China’s macroeconomic strategy can contain the fallout from Trump’s tariffs
The Australian National University
In Brief
Slowing growth and the impact of US tariffs have made the shift to a consumption-led economy both an economic and geopolitical priority for China. Weak domestic demand is driven less by shortcomings in the social safety net, as is commonly argued, and more by the troubled real estate sector and heavy local government debt, which are weighing on household spending. If Beijing can resolve these structural issues and boost consumption, it could raise living standards, ease trade tensions and help support global growth as the US economy slows.
Warning signs are flashing all over the global economy. Five years after a pandemic-induced recession that was basically unavoidable, we seem to be heading towards one that is nearly all the fault of bad economic policy. A terrible jobs report in the United States suggests that President Donald Trump’s trade war may be starting to bite domestically.
The latest US services sector data paints an ominous picture: rising input costs combined with stagnating employment. It’s still a little early to start forecasting stagflation — declining output with rising inflation — but it’s certainly a live possibility. Pity the US Federal Reserve, which will soon face the unenviable decision of whether to acquiesce to Trump’s constant demands for lower interest rates to stimulate growth or to stick to its inflation-targeting mandate and keep rates steady.
The United States, however, is no longer the predominant factor in the global economy it once was. And while the other great motor of the world economy, China, is clearly slowing to the kind of growth rates that middle income economies typically see, it is still growing, and Chinese demand will continue to play an important role in driving global growth given the country’s weight in the world economy.
For well over a decade, China has been promising to transition to a new economic model driven by domestic consumption, reorienting away from an investment-led, export-focused model.
An economic strategy that is focused more on the domestic market is rapidly becoming a geopolitical necessity for China. As Jiao Wang explained early this week, despite the enormity of the macroeconomic shock of the trade war, Chinese firms have responded relatively nimbly to the huge roadblock that US tariffs have thrown in their path. Yet there is no untapped market that can fully replace the United States as a source of demand for Chinese goods.
Chinese progress on this front has been slow. The latest national accounts figures suggest that the contribution of consumption to overall economic growth is rising, but is still well below levels seen prior to the Covid-19 pandemic. Part of the problem lies in the difficulty in knowing which policy levers are most likely to push Chinese households towards higher consumption. Stimulus measures have included subsidies for trading in durable goods and, more recently, interest subsidies for consumption loans. It is too early to know how effective these measures will be in shifting the dial.
In this week’s lead article, Yang Yao argues that China’s difficulties in shifting towards a consumption-led model have been misdiagnosed. The common theory that a weak social safety net produced large family savings is hard to square with the fact that the safety net for urban citizens — and it is urban citizens who are responsible for most of the saving — is much stronger than is commonly recognised. Rather, Yao suggests, ‘there are two elephants in the room that the Chinese authorities consciously avoid linking to weak domestic demand — the declining real estate sector and local governments’ fiscal deficits’.
It is hard to deny that the troubles in the real estate sector have weighed heavily on Chinese growth. Despite avoiding the worst predictions of financial contagion from the collapse of real estate giant Evergrande in 2021, property prices have been declining consistently, and it is only because of massive state intervention that a more serious crisis has been averted. As Yao argues, the difficulties of real estate extend beyond the sector itself. A stagnant property sector also means lower investment in durable goods, and declining property prices induce nervous homeowners to cut back on spending.
Local government finances, the other drag on growth, is according to Yao ‘a more serious problem’. It’s also a problem that is hard to quantify, given the opaque nature of local government budgets, but it is clear that local government debt accounts for a substantial fraction of the country’s overall burden. Last November Beijing unveiled a new strategy to repair balance sheets, effectively by allowing local governments to restructure ‘hidden’ debts by issuing special bonds. Though Beijing is eager to tout the effectiveness of its efforts to reduce subnational indebtedness — Inner Mongolia, for example, recently exited Beijing’s list of high-risk provinces — there will doubtlessly be more pain to come before China gets local debt under control.
China’s journey to a more consumer-oriented economic model, long heralded and long delayed, is fast becoming an imperative for a country whose manufacturing exporters are being systematically shut out of North Atlantic markets — creating new diplomatic tensions as other countries fear the impact of a glut of Chinese manufactured goods on local industries. If Beijing is successful in engineering this structural shift in its macroeconomic policy strategy, it will mean rising living standards for Chinese citizens as they move from saving to consuming and, at the same time, addressing a sore point in relations with key foreign partners over the ‘overcapacity’ problem.
As the American economy threatens to tip into recession, the world could look once again to Chinese demand to cushion the effects on global growth.
The EAF Editorial Board is located in the Crawford School of Public Policy, College of Law, Policy and Governance, The Australian National University.