How China’s Economic Slowdown Could Hurt the World

Until recently, two engines drove economic change in China: rapid growth from a low baseline and the adoption, beginning in the late 1970s, of market-oriented policies. Per capita income rose from just a few hundred dollars per year in 1978 to $12,000 today. This transformation relied on the reform and liberalization of the economy, an imperative maintained even during Chinese leader Xi Jinping’s initial years at the helm of the country. But over the past decade, the government’s tolerance for the painful side effects of reform has waned: Beijing has opted for easier policy reforms, grappled with the so-called middle-income trap (in which rising wages and the demands of a richer society put sustainable growth at risk), and faced the unsettling prospect of mounting political unrest.

As China’s rate of growth has slowed markedly, its leaders have taken a far more statist posture in managing the economy. As long as Beijing further delays liberalizing reforms, it will struggle to contend with an inevitable slowdown. This hard-wired macroeconomic shift has profound implications for numerous areas, and potentially serious consequences for Beijing’s effort to decarbonize the economy. If the Chinese Communist Party cannot embrace economic reforms and continues to rely on old-style energy- and emissions-intensive investment to drive growth, then China will not be able to ramp up its climate goals in concert with its global counterparts. The travails of an economy as large as China’s are not China’s alone. The macroeconomic changes underway will affect not only China’s decarbonization efforts but also those of many other countries. Beijing must change course, instituting reforms so that its slowdown does not imperil its prosperity—or the planet.

THE SLOWDOWN

The Chinese government acknowledges that the country fell well short of its 2022 growth target. China reported only three percent annual growth, far less than its 5.5 percent goal. And the real rate may have been worse: official statistics are increasingly dubious, and the economy could have actually contracted last year. With the exception of 2020, when the onset of the COVID-19 pandemic crippled economies everywhere, 2022 marked the slowest reported growth in China since the 1970s, as well as the first time it acknowledged significantly missing a growth target. Leaders in Beijing attribute this result to one-off pandemic factors, arguing that the shortfall was only a temporary setback and that the spending power of Chinese consumers and further government support for infrastructure and investment will enable the country to bounce back. At the March 2023 National People’s Congress, leaders again set a target of “around five percent” GDP growth for this year.

Optimists assert that the country will revert to its prior fast pace now that it has abandoned the lockdowns and restrictions of its “zero COVID” approach. But China’s economy has been slowing because of structural conditions that predate the pandemic. The limits to its growth have been apparent for a decade, and observers recognize that the Chinese economy can no longer produce the eye-watering rates of growth that sustained global excitement in previous decades. For instance, the latest International Monetary Fund forecast expects the Chinese economy to recover in 2023, but it foresees growth subsiding to less than four percent after 2024. This is significantly lower than previous IMF forecasts, as well as projections by Chinese economists calibrated to support the goal of doubling per capita GDP by 2035.

In 2022, China’s economy grew at its slowest rate since the 1970s.

Long-term projections of potential economic growth rest on three factors: demographics, capital investment, and productivity. With China’s population aging and birthrates tumbling, demographic limits are inescapable; between 2020 and 2040, the number of Chinese people over 65 will double, as the working-age population continues to shrink, according to the UN World Population Prospects report. The growth of capital investment in the economy must slow down, as evidenced by a rash of business and bank defaults, fiscal shortfalls for heavily indebted local governments, and falling returns on investment. In short, years of unconstrained lending have not produced sufficient results: investment-led growth simply cannot play as big a role in the future as it has in the past. The growth of productivity—the improvement in output above and beyond inputs of labor and capital—has already fallen to low levels, just a fraction of past rates. Boosting productivity is possible, but only if economic performance is placed above political priorities and encouraged by policy reforms that Xi pledged to undertake in 2013 but deferred after they proved too politically challenging to implement. For instance, the government began rolling out fiscal reforms to give localities an alternative to promoting carbon-intensive property construction but delayed them in the face of resistance to taxes.

