Introduction
In the history of the world, China’s growth has been unparalleled.
In less than 60 years, China has lifted almost a billion people from extreme poverty and become the second-largest economy in the world.
In 1960, China’s GDP per capita was only $90. In 2021 it hit $12,556 and is showing no signs of stopping there.
At the same time, China’s population has grown from 654 million to 1.425 billion.
What’s even more astonishing is that in 1960, China’s GDP was a mere $59.72 billion. In 2021 it was $17,734 billion (or $17.7 trillion).
Unfortunately, nothing lasts forever. In recent years, China has begun to reach the limits of its exceptional growth.
Although the world’s attention has recently been caught by China’s ruthless zero Covid policy and the third term of Xi Jinping, there are deeper issues that the Chinese economy must overcome.
In the long term, China is struggling with a rapidly aging population, dropping productivity, and slowing growth.
Problems that China faces aren’t unique to China but are unique because of the sheer size of its economy.
Everything that happens in China happens on a massive scale.
Here we take a look at what are the 3 major problems in Chinese economy.
Aging Population
Back in its agricultural days, Chinese families had a lot of children to combat the high infant mortality rate. It was logical to give birth to as many children as possible so that there are also as many surviving children as possible.
As the quality of life rises, the child mortality rate drops while the fertility rate is still high.
What this has meant for China, is that in the 1960s and 1970s Chinese population grew by over 200 million. When China decided to adopt the East Asian developmental state model in the late 1970s, it started to invest in infrastructure and export manufacturing.
China had an abundance of low-cost working population to fill the world with its exported goods.
Unfortunately, the Chinese workforce is getting on in years. In 2020, approximately 19 percent of Chinese people were over 60 years old. By 2050, it is estimated that 25 percent of the population of China will be over 65 years old.
Due to 36 years of China’s one-child policy, the working population is diminishing. The one-child policy was introduced in 1980 to control population growth and mitigate social and environmental issues.
As a result, China’s fertility rate dropped from 2.6 to 1.3 and is estimated to fall even further to 1.0. This can be considered extremely low since the population usually starts to decline at around 2.0.
What this means, is that China desperately needs more workforce to support the aging population. The most obvious way to increase the number of workers is to either make more babies or raise the retirement age. Unfortunately, the issue is not that simple.
Problems With Birth Rate
The problem is that China’s social and economic structure enforces lower birth rates. First, the competition between children is brutal, which means that parents are often forced to use their resources on just one child.
Second, as the standards and quality of living rise, people start to prefer smaller families.
Third, China’s urbanization leads to more and more people living in big cities, which increases the cost of living significantly. Higher living costs mean that parents with lower incomes often can’t afford to raise more than one child.
Because China’s birth rate isn’t probably going to rise anytime soon, the other option is to raise the retirement age.
Retirement Age
Chinese mandatory retirement age is 60 for men, 55 for female civil servants, and 50 for female workers. The current retirement system was formed in the 1950s when the average life expectancy was only 35 years.
The average life expectancy in China is currently about 77 years, which means there’s plenty of room to add a few more years of work.
In its latest five-year plan, the Chinese Communist Party is committed to gradually raising the retirement age. Though, as can be guessed, raising retirement age is not met with enthusiasm, which makes it a sensitive subject to the CCP.
Even if retirement ages are raised fairly quickly, it has been estimated that it would only add about 15 million workers per year, which is not enough to solve the problem.
To get rich before it gets old, it is obvious that China desperately needs productivity growth.
Productivity Drop
Much of China’s productivity growth was achieved by opening the country to international trade and moving workers from agricultural jobs to industrial work.
As result, in the past two decades, China’s middle class has grown from approximately 40 million people to over 700 million people.
Unfortunately, China seems to have stumbled into a middle-income trap. It means that the transition from middle-income status to high-income status is more challenging than moving from low-income to middle-income status. This is usually the result of rising costs and lower competitiveness.
In China, the rising wages of the middle class have reduced competitiveness because much of its earlier success was due to low labor costs and a massive working population.
When the costs of labor rise, labor productivity should also rise to keep competitiveness at a stable level.
What’s concerning is that after the financial crisis of 2008 China’s growth has come mainly from accumulating capital, while productivity growth only accounts for about 15 % of GDP growth.
In other words, China has massive amounts of capital, but a large part of it is not put to productive use.
Private Companies
The problem is that much of the capital has been invested by the Chinese government in low-productivity and highly leveraged state-owned enterprises instead of private companies that offer a better return.
Moreover, private companies are responsible for almost all of China’s exports, innovations, investments, and new jobs.
