China’s difficult choices as export growth slows

The writer is a finance professor at Peking University and a senior associate at the Carnegie China Center

China’s export growth has been the brightest spot in an otherwise gloomy economic performance this year as the country heads towards the Communist party’s 20th national congress this month.

Industrial output in the first eight months of 2022 was up a relatively weak 3.6 per cent over the same period in 2021, while total consumption stagnated, with retail sales up just 0.5 per cent. In contrast, exports grew a generous 14.2 per cent, and China’s trade surplus rocketed 57.7 per cent.

Economists are worried, however, that China may have reached the end of this period of rapid export growth, posing difficult policy choices for Beijing. Container-shipping costs for the next few months are way down, signalling what may become a contraction in exports as American and European consumers — struggling with weak economies — cut back on imports for the all-important Christmas season.

Unfortunately, the growing importance of exports will magnify the impact on the Chinese economy of any sharp slowdown in their growth. Like any country that saves more than it invests, China runs trade surpluses to absorb its excess production.

This means that any contraction in the trade surplus must necessarily be balanced by a reduction in the gap between domestic savings and investment. In turn, this requires either that Chinese investment rises or that domestic savings fall.

There are a limited number of ways either can happen. One unwelcome way China’s savings can fall is with a rise in domestic unemployment. As Chinese manufacturers export less, they may cut production and fire workers. Unemployed workers have negative savings rates, making this one of the ways in which a contracting trade surplus is balanced.

There are other ways. All income is either saved or consumed, so a surge in domestic consumption would also reduce Chinese savings, and would allow local manufacturers to shift sales from exports to domestic consumption.

There are, however, only two ways to increase consumption. One involves expansion in household debt, which Chinese financial authorities are trying to discourage. The other requires a major redistribution of income to ordinary households, something Beijing has been trying to do for more than a decade but has so far found politically too difficult.

But if savings won’t decline through a surge in consumption, the only way Beijing can keep savings from declining though rising unemployment is with an increase in investment. This also creates problems.

The best form of new investment, an increase in private sector investment in manufacturing and distribution capacity, is a very unlikely response by private businesses to slower export growth. On the contrary, they will probably cut back investment as exports fade.

In that case, any increase in investment must be driven by expansion in government investment, which mainly means more spending on infrastructure. In fact, this is already happening as Beijing tries to counter a contraction in the property sector. But given China’s already excessive infrastructure spending, many economists worry that this will simply result in even more unnecessary projects than China already has and, with it, a rapidly deteriorating debt burden.

Unfortunately, these are literally the only ways in which China can balance a contraction in its trade surplus. There are no other options. Beijing will probably consider rising unemployment as the greater evil, and it will be unable to boost domestic consumption quickly enough except through an unwanted surge in household debt. So Beijing will most likely respond to a contraction in the trade surplus with more government investment in infrastructure.

This underlines how vulnerable the Chinese economy is to external events, with its export success largely the obverse of its weak domestic demand. The bad news is that Beijing may respond to weaker foreign demand for Chinese imports by taking further steps to support the very important export sector.

These necessarily involve explicit or implicit subsidies to manufacturing at the expense of the household sector, and so will probably only further weaken domestic demand while escalating China’s excess reliance on exports and government investment. The good news is that depressed exports may force Beijing into the difficult adjustment towards greater domestic consumption that it has long postponed.