China’s share of global gross domestic product (GDP) shrank to just 5% in 1978, but a series of market reforms supercharged the country’s economic growth. Today, China is the world’s second largest economic power and a major player on the global stage. But is its momentum sustainable?
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The Stark Contrast: Before and After China’s Market Reforms
In 1820, during the Qing Dynasty, China’s economy was the largest in the world, accounting for more than 30% of the global GDP at the time.
However, by 1978, nearly 80% of China’s industrial production was from state-owned enterprises (SOEs), as private companies and foreign firms were largely prohibited. Even foreign trade was limited to obtaining certain goods that could not be made in China. As a result, there was essentially no market mechanism to efficiently allocate resources, and China remained stagnant and isolated from the global economy.
To help spur economic development, China introduced a series of market reforms in 1978. The first aspect of the reforms was changing its centrally planned economy to a market-oriented one with a socialist ideology; the second aspect was embracing a manufacturing and service-based economy (vs. an economy based in agriculture); and the third aspect was shifting from a closed to an open economy.
After the rollout of these reforms, China’s economy evolved into one that is pro-growth, pro-market, and pro-technology thanks to initiatives that decentralized economic production, encouraged large-scale capital investment, and boosted productivity growth. The timeline below highlights several key events that accelerated China’s economic development.
Overall, the market reforms unleashed China’s economic growth potential. China’s 2021 GDP was roughly 120 times the size of its 1978 GDP, and its GDP per capita grew over 200 times during the same period.
But exponential growth can result in some challenges. In China’s case, GDP growth from exports has begun to decline, a trend that was spurred by the COVID-19 pandemic; other hurdles such as a structurally weak property market and a widening income gap add to China’s economic worries.
We believe the ability of the Chinese government to implement reforms to counteract these challenges will determine whether China can continue to maintain relatively rapid economic growth rates moving forward.
A Unique Economic Model
China’s socialist market economic model is unique; it’s a hybrid model that combines top-down (socialist) and bottom-up (capitalistic) forces. The essence of this model is that it applies socialism as a social system and the market economy as a resource-allocation mechanism so that the two approaches can coexist.
The core element in China’s economic model is the relationship between the government and market systems, which has evolved over the decades.
At the 12th Chinese Communist Party (CCP) National Congress in 1982, an agriculture-based economy was still in effect; the market only played a supplementary role to central planning. In 1992, at the 14th CCP National Congress, the government decided that the market should play a fundamental role in resource allocation to drive the economy. And at the 18th CCP National Congress in 2012, China’s government further minimized its own role, and the market now plays a decisive role in the economy.
Today, China’s government will only intervene in the economy when it believes it has an appropriate role to play. But the balancing act is ongoing—picture a pendulum constantly swinging between market forces and government macro intervention.
The balancing act is ongoing—picture a pendulum constantly swinging between market forces and government macro intervention.
Other Economic Challenges Emerge
There are three key examples that showcase how certain economic challenges have manifested and how the Chinese government has intervened.
The first example is China’s after-school tutoring (AST) ban, which is a policy implemented by the Chinese government in July 2021 to restrict private tutoring services and regulate the country’s education sector.
The AST ban came in response to a slowdown in China’s GDP growth, growing concerns of social inequality, and an unfavorable demographic makeup.
Leading up to the ban, in 2020 venture capital funding for education technology companies surged as the industry sought to leverage parents’ anxiety about their children’s education to maximize demand, as shown in the chart below.
The ban directly reduced education spending for most Chinese families, allowing for more kinds of household spending, and resulted in increased access to high-quality online education resources.
The second example focuses on the structural slowdown of China’s property market and its deep links to the financial sector and Chinese household wealth.
For decades, China’s property market has played a significant role in its economy. Nationwide average real-estate prices have increased four times since 2020, and local governments have benefited from rising property prices. But as property prices go up, land prices follow, and as land prices go up, property prices increase even further.
This cycle was exacerbated by increased price speculation and the pressure Chinese people, especially those living in tier-one cities such as Shenzhen, feel to purchase a home. But because of sky-high prices, many housing options became unaffordable; the average monthly salary in Shenzhen is around 5,000 renminbi per month, meaning people could only afford one square meter on a full year’s salary.
The average monthly salary in Shenzhen is around 5,000 renminbi per month, meaning people could only afford one square meter on a full year’s salary.
The Chinese government is working to reduce its reliance on the property market for growth, a key pivot as China’s population growth slows down. It also wants to prevent further home-price speculation and will need to strike a delicate balance to avoid impacting households and other upstream and downstream sectors such as building materials, home appliances, and furniture.
The third example highlights China’s high level of corporate debt. As of 2020, China’s debt as a percentage of GDP is 275%, 150% of which is corporate debt. Global investors have been concerned about the high debt levels in recent years. A major force driving up China’s corporate debt level is SOEs, which tend to take on more debt to facilitate large government-related projects.
However, the Chinese government has rolled out policy reforms to address high corporate debt, and its elevated savings level, which reached nearly $7 trillion in 2020, is a mitigating factor.
Understanding China Series
Part 1 | Politics and Governance
Part 2 | Economic System
Part 3 | Society and Foreign Policy
Evelyn Kong, CFA, is a research associate on William Blair Investment Management’s global consumer team.
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