What is Holding Back China Stimulus?

One of the vexing questions for China watchers has been the lack of stimulus delivered, despite the maintenance of the government’s 5.5% GDP target for 2022 (although there is skepticism around the ability to reach that 5.5%). This is especially puzzling given the lockdowns that occurred during the first half of the year, and the precarious situation of the housing market (which is impacting consumer confidence). It’s possible that some of the spending was delayed by this year’s COVID-19 outbreak itself, as the government’s focus amid rising infections in March and April shifted to keeping the virus contained.

Another suggested reason is that China’s desire to escape the middle-income trap is holding back some of the stimulus. China is already significantly leveraged and has unfavorable demographics—and the combination of these two puts pressure on future growth prospects. This could limit the desire to further add to the debt burden of the government, and the private sector, through fiscal and monetary stimulus.

What is the middle-income trap?

But what exactly is the middle-income trap? It is a reference to the situation where a middle-income country fails to become a higher-income nation. In fact, very few counties have successfully managed the transition from middle to high income, with many economies in Latin America, the Middle East and East Asia struggling to break into higher-income status. The World Bank estimates that of 103 middle-income regions in 1960, only 13 were high-income by 2008.1

Could an aggressive Fed tip the U.S. economy into a recession?

Brazil and South Korea are both good examples of countries that fell into the middle-income trap and managed to break through it. This brings us to the obvious question: is China more like Brazil or South Korea? We believe China is working toward becoming more like South Korea, with its focus on increasing domestic consumption and demand—dual circulation is the vernacular used by Chinese policymakers. China is also climbing the value-add chain through increasingly sophisticated manufacturing. An often-underappreciated development is that China now leads the world in patent applications.2 This is similar to what South Korea did with its technology exports—and something that Brazil failed to do. Case-in-point: To this day, nearly 65% of Brazilian exports are mining and agricultural products.