Executive summary
Growth is back to its pre-crisis trend trajectory, thanks to strong investment and exports. The pandemic appears to be under control in most of the country, but sporadic emergence of clusters continues. Revamping of the social security and fiscal revenue systems will be needed to achieve inclusive and sustainable growth.
China’s contribution to world growth temporarily increased as its recovery gained momentum, while other countries were slower in rebounding. As China catches up with the advanced countries and its working-age population continues to shrink, the pace of growth will also slow, though it will remain high by international standards in the medium term.
Source: OECD Economic Outlook 110 database.
Rebalancing toward a consumption-driven growth model has paused due to the investment- led rebound and the slow recovery of tourism-related industries likewise set back the rebalancing towards services. Even though finance and information technology were key drivers when many other industries shrank, they are not as important for employment creation as retail, or hotels and catering are. Losing their jobs, many migrant workers returned to their hometowns, thereby reversing urbanisation, another growth-enhancing process. Urban unemployment rates are falling after a moderate rise during the start of the pandemic.
Infrastructure investment, half of which goes to transportation and public facilities, has levelled off. Increasing industry capacity utilisation rates keep business investments strong. Real estate investment has stalled on the back of property company defaults and falling sales.
Exports reached historical highs, but imports lag somewhat behind. Pent-up global demand for COVID-19-related protection materials and for teleworking-related goods boosted exports. Imports keep slowing as producers are increasingly relying on domestic inputs and the import content of consumption remains low. Lagged recovery of consumption and worldwide travel restrictions weigh on tourism services imports. China’s commitments under the Phase I trade deal with the United States have been delayed.
The recovery brought activity back to pre-crisis levels in the third quarter of 2020 and has maintained momentum. The growth rate in 2021 will be high (reflecting the low base), but will return to its gradually declining path thereafter. China needs to spend more on “soft” (education, health, social protection) as well as “hard” investment (environmental facilities, renewable energy, urban transit systems etc.), while excess capacity in real estate should be worked off.
Monetary policy remains supportive, providing adequate liquidity, while shadow banking has been kept under control. The loan prime rate became the new benchmark. It will improve the transmission mechanism as it is linked to the rate charged in open market operations (mainly referring to the rate of the medium-term lending facility), which better reflects funding conditions. Before, lending rates did not always drop following falling funding costs.
Financial risks have been exacerbated by the outbreak-induced downturn. Corporate debt has surged and so did defaults, in particular in the real estate sector. Non-bank financial institutions have been hard hit by the defaults of high-risk borrowers, their major clients. State-owned enterprises, the largest borrowers, have also become more indebted and more of them defaulted. Three small banks also defaulted and their only partial bailout will sharpen risk perception. The central bank’s stress tests for the banks show that in a severe stress scenario banks may suffer inadequate capital. Implicit guarantees should be gradually phased out by allowing SOEs and other public entities to go bankrupt and losses to be incurred by creditors.
Source: Bank of International Settlements database.
Social protection needs to increase, but government revenues are low, calling for revamping the pension, healthcare and public revenue systems. Chinese people have long life expectancy relative to the country’s income level, but retire early. Various pension schemes offer different benefits, while contribution rates are a high burden for the low-income. Portability across regions is not always easy. State-owned enterprises, especially financial institutions, contribute little to the budget. China’s tax revenues are low, as is the share of income taxes in total revenue. When the economy will have fully recovered, the income tax base should be broadened and deductions abolished. A recurrent tax on the ownership of real estate and an inheritance tax should be introduced to reduce wealth inequalities.
Source: OECD Revenue Statistics and CEIC databases.
COVID-19 revealed weaknesses in the public healthcare system. Healthcare out-of-pocket payments contributed to poverty. The reimbursement rate should be increased, while keeping it sustainable, and portability across the country ensured. Better funding and staffing of centres for disease control would help avoid another health crisis. The mechanism for the infectious disease reporting system should be better enforced.
Climate-related commitments are increasing. The rebound of activity brought back pollution and necessitated a temporary closure of factories in polluting industries in many cities. More ambitious carbon emission reduction targets and commitments to increase the share of renewables have been announced. Renewables are becoming increasingly more affordable and current capacities should multiply to reach net zero emissions by 2060 or ideally earlier.
China has cut red tape in the past decade, and in recent years entry restrictions for foreign firms have been eased, but more needs to be done to level the playing field.
Barriers to entrepreneurship have declined, but unevenly across the country. Market regulations should be unified to create a single market. A one-stop shop for company start-up should be established across the country and more procedures should move online.
Fair competition is hindered by administrative monopolies (i.e. exclusive rights and other privileges granted by regulations). The Fair Competition Review Mechanism is applied to new regulations, but existing ones violating competition laws remain. Administrative monopolies should be dismantled and the power of administrative departments restricted.
State control remains strong. Large SOEs continue to dominate most segments of the natural gas and electricity market. In segments where competition developed, price controls should be lifted.
Source: OECD Product Market Regulatory database.
Subsidies helped some industries catch up or leapfrog, but often resulted in waste and distorted competition in both domestic and global markets. As an increasing number of Chinese firms become global players, it is of even greater interest for all to face fair competition worldwide. Equally, as China is becoming an increasingly important global inventor, strengthening intellectual property rights protection is even more relevant also for domestic firms.
Foreign firm entry and business conduct have become easier, but the playing field needs to be levelled further. More sectors should open up to foreign investment and the joint venture requirement abolished.
Source: OECD FDI Regulatory Restrictiveness Index database.
Corruption is widespread, in particular public sector bribery. Greater transparency and accountability and lower concentration of power in managers’ hands would help fight corruption and reduce the related costs.
