A stagnant China in 2040, briefly

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Key Points

There is a considerable chance China will stagnate by 2040, with gross domestic product growth at 1–1.5 percent. The process has started, seen most clearly in stark trends for debt and aging, but better-quality data on productivity would clarify how far along stagnation is and whether it at some point reverses.

China shows no sign of adopting pro-productivity reform. It will not spur growth by leveraging or bolster a shrinking labor force through current population and education policy. Innovation will help, but a large economy requires broad innovation, and the party dislikes competition.

A twist comes from China’s global position, which will not deteriorate much. Outbound investment has retrenched, and the yuan’s rise was exaggerated. Consumption exports and commodities imports will stall. But China will easily be a top-two market in most sectors, and other countries are not acting to displace it. Instead, localization will occur.

Commodities producers and some developing countries will lose, the latter as Chinese capital dries up. Countries that make difficult reforms will win. Consumer goods will see inflation, but innovation will be healthier with less Chinese influence. American firms will seek new pastures, and Chinese stagnation means production may relocate to the US.

Introduction

What would a stagnant China look like? By 2040, debt and then aging may cut annual gross domestic product (GDP) growth to 1–1.5 percent. This short report addresses how to verify that stagnation is in process, China’s likely economic policy response, the resulting changes in its international role, and a few impacts on everyone else. This scenario is both more likely and less damaging to China globally than commonly thought.

How to Know

A stagnant China in 2040 is likely: There has already been essentially every major sign of stagnation, especially with debt accumulation, though little is pressing as yet. Official real GDP growth was 10.6 percent in 2010 and 6.1 percent in 2019, with Beijing guiding expectations further downward. If there is no return to pro-productivity reform, a simple projection for the start of the 2030s is 3.2 percent and falling from there. Sharply deteriorating demographics argue for the slowdown to intensify and be more difficult to escape as time goes on.

Personal income is often underemphasized. When defenders of Chinese performance downplay the GDP slowdown as expected, they neglect how far behind China is in income. Official data imply 2019 GDP per capita of 71,000 RMB, but GDP per capita is an accounting result that cannot be spent or saved. The government itself reports personal income at 31,000 RMB in 2019.1 The most comparable American figure is 11 times higher.2 Failing to close that gap considerably over a decade would be a more telling sign of the stagnation process.

The Communist Party is unlikely to reveal the extent of macroeconomic slowdown, and regardless, labor productivity is superior to GDP in predicting future prosperity. However, productivity is notoriously hard to measure. The US government should create multiple productivity estimates to track over time for China, even though the method and base figures for each would be subject to dispute. Obviously related is the raw quantity of labor: A shrinking labor force for an extended period eventually means no aggregate growth, though individual income can rise.

The most important external indicator is net capital flow. China can of course falsify balance of payments accounting as it does with GDP accounting. However, reports by large economies of their current account balances with China are a baseline. They can be compared to China’s reserves, to see if reserves are pressured by net capital outflow. In addition, commodities exports can be documented outside China. The energy consumption pattern will shift, and expecting rapid growth is unreasonable. But inadequate domestic resources mean that, if China is growing, it must import more energy of some sort. If incomes are rising, so should food imports.

There is no obvious time when economic struggles will be clearer than they became first in 2009 when China went deeply into (domestic) debt and then in 2015 when capital flight intensified.3 A policy misstep triggers a surge in internal stress. The ensuing rebound is shallower and narrower than expected, and there is a hesitant but ultimately consensus recalibration of the trajectory. This could happen any time, for example if China again encourages debt accumulation and excess supply in response to COVID-19 or when Xi Jinping’s replacement attempts to buy political support.