China’s Economy In The 2020s

Summary

• China’s latest five-year plan is under development; these plans are relevant to investors.
• The growth target is likely to be 5-6% in 2021-26, and China will struggle to meet this.
• National security is a higher priority; this will shape both economic (IT) and military outlays.
• China wants to raise its global role and influence in the coming decade.

China is currently developing its 14^th five-year plan, to be implemented in 2021-26. Central planning was how almost 50% of the world ran its economic systems even as late as 1980. Now, it is a minority activity. India, for example, abolished its Planning Commission in 2014. Five- or ten-year planning is now something done in corporate boardrooms rather than government agencies. Yet China has been an important exception to this trend, and so its planning process matters for understanding the probable direction of the Chinese economy in coming years.

China’s ability to plan over a longer-term horizon has helped sustain its rapid growth and unprecedented economic success. When evaluating the success of government central economic planning techniques across countries and time, there is such a range of outcomes that it is obvious many other factors are in play (Chart 1). Central planning is neither a necessary nor sufficient condition for economic success or failure. At both the national and corporate level, success comes from the combination of a clear medium-term plan with the application of market discipline, and an ability to react agilely to its shifting forces.

The 13th Five-Year Plan: 2016-20

Each of China’s plans sets multiple development objectives, although the overall pace of economic growth can act as a benchmark of both aspirations and success (Chart 2). China established a growth target of 6.5% for the 13^th five-year plan from 2016-2020. With the economy likely to eke out growth of 1.75%y/y in 2020 (good by global standards, but awful by Chinese ones), the annual average growth outturn for the latest plan will be 5.7%. That’s the first undershoot since the reform program began in 1978.

Two major factors dented China’s growth performance towards the end of the 13^th plan: the trade war and Covid-19 (the spread of which began in China). The impact of the latter was far graver than the former. China handled the the pandemic with a severe economic lockdown, which caused activity to decline dramatically in 20Q1.

One of the initiatives China pursued during the 13^th plan was the Belt and Road Initiative (BRI). This was designed primarily to lift economic development in China’s west as well as in the region to its west. It is too early to judge the initiative’s success. It underlines, however, that China has turned its gaze (and planning) increasingly outwards. And this will be an important component of the 14^th plan.

China Has Entered a Phase of Fundamental Slowing

So far, we know the broad outlines and areas of emphasis in the 14^th plan. The Central Committee of the Communist Party agreed these at a meeting in the last week of October. We will learn more about the plan’s specific targets in coming months, with the final rubber-stamping coming at the National People’s Congress in March 2021.

The 2021-25 growth target will be under the 6.5% rate established for 2016-20. The plan’s (already set) medium-term objective is to double GDP per capita from $10,000 in 2020 to $20,000 (in 2020 USD) in 2035. China sees this as moving to middle income status (Chart 3). This target implies an average annual growth rate of 4.75%.

There are two reasons why China is on a trajectory to slower growth (and quite possibly less than the 5-6% likely target for 2021-26).

First, China’s demographic will transition over the next decade. The population will decline after 2026, about 17 years after Japan’s peaked (Chart 4). It will also age significantly: the share of the population 65+ will rise from 12.3% in 2020 to 17% in 2030. China cited its creation of the world’s largest social security system as one of the 13^th plan’s achievements. As the population increasingly uses that system over the next few decades, so China’s saving, investment and growth rates will fall.

Second, China’s rapid growth since 1980 has come from rural to urban migration and, more recently, rapid development of its interior provinces. One of the advantages of China’s planning process (and the strong central government underpinning it) has been its ability to spread economic success geographically (albeit with considerable criticism of the treatment of ethnic minorities in the West).

Beyond the lower growth target, five aspects that we know about the plan are worth emphasizing.

Information Technology (IT) Catch Up

China developed its Made in China 2025 Plan on the eve of the 13^th plan and emphasized the modernization of its industrial base. The Trump administration targeted the plan to justify protectionism. Rather than causing Chinese authorities to withdraw from this approach (as Japan had done in the mid-1980s when it controlled a sizeable share of many IT sectors), the Chinese authorities underlined their determination to move even more rapidly in the area of IT, especially with artificial intelligence. One important problem for China is that it accounts for over 1/3 of global semiconductor demand but only 1/20 of global production (Charts 6 and 7). The 14^th plan will likely include greater emphasis on developing local semiconductor capacity. This determination will have increased following US actions to curtail Chinese firms’ ability to buy US technology in recent months.

Green Development and Energy Reform

The 13^th plan was the greenest to date, the 14^th will be even more so. China is the world’s largest CO₂ emitter, although its share has levelled off in recent years (Chart 8). The country has done well promoting the use of cleaner electric vehicles (EV). In 2019, it had more publicly available EV charging stations than the rest of the world combined.

China’s rising energy needs are a function of two things. First, its (relatively) strong growth. Second, the rise of average income levels above those that typically trigger rapid acquisition of energy-intensive consumer products (e.g. autos and air conditioning). In 2015-19, Chinese energy demand (of all types) rose by 2.7% per year; in the OECD, the growth of energy demand was 0.4% per year.

China’s main challenge is sustaining growth while also meeting its domestic objectives (and international commitments) for carbon control and eventual reduction. Under the Paris Climate Accord, China agreed that the absolute amount of its CO₂ emissions will peak in 2030 and that by then the non-fossil share of its energy consumption will be 20%. China’s dilemma is its reliance on coal for about 57% of primary energy consumption (Chart 9). Hydro, nuclear and renewables account for about 15% of energy consumption. At the margin, China will need to increase development of its renewables sector and sharply lower its coal dependency to achieve the objectives of both its domestic plans and its international obligations.

A Stronger Domestic Market

China has been attempting to reorient the growth of its domestic economy away from goods towards services and away from investment towards consumption for well over a decade. In the past five years through 2019, consumption indeed accounted for 63.4% of overall growth, the highest share since the five years through 2002. In 2020, Covid-19-induced behavioural changes severely impeded consumption.

Particular emphasis will be put on education, distribution and healthcare in developing the domestic market over the next five years. China has been a big buyer of education services on global markets (sending students abroad). This could change as Covid-19 lingers, restricting cross-border travel.

Opening up to the Rest of the World

The plan envisages a ‘high-level’ opening up to the rest of the world, which would ‘promote a new type of international relations.’ This would involve greater trade and investment liberalization. I interpret this as part of China’s effort to increase its global influence (especially in the emerging world) as it perceives the US withdrawing (the BRI will continue). It will be interesting to see whether a Biden administration can rebuild US relations with other parts of Asia. The obvious way to do this would be through a renewed effort to rebuild the Trans-Pacific Partnership. China will probably also increasingly advocate for raising its role in global institutions in line with its growing economic power (Chart 10).

Building Military Strength, but at What Cost?

Finally, the plan puts more emphasis on national security and military strength to maintain both external and social security and stability. It is also seen as ‘necessary to maintain the long-term prosperity and stability of Hong Kong and Macao and promote the peaceful development of cross-strait relations and the reunification of the motherland.’

Chinese military spending has been in secular decline (as a share of total government outlays) for the past 20 years, contrasting the US trend (Chart 11). This has allowed China to allocate public spending towards other spending (e.g. investment in infrastructure). If, as seems likely, China is about to raise its military and security spending at a time when other current claims on government spending are on the rise (e.g. social security), then this could be another factor dampening growth in coming years.