The slowdown

After four decades of amazing performance, China’s economic growth is slowing. Substantially.

Since Deng Xiaoping’s reforms in 1978, the economy has grown an average of 9 percent per year, a four-decades-long run unmatched by any other country. But this year is different: A recent Barron’s article went so far as to suggest that the economy might contract for the year, which, if it occurs, would be the first time since Deng’s reforms.

What’s more, the slowdown is a surprise to the Chinese government, which announced a 5.5 percent growth target for this year. Barring massive government stimulus, it is almost certain that for the year, economic growth will be materially below the government’s proclaimed target for only the second time in three decades.

The slowdown is a surprise to the Chinese government

Even pre-pandemic, China’s growth had been slowing relative to the scorching post-1978 rate. In fact, the last time annual growth reached 9 percent was a decade ago. Part of this is by design. In the five-year plan announced at the 2017 19th Party Congress, the government signaled that the economy would transform from a singular focus on growth—in particular, export-led growth—to a multiple-objective, high-quality growth framework that focused on domestic demand. Such a structural transformation was always going to be accompanied by slower growth. More recently, an added drag comes from substantial stresses related to property developers’ debt.

But the biggest driver of the current slowdown is COVID-19, in particular this year’s severe zero-COVID-related lockdowns in several key cities. For example, Shanghai, a major economic hub, went into a lockdown in March, emerged from it on June 1, and is now, in parts of the city, in lockdown yet again.

The biggest driver of the current slowdown is COVID-19, in particular this year’s severe zero-COVID-related lockdowns

Lockdowns essentially stop economic activity in affected areas and sectors. Not surprisingly, the downgrading of GDP forecasts has been swift. Since February 18, JPMorgan’s China economics team has reduced its forecast of H1 growth by a whopping 5 percent and now forecasts just 3.7 percent growth for the entire year. China’s economy will recover once lockdowns are a thing of the past; that could occur soon, but it might not.

The spillovers

A slowdown in China, the second largest economy in the world, will undoubtedly affect the rest of the world. But the severity of the impact is difficult to estimate for a reason that might not be immediately apparent and yet is obvious once you think about it. China’s quarterly GDP numbers are incredibly smooth—some would say too smooth. The smoothing that apparently has been done to quarterly GDP numbers means that (1) using official GDP data would naturally produce the result that China’s GDP fluctuations have little effect on other countries because, in a statistical sense, a smooth series has little effect on anything that isn’t smooth, and (2) if you want accurate quarterly GDP numbers you have to create them yourself. Many outfits are doing so. Some are creating an alt-GDP index from as many as 40 indicators that actually fluctuate.

JPMorgan estimates spillovers to developed and emerging markets using reported GDP, their nowcasts of GDP, and their forecast revisions. Their analysis suggests spillovers to the U.S. and other developed economies will be muted, with emerging markets facing a larger but not enormous impact. In part based on an assumption that reopening dynamics will produce a sizeable bounce-back in China’s economic activity, overall the impact of a China slowdown on the rest of the world seems muted.

JPMorgan estimates spillovers to developed and emerging markets using reported GDP, their nowcasts of GDP, and their forecast revisions

Recent analysis by Federal Reserve economists might suggest a different view. After noting that China’s real GDP data are the smoothest in the world, especially since 2012—see the striking Figure 4 in their paper—they create an alt-GDP series “using a large set of [31] indicators of economic activity that are believed to be less subject to smoothing by the government, including property market data, auto sales, reported exports to China from other countries, satellite nighttime lights data, and pollution data.” While not the focus of their paper, the alt-GDP series presumably would suggest larger spillovers to other economies, including the United States.

The 'alt-GDP' series presumably would suggest larger spillovers to other economies, including the United States

In summary, while it takes some expertise to interpret China’s GDP data, economic growth is slowing. In part, this is due to the government’s ongoing structural transformation strategy. But this year’s slowdown is more severe because of strict lockdowns. That slowdown will impact the rest of the world. How much is an open question.