Worries about China's economic power are overdone
Core realities suggest that it will never establish a meaningful lead over the West. Originally published in Nikkei Asia.
The Ukraine war has accelerated fears that the world is hurtling dangerously toward a new Cold War, pitting a neo-authoritarian axis of Russia and China against the world's rich democracies.
Yet, the war has so far proven disastrous for Russia, which seems likely to emerge with its military humbled, its economy crippled and the European Union more geopolitically emboldened than ever. Vladimir Putin, it appears, has greatly miscalculated.
What about China? China is not Russia by any means, nor are its relations with the West quite so one-sided, or foregone.
Nevertheless, the inescapable lesson of this crisis is that the terrifying possibility of war between nuclear-armed great powers is real and the world must prepare for the worst while at the same time acting to prevent it.
Another critical take-away from this crisis is the importance of not overestimating the other side and the challenges it represents.
To be sure, Russia is an economic minnow, a shadow of its former Soviet self. This has left it fundamentally weakened and vulnerable to powerful Western sanctions. China's economy, by contrast, is around ten times larger than Russia's and has already far surpassed the economic strength that the USSR was ever able to build relative to the U.S.
Moreover, many believe China will continue to sustain rapid growth for decades to come. For instance, capturing the mainstream calculus, the Chicago-based investor Ray Dalio has argued that China's economy will one day be twice the size of America's, pointing to China's huge population and assuming its income per person will continue catching up rapidly to that of the U.S.
Expectations matter because this shapes the decisions and behavior of investors, companies, governments and nations today. If Western governments had fully appreciated Russia's evident military and economic weakness beforehand, perhaps a very different course of events would have unfolded.
As it stands, mainstream expectations imply China is destined to become a veritable economic bloc unto itself, singularly outweighing the collective heft of the Group of Seven nations and almost matching that of the entire West combined. An enfeebled Russian partner would not matter much to such an empowered China, which would have the raw economic strength to quite possibly dominate the world financially, technologically and even militarily.
But is this really the most likely scenario? A closer examination of China's growth fundamentals suggests not. China's workforce is shrinking rapidly, and, within the window of the next few decades, there is little Beijing can do to substantially alter this outlook.
China's growth has also been incredibly capital-intensive. But housing investment is now entering a period of structural decline while infrastructure investment is close to reaching its limits. Even the growth contribution of business investment will decline sharply unless there is faster productivity growth.
But China's productivity growth has also been decelerating and will probably continue to do so. Partly this is to be expected as China's economy matures and the scope for easy catch-up wins fades.
China faces other significant additional headwinds. Unlike its East Asian miracle predecessors, China's size and geopolitics mean it can no longer benefit from relatively unfettered access to global export markets and technology.
China is therefore looking to rely more on domestic consumption and indigenous innovation. This may be necessary, but it is a recipe for slower productivity growth. Meanwhile, progress with key economic reforms has been limited.
Bringing this macro picture together, new research by the Lowy Institute projects that Chinese economic growth is likely to slow dramatically over the coming decade to around just 3% a year by 2030, less than half its pre-pandemic trend pace. Over the entire three decades to 2050, we project growth might only average between 2-3% a year.
This is not based on China failing. It simply reflects the core realities of China's economic circumstances, even assuming a reasonable degree of continued policy success.
Of course, China notionally has the potential to do better. But doing so would require going well beyond its historical track record of reform which, while impressive, has demonstrable limits. Alternatively, China could easily perform much worse, given the toxic combination of slowing growth and deep financial vulnerabilities after more than a decade of rapid credit expansion.
Assuming China is not derailed prematurely, our research suggests that China might overtake the U.S. as the world's largest economy measured in dollars by around 2030. Yet it would never establish a meaningful lead.
Yes, China would become a true peer competitor to the U.S., but it would lack America's network of allies and partners and would not possess the raw economic strength to compete with the West as a group financially, technologically, or militarily. This is even more true now that Putin may have awakened the sleeping superpower that is the European Union.
The economics, therefore, provides some hope in meeting the world's budding neo-authoritarian challenge as long as the West itself does not fumble its many advantages.