China’s economy is at a critical juncture as President Xi Jinping bets the country’s future on revitalizing manufacturing, even if it means antagonizing trade partners and spooking foreign investors.
Manufacturing plan raises trade tensions
Xi’s new economic blueprint, unveiled at October’s Party Congress, makes clear that manufacturing will be the priority for investment and policy support. The strategy calls for technology self-sufficiency, aiming to insulate China from external sanctions and supply chain turmoil.
But this inward focus threatens to set off a new trade war by unfairly subsidizing Chinese companies at the expense of international competitors, according to analysts. At the World Economic Forum in Davos this week, economists warned that Xi’s policies could “backfire” if major economies like the US, India and Europe respond with punitive tariffs to offset the support for Chinese firms.
Major partners warn of impacts from China's manufacturing plan
Country Warning
US Risk of new tariff war
India Unfair subsidies could hurt Indian industry
Europe Violates principles of open trade
The US and Europe have already filed formal complaints with the WTO arguing that the “Made in China 2025” plan provides an unfair advantage through subsidies, market barriers and forced IP transfer. And India sees the potential for mass unemployment if its huge manufacturing base is undercut by cheaper Chinese exports.
This brewing backlash presents economic risks for China’s $18 trillion economy if reduced demand or sanctions from major trade partners lead to an even sharper downturn.
Growth forecasts slashed
China’s post-COVID recovery has already disappointed, with Q4 GDP growth of just 2.9% undershooting the government’s 5.5% target. The IMF and other forecasters have steadily reduced their 2023 outlooks to below 5% as drags from the property slump, weak consumption and feeble private investment outweigh the boost from infrastructure spending.
And Xi’s doubling down on manufacturing led growth, while politically popular at home, is unlikely to quickly supercharge the economy. Economists doubt that factories and equipment alone can drive China’s next phase of development absent more holistic reforms to catalyze consumer demand and unleash private enterprise.
China GDP growth forecasts
Year IMF World Bank OECD
2023 4.4% 4.3% below 5%
2024 below 5% 4.6% NA
Youth abandon rat race
There are also worrying signs that China’s educated urban youth are losing faith in their economic prospects. After decades of breakneck growth lifted 800 million citizens out of poverty, the next generation faces a slowing economy and stiff competition for decent jobs.
Already youth unemployment has hit 20% with 8.3 million graduates struggling to find work in 2022. And surveys show more of China’s Gen Z are eschewing the grueling “996” work culture to join the tang ping or “lie flat” movement prioritizing life enjoyment over career advancement.
This pessimism is reflected in slumping marriage and birth rates that threaten a looming demographic crisis. The government’s recent abandonment of population targets indicates policymakers have largely given up hopes of a turnaround in the birth dearth.
Local debt risks exposed
Policymakers are also scrambling to contain systemic risks from the unfolding property sector crisis. Hundreds of thousands of middle class investors who pre-paid for yet-to-be-built apartments now face default as cash-strapped developers halt projects.
The crunch in the crucial real estate industry has also highlighted the precarious debt sustainability of local governments who relied on land sales for 40% of revenues. Already 34 provincial or municipal governments missed bond payments in 2022. And Moody’s estimates regional government financing vehicles have ¥53 trillion ($7.8 billion) in outstanding debt maturing by end 2024, with few viable means to refinance.
Tail risks underestimated
While Xi touts policy “consistency,” the government’s halting attempts to stabilize the property sector have struggled to restore buyer confidence. Price caps and mortgage rate reductions for primary residences have done little to move the needle while developers balk at pressure to cut prices on unfinished units.
If the real estate slump gathers pace, the construction falloff would remove an estimated 30% of GDP from the economy while triggering unambiguous recession. Already housing investment tanked 10% last year while property sales by volume cratered 28%.
And despite assertions of transition towards a high value industrial economy less reliant on housing wealth, economists see daunting headwinds from eroding competitiveness in industries like chipmaking and advanced manufacturing. The risk is that Xi’s policy pivot comes too late while snuffing out the remaining dynamism of China’s mixed economic model.
Policy easing constrained
With the economy wobbling and credit risks mounting, Beijing has modest scope to prime growth through policy easing. The PBoC cut interest rates in August and lowered bank capital buffers to encourage lending. But monetary loosening is hampered by the need to avoid further currency weakening as hot money flees slowing growth and unpredictable policies.
Fiscal spending is also hemmed in by worries over accumulated local government and SOE debt now above 290% of GDP. Meanwhile tax cuts seem off the table given the budget deficit already hit a record 5% last year.
Of course, policymakers have tools to mitigate crisis, including potential bailouts for distressed LGFVs, banks and developers. But analysts warn that concerns over moral hazard and financial stability make aggressive state intervention a last resort option fraught with its own uncertainties.
Conclusion: High stakes wager
In conclusion, President Xi has embarked on a high stakes gamble to restore China’s economic dynamism by betting on an industrial policy centered on manufacturing self-reliance and technology security. But this strategy risks antagonizing trade partners, driving away foreign capital, and further distorting incentives in a state led economy in need of pro-competitive reforms.
Xi is staking his personal legitimacy and the CCP’s ruling mandate on this policy shift reinvigorating China’s $18 trillion economy after recent malaise. But with headwinds mounting, economists warn that over centralizing power in capital allocation risks poor outcomes the longer reform lags. If mishandled, churn in strategic industries could leave China less secure while spurring financial distress that policymakers appear ill-prepared to resolve.
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