As the world navigates financial and geopolitical turbulence, one key question is how China will fare amidst the maelstrom of volatility. 2022 has not been kind to the world’s second-largest economy, as the country navigates a crashing housing market, a hardline zero-COVID policy, and high rates of both inflation and youth unemployment. We asked Christian Lundblad, Senior Associate Dean for Faculty and Research & Richard “Dick” Levin Distinguished Professor of Finance, UNC Kenan-Flagler Business School, about what this year’s downturn means for China, and how the country’s COVID policies affect its economic standing.
A recent World Bank forecast projected that growth in the rest of Asia is expected to outpace China for the first time in over two decades. The OECD and Asian Development Bank also recently downgraded China’s growth prospects. Do you agree with these forecasts, and what is your perspective on long-term Chinese growth?
China’s growth story is a complicated one, to be clear. There are at least three components that deserve attention. First, the good news for China is that this is now a largely middle-class country. From 1978 to the global financial crisis, China managed a truly remarkable transition up the development ladder; I say remarkable because the pace of growth is simply not mirrored elsewhere in human history. However, the cost of that success is that the low-hanging fruit are picked. Even if things continue to progress for China, baseline rates of growth should slow, and eventually were China to make it to full high-income industrialized status, its growth rate should face the same technological speed limits that we face in the U.S. and Western Europe. So, Chinese growth should be slowing exactly as a result of their success. Second, despite this success, the Chinese economy significantly misallocates important financial and labor resources. State-owned and controlled firms and banks play too large a role in the allocation of scarce resources, relative to allocations based on compelling business ideas and market forces. The costs of that are real, particularly when one appreciates the reality that it is much easier to move from low-income to middle-income than from middle-income on up. Development economists have a name for this – ‘the middle-income trap’ – and China is in real danger of finding itself stuck. In fact, the necessary step to high-income status involves hard institutional reforms from which the current Chinese leadership is frankly moving away. Resource misallocation is costly (think Chinese real estate and the associated debt burdens of non-performing loans), so growth is also slowing because of the inevitable costs of such misallocation. Third, we have the very unusual moment of China’s zero-COVID policy. There are very real economic costs of shutting down critical components of one’s economy, and this approach is creating major headwinds.
How much has China’s zero-COVID policy affected its economic prospects?
China’s zero-COVID approach is, simply put, a mistake. No one argues that a lockdown is effective at limiting the spread of the virus; however, a lockdown policy carries with it tremendous costs along other dimensions. The economic implications alone are sizable. While it’s hard to say for sure how much this has trimmed off Chinese economic growth, one can guess that it is at minimum several percentage points of GDP if not much more. Instead, policymakers should internalize these uncomfortable tradeoffs, and a singular focus on virus transmission is simply an incomplete characterization of the problem. Further, from a purely human perspective (think beyond just GDP points), one must weigh the additional implications of a lockdown for mental health, anxiety, depression, student educational attainment, and so much more. When the lockdown debate was raging in the U.S. back in 2020, we at the Kenan Institute wrote about the need for a more holistic approach to the internalization of these tradeoffs.
Nevertheless, for a moment, go back in time. As the rest of the world was struggling mightily with the virus in 2020, China’s categorical response looked like a real winner. However, thanks to remarkable medical advancements that have allowed us to significantly reengage with one another, global economic activity has largely bounced back. I would contend that we are approaching whatever post-COVID normal is going to be. However, despite the successes outside of China, its continued isolation has instead yielded a situation in which that earlier short-run success has been replaced with a very dire reality. They are reluctant to engage with the medical advances that have allowed the rest of the world to move forward nor have they learned from the evolving approaches we have developed to navigate these competing tradeoffs with better, more holistic thinking. For example, they have had little virus or mRNA vaccine penetration – and frankly, both are necessary. In a way, all that we had no choice but to work through over the last couple of years still lies ahead for China. China’s singular focus on virus transmission has left it stuck in a sort of 2020 stasis chamber. In sum, the tremendous economic costs that the Chinese people have suffered have little relation to what still must come. So why make this mistake? The reality is that the approach is driven more by political narrative. The current leadership has attached its legitimacy to COVID transmission in a way that is long-run unsustainable. I can’t predict how this will play out, but I will caution that the intermingling of political power with what should be sober policymaking is unfortunate.
Last, I would say that the self-isolation of China has only exacerbated the growing fault lines that exist between it and the rest of the world. At an individual level, we simply aren’t talking to one another, learning about each other’s challenges, or seeing each other’s humanity. Items such as global travel and economic activity, and student engagement are important forces that engender understanding even if they fall short of collaboration or conflict resolution. At a minimum, I fear economic fragmentation – deglobalization is a risk that could prove economically costly. Every firm or investor engaged in significant global activity must have a clear articulation of what global fragmentation means to them. Worse, at a much higher altitude, we are facing a very dangerous situation where a misunderstanding could lead to miscalculation.
I firmly believe that China and the rest of the world should be competing like mad in the economic arena; competition sharpens the mind and promotes innovation—thereby making us better off. We are all far better off competing in that arena than on other, far more dangerous battlegrounds.