CHINA HAS freed its economy from the lockdowns, quarantines and other restrictions of its “zero Covid” regime this year. But it hasn’t rid itself of longer-term worries about its growth prospects. Its population is shrinking. The epic real estate boom is over. Thanks to a regulatory crackdown on e-commerce companies, the Communist Party has intimidated the tech billionaires they once courted. Jack Ma, a former teacher-turned-one of China’s most famous entrepreneurs, has returned to teach – in Japan.
The Communist Party today prioritizes security over prosperity, size over growth, strong self-reliance over the delicate interdependence that has characterized China’s past economic success. Foreign investors are more cautious and are looking to relocate or at least diversify their supply chains. And America is keen to restrict Chinese access to some “basic technologies.” The economy of mutual benefit has given way to the geopolitics of mutual distrust.
All of this has led many analysts to lower their long-term forecasts for China’s growth, although they are raising forecasts for this year. Some wonder how much longer China’s economy can grow faster than America’s. The answer will involve far more than just factory jobs or personal income. It will shape the world order.
The consensus so far, both inside and outside China, was that its economy would soon eclipse America’s. This, in turn, would allow China to become the world’s leading military power, ousting America as the world’s most powerful country. This remains a common view. Yao Yang, a respected economist at Peking University, believes China’s GDP may overtake America’s GDP by 2029.
However, others believe China’s economic power is peaking relative to its peers. Hal Brands and Michael Beckley, two American political scientists, argue that China’s rise is already faltering. The age of “Peak China,” as they call it, is upon us — and it’s a far less Olympic peak than most predicted.
In 2011, Goldman Sachs predicted that China’s GDP would surpass America’s GDP in 2026 and grow by over 50% by mid-century. No summit was in sight. At the end of last year, the bank revised its calculations. It is now believed that China’s economy will not overtake America’s economy until 2035, peaking at just 14% larger (see chart).
China’s peak looks similar in an influential forecast last year by Roland Rajah and Alyssa Leng of the Lowy Institute, an Australian think tank. Others see an even lower peak. Research firm Capital Economics argues that China’s economy will never be number one. In 2035 it will reach 90% the size of America and then lose ground. As far as the peak China thesis can be captured in a single projection, it is.
What is the reason for the lower expectations for the Chinese economy? And to what extent is a reduction justified? The answers depend on three variables: population, productivity, and prices. Start with the population. According to official statistics, the labor force in China has already peaked. There are 4.5 times as many 15-64 year olds as America. According to the UN “median” forecast, by the middle of the century there will only be 3.4 times as many. By the end of the century, the ratio will drop to 1.7.
But China’s demographic outlook has changed little over the past decade, even as forecasts for economic growth have come down. In fact, the new forecasts from Goldman Sachs assume a gentler decline in the Chinese workforce than the old ones as health improvements may keep older workers at the grindstone longer. The bank expects China’s labor supply to fall by about 7% from 2025 to 2050.
The biggest shift in sentiment isn’t population, it’s productivity. As early as 2011, Goldman Sachs assumed that labor productivity would increase by an average of around 4.8% per year over the next 20 years. The bank is now anticipating growth of around 3%. Capital Economics’ Mark Williams takes a similar view. China will “fall from being an Asian outperformer to being a solid, respectable emerging economy,” he says.
There is good reason to be gloomy about the productivity of Chinese workers. As China ages, it will devote more of its economic energy to caring for the elderly and less time to invest in new equipment and capacity. In addition, after decades of rapid capital accumulation, returns on new investments are falling. A new high-speed line through mountainous Tibet offers far fewer benefits at a much higher cost than, say, connecting Beijing and Shanghai.
China’s rulers are trying to impose more discipline on the local governments that build much of China’s questionable infrastructure. Unfortunately, they also seem keen to impose their will on China’s private companies. Unlike elsewhere, companies in China generate a lower rate of return on their assets as they grow larger, Capital Economics points out: “Beyond a certain size, companies have to think as much about meeting the needs of officials as they do those of consumers.”
It’s not just their own government that is holding back Chinese companies. In October, America imposed restrictions on the sale of modern computer chips to China. This will hurt Chinese companies that make products like cellphones, medical devices and cars. Goldman Sachs hasn’t included this damage in its long-term projections, but estimates that China’s GDP could be about 2% smaller than it otherwise would be by the end of this decade.
The technology war could go further. The IMF’s Diego Cerdeiro and his co-authors have examined a scenario in which America restricts its own technology trade with China, persuades other OECD members to follow suit, and forces countries outside that club to take sides in the struggle decide. In this extreme scenario, the Chinese economy could be about 9% smaller in ten years than it otherwise would be. In other words, the idea that China’s productivity growth could be closer to 3% than 5% is not far-fetched.
All forecasts on the economic future should of course be treated with caution. Forecasts often go wrong. Small differences in productivity or population trends, when combined and amplified over many years, can lead to wildly different outcomes.
Forecasts are also sensitive to prices – particularly the relative price of currencies. Unexpected movements in exchange rates can throw off forecasts of relative economic growth. Currently, a shopping cart of goods and services that costs $100 in America costs only about $60 in China. This suggests that its currency, the yuan, is undervalued. Capital Economics expects this undervaluation to continue. Goldman Sachs, on the other hand, expects it to contract, either because the yuan is strengthening or because prices are rising faster in China than in America. This process will add about 20% to China’s GDP by mid-century, according to Goldman.
If China’s prices or exchange rate don’t rise as Goldman Sachs expects, China’s GDP may never overtake America’s. If China’s labor productivity grows just half a percentage point slower than Goldman Sachs expects, its GDP will, all else being equal, never outperform America’s either (see chart). The same is true if America grows half a point faster (as Capital Economics projects). If China’s fertility rate continues to decline (to 0.85 children per woman by mid-century), the country could regain its lead in the 2030s but lose it again in the 2050s. Even if China’s economy were to become the largest in the world, its lead is likely to remain small. It is unlikely to gain a head start over America equal to the 40 percent lead America currently enjoys, Mr. Rajah and Ms. Leng argue.
It’s also safe to say that China and America will remain in a near-equal position for decades to come. In Goldman Sachs’ scenario, China has maintained a small but sustained lead over America for more than 40 years. Even according to Capital Economics’ forecast, China’s GDP will still be over 80% of America’s GDP in 2050. China will remain a geopolitical rival to be reckoned with. This is critical: if China’s peak resembles Table Mountain more than K2, its leaders will have little incentive to rush to confrontation before the decline begins. ■
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