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China’s “Common Prosperity” policy looks set to be a game changer for the country as it refocuses its priorities away from economic expansion at breakneck speed at any cost towards a long-term goal of reducing domestic inequality in the years to come. We consider some of the key implications of the new policy and what they mean for the global economy.
The Common Prosperity policy represents a paradigm shift for China, with its focus on narrowing inequality and overturning the prior 40-year consensus of rapid market expansion at all costs and “letting some people get rich first”. The government plans to use taxation and other means to redistribute income to expand the proportion of people in the middle class and increase the incomes of the poor, as well as reducing what it deems the “excessive” incomes of the super-rich.
The new policy means that local government officials will no longer be pressured to achieve lofty economic growth targets and will instead be incentivised to achieve what might be called “quality” growth. But this isn’t to say that the Chinese growth story is in jeopardy: over the longer term, consumption by China’s growing middle class and higher manufacturing value-add should ensure growth over a multi-year horizon is well supported. It’s just that there will be a shift away from the debt-driven property and infrastructure investment of the past few decades.
China’s contribution to global economic growth (GDP*) is projected to fall below the combined contributions of the US, UK, and EU for the first time in more than a decade
Meanwhile, further regulatory crackdowns look likely after the tutoring, internet, entertainment and gaming sectors were in the crosshairs earlier this year. For 2022 and beyond, President Xi has set out his aim to crack down on monopolies and the “disorderly expansion of capital”. We would not rule out continued risks for domestic markets, although we’d expect them to be better signalled than they were in 2021.
Even though China’s drive for common prosperity is aimed at levelling up conditions within China, it has big implications for the rest of the world. Here are the six that are crucial for the global economy.
A key priority for China will be its continued focus on the development and competitiveness of high-tech, high-value-adding sectors like electric vehicles, artificial intelligence, high-end manufacturing, semiconductors. These sectors have been priorities for at least five years.
Yet the state’s continued push towards indigenous technologies and innovation doesn’t mean China will decouple from the rest of the world. Rather, it suggests to us a desire to protect itself from external trade and policy shocks like the Trump administration’s trade wars and from increased competition with developed nations for dominance in tech. As ever, capital flows remain an important source of funding to fuel the investment needed to achieve these goals. Indeed, foreign direct investment (FDI) inflows into China have remained robust despite the pandemic and trade war with the US in recent years.
In the years to come, imports will be important in helping China meet its aim of increasing domestic consumption and shifting its growth model, with the current account surplus returning to its earlier trend of narrowing, before eventually moving to deficit.
Trade relations look set to “build back boring” in 2022 and become much less volatile. It’s not just about trade – the focus is on competition for technological superiority and China’s state-led development policies in the tech sector. If anything, we would expect the focus of tensions to shift more hawkishly towards tech, with the overall rules of engagement emphasising competition rather than tariffs.
Recent US rhetoric suggests there will be continued enforcement of the Phase I trade deal, with no intention of removing existing tariffs and continued marshalling of US allies on a coordinated China trade policy. But coordinated action and a common agenda against China will be difficult given different countries’ hugely varying bilateral exposures to Chinese trade, as well as the risk of persistent supply chain shortages.
Geopolitical tensions are likely to persist, but they should remain contained. But China’s more assertive foreign policy (especially in its own backyard) will mean that regional tensions are likely to persist and will represent a source of headline risk. Issues such as Taiwanese independence, the South China Sea, and relations with the Australia, UK and US alliance could be particular focal points. Despite this, we don’t think escalation into open conflict is on China’s agenda, as we expect that it will stick to its current diplomatic playbook of hawkish rhetoric and posturing instead.
China’s economic ambitions do not mean that the country will be able to rapidly end lower-value manufacturing. In fact, 2020 and 2021 have shown that China has been opportunistic in increasing its shares of trade and manufacturing.
Supply chain shifts were underway long before the onset of the pandemic. For example, the garment manufacturing chain has been partially relocating into south / southeast Asia since the mid-2010s due to Chinese wages rising – without any significant impact on global inflation.
If anything, decisions to near-shore (or onshore) manufacturing, reduce supplier concentration and fragilities (by introducing redundancies), or take on board more ESG considerations are more likely to be drivers of global inflationary pressures.
The sheer volume at which China produces things will be enough to backstop commodity demand, but we don’t expect the country’s credit impulse – the change in new credit as a proportion of gross domestic product (GDP) – to be big enough to lead to further major commodity rallies.
The impact of this on emerging markets as a whole should be muted, particularly in the FX space. While emerging-market currencies have generally moved broadly in line with commodity prices in the past, their performance has lagged during this upswing in the commodity cycle, despite exports performing reasonably well. We attribute their lacklustre performance more to lagging growth in emerging economies and subdued capital flows.
We expect export flows for China and its Asian manufacturing peers to continue to perform well as shortages persist into the first half of 2022. Financial flows into China will remain supported, particularly as passive inflows continue with the gradual inclusion of Chinese government bonds in the FTSE World Government Bond Index over the next three years.
Global exports remain resilient – and will continue to support the yuan
Importantly, we think that outflows will be constrained as well. Financial inflows slowed, but did not register outflows in 2021, even during the Q3 regulatory crackdown. A belated reopening of borders will also mean that tourism, the primary source of current account outflows, will remain muted and will resume later rather than sooner. The lack of outflows will bolster the current account balance in China, providing support for the yuan.
Finally, we think that stringent border controls and the zero-tolerance policy towards coronavirus are likely to persist well into the first half of next year as the government keeps a tight lid on infections in the lead-up to February’s Beijing Winter Olympics and beyond. The return of Chinese outbound tourism will probably be belated, and the risks appear skewed towards a later and slower recovery of tourism-dependent economies in the region.