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November 24, 2023

News in Charts: China makes a show of weakness, not strength

by Fathom Consulting.

China’s fixed ambition has for many years been to become the richest economy in the world, and it has adapted its tactics to the geopolitical environment several times in order to achieve this goal. The most recent tactic is what Fathom calls the ‘broken wing’: allaying the fears of its trading partners abroad by drawing attention to the many structural weaknesses that beset the Chinese economy. Those weaknesses are not new, but the tactic of acknowledging them now certainly is.

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Thanks to its accession to the World Trade Organisation in 2001, China was able to massively increase its standards of living, while the rest of the world benefited from cheap manufactured goods and low interest rates. However, these changes also led to higher levels of debt in advanced economies, along with lower real wages in some sectors as a consequence of the offshoring of jobs to China. Taken together with poor banking regulation, these circumstances led to the global financial crisis of 2008/09 — which China managed to escape thanks to a huge fiscal stimulus.


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After the GFC, the exports-led growth model that had served China so well since the early 1990s had run its course. Global prices of manufactured exports had cleared at Chinese levels, while developed economies were now reducing their demand for Chinese goods as they were still recovering from the crisis. China therefore adopted a new model that required different tactics. As its rapid industrialisation had led to excessive investment, China tried to rebalance its economy. It did this by reducing its reliance on investment; but there was no countervailing increase in the contribution from consumption. This was the ‘bad’ kind of rebalancing, and it led to much slower growth. The true magnitude of the slowdown was not reported in official Chinese GDP data, but it was captured in Fathom’s proprietary China Momentum Indicator (CMI). By 2015 China had abandoned its attempt to rebalance and reverted to the growth model that had seen it through the GFC: full employment, supported by unproductive investment — this time not in manufacturing and exports, but in infrastructure and, especially, housing construction.

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China’s strategy then turned to becoming self-sufficient in the technology needed for its economy to grow in the long term. In 2015 it announced its ‘Made in China 2025’ plan, which aimed at transforming the country’s manufacturing base into a high-tech powerhouse in nine key sectors, shown in the chart below. Initially China enjoyed success through the tactic of tech acquisitions, but in 2016 the West started to wake up to the threat and the incoming Trump administration responded with a variety of trade restrictions. The Biden administration has not only continued the Trump tariffs but started to take more accurate aim at China’s role in global tech supply chains, introducing the idea of tech ‘decoupling’ or ‘de-risking’, potentially with US allies in tow. These policies pose a potential threat not only to China’s dominance in global export markets, but also to its long-term hopes of escaping the middle-income trap.

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So now China’s tune has changed again, this time to what Fathom thinks of as the ‘broken-wing’ blues. Previously Beijing has shown reluctance to publish bad news about the economy. This new tactic however consists of advertising its economic weaknesses where they exist: if the US and its allies can be made to believe that China has passed its peak then they will have no need to de-risk, since China cannot pose a serious threat to US hegemony. This would allow China to retain its access to cutting-edge technology innovations and build up its capabilities in the labour-replacing tech it needs to maintain its position while its working-age population dwindles. One example of the ‘broken-wing’ tactic in practice was the recent statistical release (illustrated in the chart below) showing the first-ever deficit in China foreign direct investment, which implicitly recognises a lack of confidence in China by international investors. However, Beijing will need to strike a careful balance – talking down the economy more than necessary could be seen as too obvious and reveal the tactic, as well as risking a that could drag the Chinese economy into an actual downturn.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.


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