The pandemic period could have spurred needed reforms, but through the end of 2022 it did the opposite. With no room for debate, Chinese officials sanctioned more state control and more administrative intervention in the allocation of capital. Crackdowns on numerous once thriving Internet sectors, for instance, have left many new and growing industries diminished. The haphazard end of zero COVID was evidence not of a transformation in the system but simply of a lack of better ideas.

China’s economy can take one of two paths forward, neither of which is likely to double per capita GDP by 2035. If leaders remain fixed on statism, the growth rate might rise somewhat for a year or two, but then it will fall to potentially two percent or lower in the second half of this decade. This statist approach would likely entail trying to sustain the property bubble and other sectors for the next two years or so and restructuring mountains of local government debt at the expense of households and other savers, thereby locking up long-term capital in low-return sectors and limiting investment in future growth, innovation, and value. If China re-embraces reform, by contrast, growth would drop even lower through the medium term but could then climb back to potentially four percent as 2030 approaches—a solid rate of growth for a middle-income country of China’s size. But reform requires tough structural adjustments, with pain in overcapacity areas such as heavy industry; relinquishing considerable state control over property and commerce; and accepting weaker growth while adjustment takes place. Whether Beijing embraces reform or not, the days of super-high growth are over, but that is a measure of the success of China’s development and no reason for disappointment.

GREEN TROUBLES

A statist approach, however, will jeopardize Chinese plans to decarbonize the economy. Li Keqiang, China’s recently retired premier, highlighted the country’s energy and environmental performance in recent years in his final report to the March 2023 National People’s Congress. Li noted that although GDP grew at an annual average rate of 5.2 percent from 2018 to 2022, energy intensity of GDP decreased by 8.1 percent, and the carbon dioxide intensity of GDP fell by 14.1 percent. Energy intensity of GDP is a measure of the energy efficiency of an economy, how many units of energy it takes to generate economic output. Carbon intensity of GDP is similarly a measure of how much carbon dioxide is emitted per unit of GDP. Together, the two measures help track the progress of China’s climate transition.

The combination, however, of slower growth and the continued reliance on energy-intensive economic activity is causing China to fall off its expected trajectory. China’s reported 2022 data already demonstrates this problem. According to official statistics, China achieved only a 0.1 percent reduction in energy intensity and 0.8 percent reduction in carbon intensity last year. Energy intensity reductions have stagnated since 2020. China has historically averaged 2.2 percent annual reductions in energy intensity for the last 20 years and a 3.0 percent annual average in the last 40 years: today’s tiny reductions are reminders that past performance does not guarantee future results. Chinese officials are aware of this decline, and Beijing has been walking back the importance of energy intensity targets. Since 2021, it has stopped setting annual targets for these reductions altogether.

The good news is that regardless of which macroeconomic scenario plays out for China in the years ahead, its carbon dioxide emissions will likely peak before 2030. China’s continued commitment to building new zero-carbon infrastructure, such as wind turbines and solar plants, certainly helps. In 2022, the country consumed nearly three percent more total energy than in 2021, but more than 17 percent of the total was met by nonfossil fuel sources, up from 16 percent in 2020. Carbon dioxide emissions tracked by the Carbon Monitor, a group that estimates daily emissions, appear to have either stayed flat or decreased slightly, despite a reported increase in coal consumption. Some models, including those used by the International Energy Agency, suggest that China’s carbon dioxide emissions should have already peaked.

Without reform, China will struggle to reach its climate targets.

The bad news is that delaying reforms and relying on old models for another half decade will make it hard for China to reach its broader emissions intensity targets by 2030. Although China is relying more on nonfossil fuel sources for energy production, its energy intensity of GDP is no longer trending down. China will have to outperform historical energy intensity trends and increase the overall nonfossil share of energy to reach its goal of a more than 65 percent reduction in carbon intensity by 2030, things it can do only if it embraces reform and marketization. Reform will allow China to chart a faster and more consumer-driven growth trajectory that can better enable the transition to higher energy efficiency and lower emissions intensity. But the current statist approach will lock the country into a lower growth trajectory that is less energy efficient and does little to reduce emissions, all propped up by heavy industry and the overreliance on investment in infrastructure.

