy is getting back on its feet but it can’t run like it used to.”

2022 marked a historic turning point for China as its population fell for the first time in 61 years, shrinking by 850,000 to 1.4bn according to The National Bureau of Statistics.

The decline is the product of Beijing’s decades-long policy of restricting how many children couples can have, motivated originally by fears that overpopulation would exhaust resources.

Couples were restricted to one child from 1980 onwards. The policy was relaxed to two children in 2016 before being scrapped altogether in 2021.

However, Beijing has struggled to boost birth rates given the fact China’s entire society has for decades been oriented towards single child families. The country’s fertility rate has in fact declined since the two-child policy was introduced, according to the World Bank.

India is now set to overtake it as the world’s most populous country this year, according to UN projections.

A shrinking population “aggravates” other issues, according to Magnus. China, like much of the developed world, now faces the prospect of an ageing population that will put ever greater financial strain on its workers.

Even now, the economy is stuttering. A massive credit bubble, which drove China’s bumper growth over the past decade, is starting to unwind.

“There's a lot of debt in China, it's over 320pc of national income. A lot of that debt is uncommercial. Borrowers are finding it very, very difficult to keep current with their interest payments and paying off their loans,” Magnus says.

The unwinding of this debt bubble is triggering serious problems in the property market. Analysts at UBS estimate that China’s real estate slump will cost the nation’s banking system as much as $212bn (£170bn) in losses on loans, bonds and other assets.

The country’s finance industry has already lost ground to rival Asian centres like Singapore in recent years. Many international banks have turned their backs on Hong Kong in the face of draconian Covid restrictions that have made it difficult to do business there in recent years.

China's tech sector has also lost its lustre. Revenue growth at some of its biggest companies, including e-commerce giant Alibaba and games company Tencent, has slowed as Beijing has turned its draconian glare on the industry.

“The government in the last several years has taken a much more authoritarian and controlling view about its relationship with private firms and entrepreneurs. Lots of private firms and entrepreneurs have had their wings clipped,” Magnus says.

The most public example was at Alibaba. After founder Jack Ma criticised regulation in a speech in October 2020, Beijing launched an intense crackdown on Ma’s business empire that derailed plans to list his financial business Ant Group. Ma himself disappeared from public view for three months.

While Beijing has exerted greater control over tech, it has come at a cost. Revenue from customer fees at Alibaba, China's answer to Amazon, fell by 7pc in November.

In recent months, President Xi Jinping has given signals that the tight grip on tech could be easing. This week, ride-hailing company Didi announced it had reached an agreement with China's authorities to begin adding new customers to its app again. Didi had been forced to pull its US listed stock due to data concerns from Beijing.

However, the damage is done. China's position as the world's tech manufacturing hub has been severely weakened and US companies are seeking to reduce their exposure to the country.

Apple is a prime example. It has relied on Chinese labour to manufacture its iPhones since they were first released in 2007 but has now begun to shift manufacturing to markets such as India and Vietnam.

Apple has good reason to fear disruption - trade barriers are being erected. The White House has moved to cut off China's access to Western tech as geopolitical tensions rise. Using sweeping sanctions, it has blocked Chinese tech companies from accessing advanced chip designs and Western machines used to build semiconductors.

“There are conflicts, there are tensions and those are not going to be swift to resolve,” says Karen Jackson, a Reader in Economics at the University of Westminster who specialises in trade policy.

Restrictions like these can act as a drag-anchor on China’s growth.

Not everyone is convinced China's star is waning. Diana Choylev, the chief economist at consultancy Enodo Economics, believes the clash with the US will cement China's importance on the world stage.

“The all-encompassing geopolitical confrontation between China and America, and the Great Decoupling it has led to, is by far the most important force driving global politics and economics,” she says.

As the West turns away from China, Beijing is looking to Moscow. When Xi Jinping and Russian President Vladimir Putin met in Beijing last February, they issued a joint statement asserting that the friendship between the two knew "no limits" and had "no ‘forbidden’ areas of cooperation”.

Magnus says: “I think the Chinese and the Russians basically see a moment in time when they think the West is in terminal decline and they see their moment, rightly or wrongly, to exploit that.”

However, that appears to be wishful thinking. With problems mounting at home, Xi’s focus will increasingly be domestic as Beijing battles to recapture the momentum that has powered China to the top table on the world stage. It is a difficult struggle – all the signs suggest the country’s best days may be behind it.