Mid-July 2024 saw two major events on China’s economic and trade sectors. At the Third Plenum in Beijing, the Party-State presented options to fortify China’s economy by its 80th anniversary in 2029. At the same time in Brussels, the World Trade Organization (WTO) conducted its ninth biannual review of China’s trade policy. Countries around the world, including Australia, are deeply interested in how China’s economic trajectory will forge international trade relations into the future.

The 2024 Third Party Plenum

The Third Plenary Session of the Central Committee of the 20th National Congress of the Communist Party of China is not the forum to announce a short-term stimulus package. And it is no longer the forum to announce long-term structural transformation. In 2024, the Third Party Plenum (TPP) listed a vast array of policy options available to guide China’s development over the next five years, though only incrementally and without straying far from the path that has solidified over the Xi era.

The TPP Resolution on “Further Deepening Reform Comprehensively to Advance Chinese Modernization” comprises of 15 parts, 60 sections, and 300 policy options. This paper organises the main economic aspects around frameworks commonly applied to the study of China’s economy, including macro-economic imbalance and industry policy.

The market and the State

A central concern of policy-makers in modern Chinese economic history is the degree of latitude to be given to the market, which oscillates in “control” (收shou or 抓 zhua) and “release” (放fang) cycles. While there were cycles within both the central planning and reform eras, it was generally assumed that the “Reform and Opening” program of Deng Xiaoping announced at the 1978 TPP had set China on a path of “directional liberalism.” The language of the 2014 TPP—the first of the Xi era—appeared to reinforce the direction but was followed by crackdowns on the private sector and the comeback of State-owned enterprises which, to Xi Jinping, “play a role as pillars of the economic foundation of the CPC’s rule and China’s socialist state power.”

With faltering economic growth in recent years, further decrees were issued to reassure the private sector and shore up confidence in property rights. These themes were continued in the 2024 TPP, for example Part II, Section 5 “Upholding and fulfilling the commitments to the public and non-public sectors” and Section 7 “Refining the systems underpinning the market economy.” It may be too early to tell if oscillations in the State-market relationship in recent years are cyclical or linear but restoring the confidence of the private sector will require more than decree.

Macro-economic imbalance

One model to assess China’s economic policy options is through an expenditure approach to calculating GDP, disaggregated by savings, investment, and trade. Most economies are led by consumption (mainly household but also government) which is met by production and investment. The ratio of consumption to investment in China in 2022 was 1.3, a large imbalance compared to the global average of 3.2. Furthermore, China’s domestic imbalance spills over into trade imbalances: low consumption equates with low imports while high investment equates with high exports, resulting in large structural trade surpluses.

Concerns about the structural imbalance in China’s economy were raised as early as 2007 by Premier Wen Jiabao and gained momentum through high-profile foreign political economists and economists. Many mainstream Chinese economists agree that China should rationalise investment, especially in infrastructure and real estate where diminishing returns have set in, and take measures to boost household consumption. Others caution against a simplistic either/or approach, and there is vigorous debate on the pathways for more efficient investment and increased household consumption. To cover all options, three parts of the 2024 TPP are concerned with “demand-side” measures to economic development (Parts V, VI, XI) and three with “supply-side” measures (III, IV, XIII).

Share of consumption, investment and trade in China’s GDP and global comparison 1990-2022. Source: NBS and IMF.

The consumption side

Increasing household consumption in China requires several conditions—including increasing incomes—but the relationship with China’s high savings rate is central. China has among the highest savings rate in the world, which may reflect the frugality of older generations, but is also precautionary, where households save to buffer against low levels or low access to social welfare (pensions, work entitlements) and services (education and health). While China’s social programs have expanded, access remains low, especially for the 200 million workers in the informal economy and up to 300 million rural-urban migrant workers.

The task of paying for higher social welfare requires increased tax revenue, especially for local governments that fund virtually all education, health, and social security services. Local governments, however, have a narrow tax base, which is being eroded by a slow-down in real estate development and the land taxes it generates, coupled with escalating debt in less developed cities and regions. Social expenditures and tax revenues require a re-negotiation of fiscal relations between central and local governments.

Expectations on social and fiscal reform have been dampened in recent years. For example, in 2021 Xi Jinping wrote that “we still cannot set high goals and provide overprotection: we should resolutely prevent falling into a welfare trap and raising idlers.” In country consultations with the IMF, China responded that “a modern tax system suitable for their development stage has been basically established,” noting that it doesn’t see the need to increase fiscal revenue. And while economic reforms appear technical, the obstacles are largely political. Transforming China’s economic model involves a systematic transfer of resources to households from local government and state-owned enterprises that are the beneficiaries of China’s investment-led growth model.