The future of China is in private companies, which creates an issue between the Chinese Communist Party and private companies. The CCP has started to “cooperate” with the private sector.
What the CCP is trying to do is to build modern private enterprises with Chinese characteristics. In other words, China is trying to combine capitalism and communism.
The private sector would work better without interference from the government, which is not acceptable to the CCP.
By admitting that privately-owned companies do better than state-owned enterprises, the CCP would lose credibility. Also, the Chinese government wants to ensure that the goals of private companies are in line with China’s national goals.
Human Capital
Probably the most important factor in China’s future productivity growth is increasing the human capital of China’s population.
Human capital is the driving force behind modern economies. It increases competitiveness by encouraging innovation and by attracting foreign investments.
The most effective way to increase human capital is education that is available for everyone.
A large part of China’s problematic human capital level is due to the vast educational gap between urban and rural populations.
The CCP has acknowledged the importance of education, and improvements have been tremendous already. Between 2005 and 2015, the number of upper secondary school students has risen by 51%–64%.
Unfortunately, there is still a long way to go. In 2015, only about 30 percent of China’s workforce had a high school diploma.
It is also critical that China finds a way for the rural population to shift into higher-value and high-productivity work. Increased human capital equals increased productivity.
In 2020, people living in urban areas had 2,5 times a larger level of disposable income compared to people living in rural areas.
Considering that around 38 percent (or 530 million people) of the Chinese population live in rural areas, the much-needed boost for productivity can be found living outside the major cities.
Slowing Growth
Closely related to the problem of declining productivity is the issue of slowing growth in the Chinese economy. In the past decades, China could access foreign technology, make cheaper versions of the products, and export them around the world in massive quantities.
Nowadays, China has to innovate its technology, which is far more difficult. This is also where China’s large amount of debt comes into the picture.
A high debt-to-GDP ratio and low productivity level reduce the money left for innovations.
When a country stops innovating, it loses its competitive edge in foreign markets, which means lower export levels and less money coming in.
Few things in the world encourage innovation less than an authoritarian, top-down management style. Unfortunately, innovation is what China’s economy desperately needs, and it is exactly what the presence of the CCP in private companies will most likely suffocate.
China’s economic growth so far has been achieved mainly through the vast amount of resources China has had available. Future growth will be achieved by making the slowly diminishing resources more efficient.
China has been building assets that now need to start making a proper return. Again, innovation is the key to productivity, which creates growth.
A Lot More Room for Growth and How to Achieve it
China’s economic growth was achieved through investments, exports, and industry. Household consumption only accounts for about 40% of China’s GDP. For comparison, the average around the world is roughly 65%.
When we compare China’s GDP per Capita of $12,359 to USA’s $69,288, we can see that China still has immense growth potential.
China will probably not achieve the same GDP per capita as the USA due to the vast size of its population. On the other hand, China has a vast and low-income rural population that will most likely increase its living standards, thus creating growth.
In the earlier decades, China’s average growth rate has been approximately 10%. Today, it has slowed down to 6% and is expected to be around 4-5% in the coming years.
It is important to realize that slowing growth is in some part a natural phenomenon since a 10 percent yearly growth for a country is not realistic in the long run. It’s worth noting that even with a 5 percent annual growth rate, China will surpass the USA as the number one economy in the world by 2030 or so.
How Can China Ensure Future Economic Growth
The question is whether China will remain the biggest country in the world, or will the USA continue to grow and overtake it. China not only has to achieve high growth but also maintain it.
This requires, among other things, a steady stream of foreign investments. China can’t afford to scare away foreign investors by being unpredictable. The same goes for private Chinese enterprises.
Private companies require a predictable and consistent environment, where they feel safe to make investments and thus create growth. China has been notoriously unpredictable for both foreign investors and private domestic companies.
The CCP is well aware of the situation and has declared that China aims to shift from inflated growth to quality growth.
This means that in the future, China will focus on achieving growth from consumption, exports, and business investments instead of investing heavily in infrastructure and real estate.
In other words, China might be on its way to joining other successful developed countries.
Summary
So, what China’s economy desperately needs to achieve its goals is a large, highly skilled, and innovative workforce. They should work in private enterprises that operate in a consistent and predictable environment.
Retirement age should be raised to ease the demographic dividend and a broader social support system to support working families.
China will also have to invest heavily in health care and education to increase human capital, especially in rural areas.
The shift from inflated growth to quality growth is vital to China’s future success. It requires a steady stream of foreign investments and endorsing private domestic companies.
China will also need to cooperate with other leading countries and accept its role as a major player in the world’s economy.
There is a lot more economic growth left if China manages to play well with others and make the changes it desperately needs.
