China's recent decision to abandon its strict zero-Covid policy has led many to believe that its economy will bounce back. The Economist Intelligence Unit, for example, has revised its forecast for Chinese GDP growth in 2023 upward, to 5.2%. But growth recovery is not automatic, and China must contend with several challenges, including declining confidence among firms and households about their future incomes in the short run, insufficient productivity growth in the medium run, and an unfavourable demographic transition in the long run.
Restoring confidence may be more important than expanding credit in the short run. Following a sustained period of repeated lockdowns, many small entrepreneurs and workers in traditional service sectors who have feared for their jobs and incomes are reluctant to make purchases. Likewise, many firms are wary of investing after recent revenue disruptions and tighter regulatory scrutiny in education, tech, and other sectors. In a recent survey of domestic and foreign firms operating in China, the Shanghai-based China Europe International Business School found that Chinese business confidence has sunk to a new low.
Pessimism can be self-fulfilling. If enough businesses and households lose confidence and cut their spending, there will be lower demand for products and services by other firms. But lower revenues would eventually hurt these firms' own upstream suppliers. To break the cycle of pessimism, Chinese policymakers must restore confidence in the short term. But their options are constrained. Making future policies more predictable would be very useful to enhance confidence, but policy predictability cannot be achieved by a simple government proclamation. While credit expansion would boost aggregate demand, it could have the undesirable effect of driving up inflation. Meanwhile, costly Covid-19 testing and quarantines have strained China's fiscal capacity.
One policy to consider is a time-limited reduction in sales and corporate income taxes. By reducing these taxes only temporarily, China could reduce its government debt burden and stimulate household consumption. Similarly, a limited-term corporate income-tax cut could encourage more private-sector investment than an equivalent permanent reduction would.
To increase the pace of productivity growth over the medium term, the Chinese economy needs more than additional patents and software. It needs better allocation of resources across individuals, firms, and sectors. For example, by reforming the hukou household registration system, China could deploy the same amount of human resources more efficiently while improving social equity. Another step that could help boost productivity is levelling the playing field between state-owned and private-sector firms in obtaining bank credit and government licences.
To improve medium-term growth, China must heed the lessons of its own history and focus on removing barriers to market entry and entrepreneurship. An economy's growth rate comes from a combination of an increase in the average size of existing firms (intensive-margin growth) and an increase in the number of firms (extensive-margin growth). A study of the Chinese manufacturing sector that I co-authored with Xiaobo Zhang suggests that during the last few decades, extensive-margin growth accounted for about 70% of overall GDP expansion.
In the long run, the biggest economic challenge facing China is the country's shrinking workforce. In contrast to economic competitors like Vietnam and India, China's working-age population has been declining for almost a decade. Even if productivity growth remains constant, this demographic shift would lead to ever-declining GDP growth. Some policy measures, such as importing foreign labour en masse, might work but will likely lead to social or political complications. Others, such as attempts at increasing the birth rate, raising the retirement age, or boosting female participation in the labour force, do not look very promising.
Increasing the quality of the labour force, however, is a more realistic goal. For example, China could increase the average education level of its workforce by enhancing the retention and completion rates in high schools and vocational schools in rural areas. The ubiquity of smartphones and tablets offers a new potential avenue to improve workers' skills.
Finally, China should not be too obsessed with rapid GDP growth. It must instead focus on increasing per capita income and improving the quality of life. These intrinsically matter more to the Chinese people than GDP growth and do not depend as much on population size. ©2023 Project Syndicate
Shang-Jin Wei, a former chief economist at the Asian Development Bank, is Professor of Finance and Economics at Columbia Business School and Columbia University's School of International and Public Affairs.
