Will the Chinese economy ever overtake the American?

  • China’s population may have peaked in 2021.
  • This is worrying, since population and labour force growth are key inputs in GDP growth.
  • Monetary data also point to weaker trend growth going forward.

In mid-January, there was an interesting news item from China. The number of children born in 2021 was 10.62 million, down from 12 million in 2020. The birth rate per 1,000 inhabitants was 7.52, the lowest since the People’s Republic was founded in 1949; and overall population growth was 480,000, the lowest since the Great Famine (a direct consequence of Communist Party policy) in 1959-1961. It may well be that 2021 will be the year when, in retrospect, China’s population peaked. 

In one sense, this is not news; China’s dismal demographics have been known for some time to anyone interested in the topic. Moreover, the ‘prime-age’ cohort (those aged 25-64, the bulk of the potential labour force) has already been shrinking for about ten years. Nevertheless, if 2021 turns out to be the peak year for China’s population, then it will indeed be a milestone.

This is not only of passing interest. Ultimately, economic growth is a function of the growth of labour, the growth of (physical) capital and of total factor productivity growth (difficult to measure). A shrinking population and labour force therefore, all things being equal, become a serious pointer to a deteriorating long-term economic performance.

This fits in with another interesting development, equally implying that China’s growth performance will deteriorate in coming years. That is the slowdown of broad money growth.

Historically (meaning back to the late 1980s, when reliable data begins), the Chinese economy has needed substantial excess broad money (M2) growth to produce a given GDP growth number. On average, since 1987, M2 growth has exceeded GDP growth by just short of 10.5%. Of course, this masks substantial variation. The differential was considerably higher in the 1990s; and there are variations due to once-offs, such as the Covid pandemic or the Great Recession. However, over the past ten years, Chinese M2 growth has exceeded nominal GDP growth by just short of 5% per annum. Meanwhile, actual M2 growth has slowed from 17% in 2011 to slightly below 9% in 2021, while in the three years 2017-2019 (the most recent ‘normal’ period) it was actually below 9%. 

If we assume that both these trends hold true over the medium-term, and disregarding year on year changes in either direction, the message from the monetary data would point to a Chinese trend growth rate in the 3-4% range (8-9% broad money growth, less 5% excess needed including 2-3% for inflation).

3-4% annual real GDP growth is still a very respectable number. But this would not take into account the continued demographic deterioration. This will admittedly not appear at once, but once it starts to impact growth, the effect will not only be felt but will also be very difficult to reverse – as the Chinese authorities are already finding, with the failure of campaigns to encourage families to have more children. Nor does it take account of potential further trade wars, in a situation where China has quarrelled with almost all its neighbours and trading partners except North Korea (which doesn’t have much to offer) and Russia (which is a Chinese vassal in all but name). Again, this impact may not be huge, but it will be noticeable once the world economy normalises, not least if (when!) Western manufacturers move production away from China to cheaper and less politically fraught locations.

Over the past three decades, many economists have confidently forecast that the Chinese economy will overtake the American in size by [please fill in any year you like]. This is very similar to the extrapolations once made about Japan – and in the end, Japan never did overtake the United States.

But what the combination of the demographic and the monetary data tell us, is that we should perhaps ask whether, in fact, the Chinese economy ever overtake the American in size? In one sense, this is probably a silly question. The US economy’s trend growth rate is probably around 2%. Even with a growth rate of 3-4%, it is inevitable that the Chinese economy will one day be larger than the American, the more so since China has a population between 4 and 5 times the size of the American. But it may take rather longer than expected. Moreover, the United States has a much more favourable demographic outlook: according to the United Nations medium variant population projections, by 2050, the US will have added 50 million inhabitants, while China will have lost 40 million. 

It is sometimes said that China risks growing old before it grows rich. It already is growing older. Whether it will grow richer, particularly rich enough to exit the middle-income trap, is not as clear. Certainly, unless the trends outlined here change, China may indeed overtake the US in absolute size; but it will never become richer than the US, and its moment of ‘triumph’ may turn out to be fleeting. And that carries with it another message: for a regime that relies for its legitimacy on providing economic growth and order, the failure to provide that growth and the greater reliance, therefore, on order and stability, may become a threat to the regime.