Despite the ideological and political constraints, social and fiscal reforms provide enormous policy space for China to deal with pressing problems including low consumption, an ageing population, low education levels that constrain industrial upgrading, and youth unemployment that can be ameliorated through the development of the labour-intensive social service sector. The availability of policy instruments is set out in Parts of the TPP Resolution including XI, “Ensuring and improving the people’s wellbeing,” VI “Promoting integrated urban-rural development,” and V, “Improving macroeconomic governance.”

The production side

While there is uncertainty on policy direction on the consumption side, there is little uncertainty on the production side. The central government has sought a controlled cooling of investment in both the property sector and in infrastructure projects by debt-burdened local governments. Because they account for the vast bulk of investment, a slowdown in these sectors will be accompanied by a slowdown in the broader economy, forecast by the IMF to be as low as 3.4 percent by 2028. This slowdown can’t be fully offset by increased investment in manufacturing (at lower magnitudes), but is a trade-off that the Xi regime seems prepared to make for more sustainable and higher-quality development.

Total credit loaned to the real estate and industrial sectors, 2017-2023. Source PBoC.

The emphasis on manufacturing builds on China’s long-standing industry policy through programs that include “Made in China 2025” and most recently “New Quality Productive Forces,” which commands its own Section (III, 8) in the 2014 TPP. Barry Naughton argues that China’s industry policy started with similar objectives to other East Asian economies of growth, industrialisation, and international competitiveness, but that the objectives have now turned to securitisation through subsidies and transfers that eclipse competitors. Messy but effective industry policy has fast-tracked the development of sunrise industries, most famously the new “green” industries of batteries, solar, and electric vehicles.

The traditional model of industry and global value chain upgrading is that countries move up through a flock of “flying geese” as wage and technological levels increase, leaving lower-end manufacturing to other economies down the flock. This model however has to be reconciled with Xi’s vision of a modern industrial system, which is to be not only “advanced” (先进), but also “secure” (安全) and “comprehensive” (完整). While high value-industries sound impressive, they make up just 15 percent of value-added of large-scale enterprises, and low-value industry is still needed for employment, inland development, and local government revenues. The sequence is that “the high-end must be built before the low-end is dismantled” (先立后破).

Thus, China’s manufacturing sector accounts for 30 percent of global value added, compared to the broader economy which accounts for a much lower 18 percent of global GDP. China’s government attributes this to factors that include comparative advantage, agglomeration, ingenuity, hard work, and enlightened policy. Critics attribute it to macro-economic imbalance, over-investment, aggressive industry policy, state ownership, and inter-regional replication.

Similar factors are cited in the debate over China’s industrial over-capacity. While industrial over-capacity has been a feature in assessments of China’s economy for decades, inventories increased in the post-COVID era both in absolute value and as a percentage of GDP, until a slight downturn in 2023. Subdued domestic consumption exacerbates pressure for the surplus capacity to be exported, leading to structural trade surpluses that are the subject of criticism from some of China’s export destinations. China has hit back at such claims, but is acutely aware of supply-side problems, reflected in various parts of the 2024 TPP (e.g. II. “Building a High-Standard Socialist Market Economy” (6) “Building a unified national market”).

Value of inventory and percentage of GDP for large industrial enterprises. Source NBS.

Implications

As China’s investment-led growth model, built on infrastructure and real estate, meets its limits, policymakers are adjusting course. Tentative measures taken to increase household consumption and social services are overshadowed by highly pro-active industry policy, which has been moved to centre stage of China’s development model. The alignment of domestic consumption and production factors exacerbates manufacturing surpluses that are vented to China’s export markets, and also changes market conditions for exporters to China, as explored in the next part of this series.

This article is part one of a two-part series addressing China’s economic trajectory and implications for trade, especially in Australia. The authors would like to acknowledge funding for the research from the National Foundation for Australia-China Relations.

Dr Scott Waldron wrote this articles as a Principal Research Fellow at The University of Queensland. It’s contents does not represent the view of the Australian Government or its agencies. His X handle is @ScottAWaldo

Dr Zhang Jing is a Research Fellow at the University of Queensland.

This article is published under a Creative Commons License and may be republished with attribution.