For better or worse, China has been a leader in the pandemic.
China was the first nation to experience COVID-19, the first to shut down, and the first to return to full economic capacity in 2020. The nation was poised for a year of prosperity in 2021, but it was not to be. China is facing new challenges that will prove persistent in the years ahead.
China’s pandemic response has been strict. Lockdowns have been frequent and have continued on a localized basis. Those measures merely fight the virus, but do not prevent outbreaks; unfortunately, China’s Sinovac vaccine has underperformed relative to Western formulations. Until the nation improves its vaccine, the virus will play a dominant role in the economy.
China has no time to spare dealing with the pandemic. It remains the world’s factory. China’s export volumes climbed to record highs in 2021 despite interruptions from quarantines and disruptions across the supply chain. The nation is cognizant of pressure, led by the U.S., for importing nations to reduce their dependence on Chinese goods. The factories that represent so much of the world’s productive capacity were financed by debt, and the nation cannot afford to lose its overseas customers. Fortunately for China, relocating production is an expensive and cumbersome proposition; even if the world realigns, it will play out over a long time span.
"China’s policy decisions today may determine its place in the world for decades ahead."
The more immediate risk to China is supply constraints. Ships that cannot unload their goods in Los Angeles or Rotterdam cannot return to take more exports away from China’s docks. Surging prices of coal and natural gas are already slowing China’s supply of electricity and thus its level of output. These challenges will persist into 2022.
Inflation is a global pressure as we enter the new year, and Chinese producers may seek to raise their prices to recover some of their increased costs—but by doing so, they will only support the case for moving production elsewhere. China’s reputation as a least-cost producer has been questionable for some time, and inflation will further impair it.
Click on the chart to zoom in and explore the data.
The Chinese Communist Party appears ready to adapt to a changing world. A policy realignment crystallized in 2021. The leaders of the nation’s most successful technology companies were reined in; though the companies remain private enterprises, the influence of the state became clear. Overheating in China’s property markets has long been of concern to external observers, especially as so much domestic saving is wound up in products that fund real estate development. Evergrande’s stress suggests the sector has reached its boiling point and will need to cool down. Policymakers will be challenged to prevent excessive losses to domestic savers while not rewarding excessive risk-taking by developers.
"The challenges abound: an energy crunch, insolvent property developers, international tensions and competitive positioning."
The more the world changes, the stronger the case grows for Chinese policymakers to invest further into technology development. For many years, the party has been clear in its intent to move up the value chain, not merely building products but also doing the design and engineering work. The nation’s adverse demographics, with relatively few younger workers, will further motivate investment in productivity-enhancing technology. The growth of Chinese brand names suggests the nation’s influence is growing around the world. To remain a competitive force, China will have to continue to support its exports of both products and culture.
Is all this more than the state can handle? The challenges abound: an energy crunch, insolvent property developers, international tensions and competitive positioning. In light of these, we believe China is on a course for slower GDP growth than the rate of 6% or more that was its pre-crisis norm. Executed correctly, this interval of slower growth could put the nation on a path for sustained economic independence. The stakes are high, but the rewards could be substantial.
