Ways China must tread for seamless transition to new era

IN recent years, China has found itself navigating a period of subdued inflation, stirring concerns within the market of a potential deflationary spiral. This phenomenon bears a resemblance to the country’s economic situation from 1998 to 2000, where it grappled with a similar macroeconomic environment.

At that time, the economy stood at the crossroads of transitioning between old and new drivers of growth, characterized by sluggish economic expansion and tepid demand. The echoes of the past reverberate today as we confront the challenges of economic transformation.

During that period, China initiated reforms in the real estate sector and successfully entered the World Trade Organization, and finally, facilitated a successful structural transformation in the economy.

Reflecting on the strategies employed at that time, here are some ways to facilitate China’s seamless transition to new economic paradigms at present.

To start with, the current economic landscape in China mirrors a pivotal juncture reminiscent of the late 1990s to early 2000s, which marked a significant transition between old and new drivers of growth. As the economy develops, its reliance on capital-intensive models becomes increasingly unsustainable for its highspeed expansion.

Economic indicators in China today parallel those observed during the late 1990s. Though there is debate regarding whether China’s economy is currently experiencing deflation, the persistently low domestic price levels since the middle of last year have become an undeniable reality.

Since June 2023, the year-on-year consumer price index has been around zero percent, while the producer price index has remained negative since October 2022, reaching minus 2.7 percent by February 2024.

Despite achieving a 5.2 percent growth in GDP last year, the nominal GDP growth rate stood at a mere 4.2 percent, with the GDP deflator turning negative at minus 0.54 percent, marking its lowest level since 1999. This low price reflects overall weak demand, with the 5.2 percent real GDP growth rate in 2023 significantly below the 6.7 percent average GDP growth rate during 2015-19.

The deceleration in economic growth reflects the limitations of a capital-intensive model in meeting the requirements of high-quality economic development in the new era. To achieve high-quality economic growth, China must transition from traditional factor-driven growth to an innovation-led one, and upgrade its industrial structure from capital-intensive to technology-intensive.

Against this backdrop, the Chinese top leadership first introduced the concept of “new quality productive forces” in September 2023, offering a scientific guideline for the nation’s new dynamic economic development.

Unlike traditional productive forces, new quality productive forces rely on technological innovation as the core driving force, and are characterized by innovation, excellence in quality and advancement in productivity. Strategic emerging industries and future-oriented industries also serve as the main fields for nurturing new quality productive forces.

The country outlined six major strategic emerging industries — next-generation information technology, high-end equipment manufacturing, new materials, biotechnology, new energy vehicles and new energy — as well as future-oriented industries such as 6G networks, controllable nuclear fusion, neuromorphic intelligence, quantum information, gene technology, and deep-sea and space exploration.

However, unlike the transition period of the late 1990s to early 2000s, the current period is witnessing a significant disparity in size between the old and new economic drivers, which necessitates a dual-track approach.

While China pursues progress in cultivating new quality productive forces, the country must also ensure stability in traditional industries such as real estate, in order to collectively address the challenges of the transition from old to new economic drivers.

Lingering uncertainties

Despite a slight slowdown in the decline of the real estate market, uncertainties remain for the next phase. However, there is ample space for demand from the old economic drivers, particularly considering the substantial and increasing number of new urban residents in China. To be specific, China boasts nearly 300 million new urban residents.

If policies can be implemented effectively to bolster demand and ensure that the average living space for newly purchased homes reaches the national average of 111 square meters, the annual addition of residential housing area could surge from 50 million square meters to 82.7 million square meters.

Such concerted policy efforts are expected to meet the housing demand generated by new urban residents and potentially increase newly purchased homes to 80 million square meters. It could partially offset the downturn in the real estate market.

To meet the rigid housing demand of new urban residents, it is necessary to develop a new real estate development model that combines market mechanisms and government support.

First, we suggest the government purchase commercial housing to be used as public rental housing to address the residential needs of citizens.

In February 2023, the People’s Bank of China piloted a rental housing loan support program and allocated 100 billion yuan ($13.8 billion) to eight pilot cities. If the 100 billion yuan is utilized fully, we estimate that the government could purchase 88,000 sets of commercial housing to be released into the market, thereby alleviating the residential needs of new urban residents to a certain extent.

Such efforts not only help local governments reduce inventory and stabilize housing prices but also pool resources for affordable housing and avoid redundant construction. Moreover, it satisfies the current rigid housing demand of residents and fosters a housing consumption concept of “rent first, buy later, and then improve.”

Second, we suggest that subsidies and incentives should be provided to new urban residents to purchase their first homes or upgrade their housing, including direct subsidies, interest rate discounts, lower down payment ratios and increased support for housing provident funds.

China could draw lessons from the industrial transformation and upgrading experience of the United States between the 1980s and 2000s. During this period, the US shifted toward a supply-side approach, implemented tax cuts and deregulation while establishing the primacy of enterprises in technological innovation.

Similarly, China needs to pragmatically develop new quality productive forces tailored to specific circumstances and avoid issues such as overinvestment, industrial homogenization and overcapacity.

First, the photovoltaic industry should prioritize emerging markets like the Middle East and accelerate its expansion overseas. In November 2023, the Ministry of Industry and Information Technology highlighted the risk of temporary and structural overcapacity in China’s PV industry. Other data also showed that overcapacity has been observed across all segments of the PV industry chain, with silicon wafer prices plummeting by over 70 percent since August 2022.

Looking ahead, we believe that continuous exploration of PV application scenarios is essential on the demand side, while it is necessary to accelerate technological iteration and capacity upgrades on the supply side.

In addition, China’s PV industry is well-positioned to sail into global markets against the backdrop of global energy transition. According to some forecasts, the cumulative installed capacity of PV in Saudi Arabia and the United Arab Emirates is expected to grow by 61 percent and 38 percent, respectively, each year from 2023 to 2027, placing them in the top tier of global PV markets.

Second, China must seize the opportunities presented by the electrification and intelligence of automobiles, and enhance the value of various links in the automotive industry chain. The country should drive the entire automotive industry chain to the higher end.

Third, the future development of new quality productive forces should be tailored to local conditions.

For instance, the Beijing-Tianjin-Hebei region, the Yangtze River Delta and the Guangdong-Hong Kong-Macao Greater Bay Area have prominent innovation advantages and should strengthen their ability to innovate to lead the development of new quality productive forces nationwide.

Some central regions should enhance industrial synergy and support capabilities, and actively undertake the transfer of emerging industries from eastern regions. The northeastern regions, on the other hand, have a solid foundation in heavy industries and should promote the integration of high-tech with traditional manufacturing.

The western and southern regions should leverage their abundant resources and develop differentiated key industries based on their own regional characteristics.

The writer is chief economist at Haitong Securities. – China Daily/ANN