China’s Threat to the World Economic Recovery | American Enterprise Institute
Herb Stein famously said that if something cannot go on forever, it will stop. If ever there was truth in this statement, it has to be in relation to China’s unbalanced economic growth model that relies excessively on investment and export-led growth. The real question is not whether the current Chinese economic growth model will stop. Rather, it is when and how will it stop? Will it stop soon or only several years down the road? Will it stop in an orderly way that will not disrupt the world economy, or will it stop in a manner that involves an economically-damaging world trade war?
Anyone doubting that China’s economic growth model is running out of steam has not been paying attention to China’s latest GDP report. That report suggests that the Chinese economy is now growing at around 4.25 percent, or at the slowest rate since the 2020 Covid-19 pandemic. Today’s economic growth rate falls far short of the government’s 5 percent target for 2026 and well short of the 6 to 7 percent annual economic growth rate that China enjoyed in the late 2010s. Meanwhile, there are many analysts who believe that there are good reasons to think that Chinese economic growth is a lot slower than the officially reported data.
Another reason to think that China’s economic model has outlived its usefulness is its increased dependence on exports to take care of its growing excess domestic production problem. With a high rate of investment and weak domestic consumption in the wake of the bursting of the Chinese housing market bubble, China produces substantially more than it consumes domestically. To address this problem, China uses subsidies and an undervalued exchange rate to the tune of 20 percent to promote its export sector. While such an approach might have been acceptable to the rest of the world when China was a small developing economy, it is being met with increased resistance abroad now that China is the world’s largest export nation accounting for around 15 percent of the world’s total exports.
This year, China’s export growth has been on a tear despite a sluggish world economy and despite punitive US import tariffs that have caused China’s exports to the US to decline. In the first half of the year, Chinese exports grew by around 14 percent in relation to the previous year, while in June, China’s export growth rate accelerated to 27 percent.
China has succeeded in maintaining rapid export growth by diverting its exports away from the US to other countries in general and to the European Union in particular. This is now raising fears in Europe of a so-called China 2.0 whereby, much as US industry was hollowed out by Chinese exports following China’s access to the World Trade Organization in 2001, Europe’s manufacturing base will now be hollowed out by a new wave of Chinese exports to keep that country’s economic growth rate from stalling. European fears about a flood of Chinese exports destroying European industry are particularly acute concerning Chinese electric vehicles, batteries, electronic, machinery, and consumer goods.
For both China and the world’s long term economic growth, it would be optimal if China were to rebalance its economy away from investment and exports toward domestic consumption and services. That would require China to raise household incomes, to expand healthcare, pensions, and other social safety nets to reduce precautionary saving, to reform local government finances, and reduce reliance on real estate and debt-fueled investment. By doing so, China would increase the chances of repairing its broken US trade relations and avoiding a trade war with Europe.
Unfortunately, there is little sign of the Chinese government moving decisively to rebalance its economy. Investment still accounts for around 40 percent of China’s overall economy while exports account for a further 20 percent. That must raise the chances that Europe will join the US in trying to decouple from the Chinese economy to protect its domestic industry from being hollowed out by a slew of cheap Chinese exports. In turn, that raises the likelihood of Chinese retaliation, particularly by withholding rare earths and batteries needed for Europe’s industry. From there, it is a slippery slope to a full-scale word trade war.
We must hope that China recognizes that a slowing European economy coupled with growing political polarization, means that European patience with China’s surging exports will run thin. Maybe then China will rebalance its economy to reduce its excessive import reliance. However, I do not suggest holding your breath for that to happen.