If China’s leaders continue doubling down on statist economic models, then by 2030 they will preside over a smaller economy with higher emissions. Such is the peril of the policy choices facing the Chinese government: stability bought with statism today means weaker performance tomorrow that prevents Beijing from making necessary investments in greener growth. China’s ability to achieve a green transition and successfully reach its 2030 and 2060 climate goals depends on whether it can encourage more economically efficient, lower-emissions growth.

The foundations of this necessary transition must be laid now. What matters is not only what China does well (developing more sources of renewable energy) but also what it does not do well. To ensure an orderly, low-cost transition to net-zero emissions by 2060, China needs to stop building industrial capacity reliant on coal that will lock in emissions-intensive activity for decades to come. 2060 is less than 40 years away, a period shorter than the technical lifespan of many power plants, factories, and other industrial assets. Money spent on carbon-intensive assets today to help deliver growth will create wasteful financial liabilities tomorrow that will make the cost of a green transition harder to manage.

A GLOBAL STORY

The international community must consider several climate-related challenges as China transitions into a period of slower economic growth. First, during the tenure of U.S. President Donald Trump, the cooperative dynamic that underpinned U.S.-Chinese climate action broke down. The contours of future cooperation are not yet clear. As Washington focuses on a partial decoupling and competition in trade and innovation, climate is slipping off the agenda; both countries should establish guardrails to keep their respective global climate ambitions on track. For instance, China can align with the United States on the measurement and management of methane and other noncarbon greenhouse gas emissions by joining the U.S.-led Methane Emissions Reduction Action Plan. Additionally, although the two countries will compete vigorously over the supply chains that produce green technology, their investments into expanding the capacity to make such technology and into scaling it up is beneficial to all.

Second, Chinese policymakers may choose to sacrifice spending on green initiatives as they face hard choices about local government debt restructuring and austerity measures. More mature green technology sectors—including wind and solar power and, increasingly, electric vehicles—are already being weaned off government subsidies, but emerging sectors, including green hydrogen and sustainable aviation fuel, still depend on state support. China needs to spend on costly infrastructure investments to adapt to climate change, such as building seawalls. These investments are necessary to enable the next stage of China’s decarbonization, but they will be harder to afford as a result of slower growth. Beijing cannot plan for this fiscal challenge if it does not recognize that its slowdown is not a hiccup but a longer trend.

Finally, China’s new macroeconomic normal will have negative spillover effects on the global climate action agenda. Assumptions about China’s growth lowering the costs of the climate tech supply chain will need to be revisited. Some Western analysts are so busy discussing whether the benefits of low-cost Chinese products justify the security risks (real and imagined) that they neglect to consider that the era of persistently cheaper Chinese products may be ending, regardless. The real possibility that China’s manufacturing sector might not be able to drive down global climate transition costs is a reason to think hard about Washington’s partial decoupling from the Chinese economy. Strengthening domestic manufacturing capabilities and diversifying supply chains are worthy goals, but any country that pursues disengagement in an indiscriminate way—as some in Washington want to do—will undermine its own interests.

Beyond the impact on the geopolitics of climate, a slowing China will also affect the global South in other important ways. Beijing will be more constrained in offering development assistance packages and financing green transition in developing countries. Many countries—including many of the 140-plus that have entered into Belt and Road Initiative agreements with Beijing—are counting on Chinese support to finance their own transitions to cleaner power plants and better grid infrastructure. A China that is growing slowly will also import fewer minerals and other raw materials from countries hoping to sell to the enormous Chinese market. China’s growth shortfall will not only impinge upon its domestic priorities but also hurt the rest of the world.