Pew Survey shows that much of the world doesn’t see China as a warm and fuzzy country

 

China Doubles Down on Exports:

Over the past year, China achieved a major economic milestone, becoming the first country to post a $1 trillion trade surplus.  However, contrary to what one might at first glance believe, this should not be any cause for celebration.  China’s massive trade surplus instead reflect two major underlying current weaknesses in its economy.  One is the decreasing inflows of foreign investment, which has played a crucial role in the rapid growth of the Chinese economy over the past three decades.  The trade surplus also underscores ongoing anemic consumption in China and the unbalanced and unsustainable natures of its current economic growth model.

While China has consistently run large trade surpluses ever since becoming the workshop of the world during the 1990s, these surpluses have spiked over the past seven years.  In 2018, the gap between what China exported and imported was under $500 billion.  It reached $500 billion in 2020 before rapidly rising to $1 trillion in 2024.  As the chart below shows, over the past three years, the share of the Chinese trade surplus taken by the EU and Associated of Southeast Asian Nations (ASEAN) compared to that of the US has risen substantially.    

Since a country’s balance of payments must, as the term implies, always balance, trade surpluses or deficits comprising one side of the balance, the current account ledger, must be offset by the net flow of capital comprising the capital account side of the balance of payments.  In other words, to greatly simplify matters, the following formula applies:  trade balance + net inflows of capital = 0.  Thus, China’s enormous trade surplus implies a large net outflow of foreign investment from the country.

This, in fact, is precisely what has been going on in China over the past few years.  In 2023, investment by foreign companies in China dropped to its lowest level in 30 years; foreign direct investment (FDI) on a net basis was $33 billion, according to the State Administration of Foreign Exchange (SAFE), a fall of 80% from 2022.  The downward trend in foreign investment flowing into China continued through 2024.  According to SAFE, from April-June, China’s direct investment liabilities in its balance of payments fell by almost $15 billion, marking only the second time that figure had turned negative.  During the third quarter of 2024, outflows of FDI exceeded inflows by $8.1 billion.

The diminished draw of China for foreign investment reflects its weak recovery from the Covid pandemic and attendant draconian government lockdowns.  Foreign companies operating in China have cited sputtering domestic demand.  Louis Vuitton Moët Hennessy (LVMH), whose China sales had helped make it the biggest European company by market capitalization prior to 2023, declaring late last year that Chinese consumer confidence was at an “all time low.”  LVMH is not alone among major foreign companies in having doubts about China.  In its annual position paper issued in September of last year, the European Union Chamber of Commerce, China, argued that foreign investors must accept that the problems they currently face in the Chinese market may be “permanent features that require substantial strategic rethink.”  The Chamber added that foreign business operations in China are at a “tipping point.”   

Further complicating matters for these firms is an increasingly fraught political environment in China.  In 2023, the Chinese government cracked down on foreign consultancy firms providing the due diligence that is critical to overseas companies in evaluating potential investment opportunities.  That move, coupled with a more stringent regulatory environment, especially a national law restricting cross-border data flows, have made foreign business investing in China amuch dodgier proposition.  An August 30, 2024 International Monetary Fund paper found that declining inflows of foreign direct investment to China stemmed mainly from rising geopolitical risk and Chinese government economic policy uncertainty. 

The pulling out of foreign investment from China does not bode well for its economy.  FDI was an especially criticalfactor spurring the double-digit growth of the Chinese economy from 1980-2010.  According to the Chinese Ministry of Commerce, foreign invested enterprises accounted for over half of China’s exports, 30% of its manufacturing output, and 22% of its industrial profits, despite employing just 10% of the Chinese labor force.   Thanks to the positive spillovers with respect to knowledge and technology transfer, industries with high levels of FDI had significantly higher levels of productivity compared to sectors with lower levels of FDI. 

China’s rising current account surplus reflects both continued strong exports, one of the few recent bright spots in its economy, and declining demand for imports.  In 2023, sales of foreign goods to China fell by nearly $150 billion,[9] or 6%.  The flow of imported goods into China remained anemic all through 2024, dropping by 3.9% in November alone.  

