Deflated dreams: China bets on technology to avoid economic slowdown

Analysts are already beginning to discuss the possible "Japanification" of China, referencing the long, deflationary stagnation that plagued Japanese economy after its boom years ended in early 1990s

The weeklong National People’s Congress of the Chinese Communist Party this year was — as it usually is — a celebration of President Xi Jinping’s leadership. The optimism on display might sit somewhat awkwardly with the rest of the economic news out of China, however. Deflationary pressure has become difficult to ignore, with prices falling for consumers over the first months of the year, signifying that demand is still weak and overcapacity a problem. This follows two years in which broad measures of prices appear to have slipped into deflationary territory. Questions about the excess capacity in the economy will become even more urgent as and when various trade restrictions and tariffs promised by the new administration in the United States begin to bite.  The government has been quite sanguine in public about the tariffs, indicating that domestic issues take precedence — but that confidence should be dismissed. In this case, external factors will only intensify domestic structural problems, which have been building up for some time. Growth targets of 5 per cent and inflation targets of 2 per cent, therefore, seem quite ambitious. Sectors that continue to be dependent on Chinese prices and production — such as metals exports from India — will need to be revalued. 

Analysts are already beginning to discuss the possible “Japanification” of China, referencing the long, deflationary stagnation that plagued the Japanese economy after its boom years ended in the early 1990s. In 1990s Japan, as in China, this period was extended by a property market, which overextended itself and did not wind itself up in a timely manner. About $18 trillion in wealth may have been lost by Chinese households thanks to its real estate troubles, meaning that it will take a long while for consumer demand to revive. There is thus little sign of resolution of the macroeconomic imbalance between production and domestic demand, which is central to China’s current problems. In real terms, this means that capital is being misallocated on an enormous scale: Firms are maintaining or expanding capacity and production even when they are only marginally profitable or even loss-making. Deflation also encourages people to save rather than spend — which, together with restrictions on capital mobility, simply adds to the pile of misallocated capital.

  The logical way for Mr Xi to address this issue would be to free up capital mobility, allow for some unprofitable but politically connected producers to go under, and reduce the political constraints on spending and investment by households and the private sector. However, these are not choices that the government is willing to make. Nor is it wise to address this problem as similar issues in the past have been handled, through a vast fiscal stimulus — since that would merely add to overcapacity. Thus, Mr Xi has chosen a third path, which was visible during the National People’s Congress. Political attention and resources are being poured into technological endeavours, in the hope that this will boost productivity and ensure Chinese leadership in the industries and exports of the future. In 2021, investment in research and development in China was only 16 per cent less than in the US. With recent cuts in government spending in the US, and sharp budgetary increases in China, the lead might be wiped out. Mr Xi clearly believes that tech leadership can dig China out of what otherwise might be a decades-long deflationary spiral.