China is on a mission to transform its economy by encouraging “new productive forces,” a phrase that was reasserted during the recently completed Third Plenum of the Chinese Communist Party (CCP), a twice-a-decade policymaking meeting.
To anyone paying attention to the Chinese economy, this phrase has been reiterated many times in the last year as CCP leader Xi Jinping tries to shift the country’s economy away from its traditional growth drivers, which are mired in various forms of decline.
Beijing wants to diversify China’s economy away from export-driven industry, debt-fueled investments, and real estate—which have powered its growth for decades—and toward innovation, technology, scientific research, and domestic consumer consumption.
The nation’s economy and the CCP’s credibility both depend on Beijing pulling this off. The two key questions are: Can it work, and will it make up for (offset) the decline in other sectors to prop up the economy?
The jury is out on the first question and will take years to conclude. CCP officials made their arguments again during the plenum.
Details were disappointingly scarce from the official communiqué post the plenum meeting. While Party officials reemphasized the country’s goals—which have been repeated in the past—they also acknowledged the challenging path ahead to implement these economic policies.
“It is a re-packaging of the new development framework as emphasized since the 19th Party Congress in 2017. ... It does not shift the policy priority to economic growth, nor does it shift the focus to security or self-sufficiency,” a JPMorgan note to clients summarized the recent CCP policy meeting.
It is not an easy task to holistically shift China’s economy using a mix of planned and market-based policy changes.
“Pushing forward Chinese-style modernization faces many complex conflicts and problems, and we must overcome multiple difficulties and obstructions,” Tang Fangyu, a deputy director within the CCP’s policy research office, recently told reporters in Beijing.
The second question is more poignant as we watch China’s economy transition in real time. There is immense pressure to show results, or at least progress, as consumer and business sentiments are at record lows, and the traditional growth drivers of infrastructure investment and real estate are in deep doldrums.
Given that technological innovation will take years, the CCP has been hinging its hopes on the domestic consumption economy to fill the gaps in the near term. This is the single most important determinant of the Chinese economy’s trajectory.
But so far, household consumption has severely disappointed.
Retail sales growth was only up 3.7 percent in the first half of 2024, while disposable income per capita grew 5.4 percent during the same period, according to official statistics. In other words, Chinese consumers have been saving, not spending.
Official data from the People’s Bank of China showed that Chinese households added 9.27 trillion yuan ($1.3 trillion) in new deposits during the first half of 2024. That figure is 22 percent lower than the first half of 2023, but retail sales have not increased. In fact, June retail sales rose only 2 percent year-over-year, the lowest growth in a year and a half.
So far, Beijing officials have not been able to coax consumers to spend. Chinese household spending only accounts for 39 percent of the country’s economy, while the average among OECD (Organization for Economic Cooperation and Development) economies is around 54 percent.
And actual figures could look more bleak than official stats. “Alternative data series point to declining household spending in 2022 and only a modest recovery in 2023 and early 2024,” the Rhodium Group wrote in a July 18 report on Chinese consumer spending.
There are deep-seated structural issues holding back consumption. One is relatively low levels of household income and extreme inequality of income. “Reducing savings rates alone is unlikely to boost overall spending significantly, given the low levels of savings among lower-income households,” opined Rhodium Group.
But even high earners are tightening their purse strings. Perhaps the most visible sector of Chinese consumption, luxury goods retailers, have already sounded the alarm. Swatch Group, in its quarterly earnings release last week, said there had been a “sharp drop in demand for luxury goods” in China. Luxury goods retailers, including Burberry, Richemont, and Hugo Boss, all reported significant drops in Greater China sales.
One traditional growth engine—which the CCP has been trying to diversify away from—that has temporarily boosted the Chinese economy in 2024 has been manufacturing and exports. Powered by strong foreign demand and CCP subsidies, the manufacturing sector has been able to offset lagging investments, real estate growth, and consumption.
But this boon could be fleeting. There’s bipartisan support in the United States for increasing tariffs on Chinese goods. Former President Donald Trump recently floated a flat 60 percent tariff on all Chinese-made goods should he return to the White House.
While China has warned that increasing tariffs significantly would be a double-edged sword, hurting the U.S. economy, the actual consequences are still to be determined. The last flurry of tariffs, enacted by the Trump administration in 2018, did not significantly increase U.S. inflation nor bring about material negative effects.
The Biden administration kept portions of former President Trump’s previous tariffs on China intact and even increased tariffs for some sectors, such as electric vehicles. This signals that hawkish pressure on China will likely remain, and there’s little resistance in Washington to tamper down tariffs on China.
Goldman Sachs recently estimated that a 60 percent tariff would cut Chinese GDP by 2 percent-points. Analysts at UBS calculated a 2.5 percent hit, or roughly half of China’s estimated GDP growth.
The efforts to rebalance and rewire China’s economy just got even more arduous.