The recent weakness in imports, a critical element in China’s huge current account surplus, is another cause for alarm and reason why that surplus is an indication of economic weakness, not strength.  In particular, it underscores that domestic consumption has not rebounded in China.  That failure, in turn, is boosting the possibility of deflation.  This trend is reflected in the recent Chinese price data, which shows the consumer price index flatlining, barely rising at all through 2024, while the producer price index fluctuated in negative territory all through 2023-2024.  Commenting on these data in Reuters, Zhang Zhiwei, president and chief economist at Pinpoint Asset Management, observes, “The deflationary pressure is persistent,” adding, “The property sector downturn has not ended, which continues to weigh on consumer sentiment.” 

Rather than opening their wallets to buy things, Chinese households are busy saving money for a rainy day.  In 2022 China’s savings amounted to 47% of its GDP, or double world average.  In the year that followed, Chinese households squirreled away $19.13 trillion, setting yet another record high in the amount of money saved, while indicating extremely high levels of consumer caution.  Private consumption amounted to about 39% of the Chinese GDP in 2023, compared to nearly 68% in the US.  Logan Wright of the Rhodium Group points out in his September 2024 article, “China’s Economy has Peaked”, that household income as a proportion of the GDP remains relatively low, amounting to just 61% of the economy.  Wright further argues that the extreme inequality of this household income severely constrains economic rebalancing toward consumption.  He notes that even if China’s relatively poor rural population, which still comprised 1/3 of all Chinese in 2021, were to suddenly cut their savings in half, this would lead to just 0.6% of GDP worth of additional annual consumer spending.

Starting with the 2004 Central Economic Work Conference, Chinese leadership has paid lip service to the need for boosting the importance of consumer demand in the economy.  However, it has continued even recently to prioritize raising manufacturing production—currently in the form of “new quality productive forces”—over enabling households to buy more of that output.  For example, in Premier LiQiang’s annual work report in the rubber stamp National People’s Party Consultative Congress in March of 2024, the terms “investment,” “industrial,” “industrialization,” or “manufacturing,” appeared 69 times.  The term “consumption,” by contrast, got just 11 mentions.  Beijing’s latest stimulus packages have done very little to transfer income directly to hard-pressed households to boost their consumption activity.  

In the face of ongoing weak consumption, China could continue meeting the 5% annual GDP growth target it has set for itself by boosting investment.  This is easier said than done.  After years of excessive investment, infrastructure projects, which had been a key element in Beijing’s playbook for maintaining economic growth since the 2008-2009 financial crisis, are yieldingdiminishing returns.  Since infrastructure construction is financed with borrowing by local governments, throwing more money at this activity will only boost China’s already swollen portfolio of non-performing loans and exacerbate its debt problems.  Moreover, local governments, thanks to declining revenues from land sales, are strapped for money.  That fiscal crisis, in turn, stems from the once red-hot real estate industry going into free fall, leading to a huge inventory of unsold flats and villas and limiting the need to build new housing.  Nor is it possible for “new productive forces,”—sectors like electric vehicles, green energy, and high tech—to fill the void created by diminished investment in infrastructure and housing and its attendant negative impact on older industries like steel and cement production.  With the latter at their peak together accounting for nearly half, 40%, of the Chinese economy, it will be very hard, as Wright emphasizes in “China has Peaked,” for “advanced manufacturing” to fully to fully take their place. 

Without stronger domestic consumption and/or investment, China can maintain its current levels of GDP growth only by running large current account surpluses with its trading partners.  However, this strategy is meeting strong push back and not just from the US and EU.  The trade backlash has even extended to China’s fellow BRICs group members.  For example, Brazil recently imposed news tariffs[17] on Chinese imports, including iron, steel, and fiber optics, in an effort to counteract dumping.  Having the vast quantities of manufactured goods China exports wind up back on its domestic market would surely exacerbate already severe supply-demand imbalances and increase the threat of deflation. 

Thus, far from being an indication of the strength of its economy, China’s trillion-dollar trade surplus underscores critical weakness in and the unsustainability of its current economic growth model.  In particular, it points to the urgent need for China to rebalance the economy away from the previous growth drivers of investment and exports to boosting the incomes and consumption of private households.  This shift will have to involve some pain over the short-term, as it implies, at least during that period, a slowdown in GDP growth.  But making that change is an urgent necessity not just for putting China on a sustainable economic development path, but limiting trade and broader geopolitical tensions with other countries.  Kicking the can once again down the road is a sure-fire recipe for making things worse over the long-term.