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China's zero-Covid policy puts growth under threat

Updated: Aug 29, 2022

British cheese-processing boss Nagma Ebanks-Beni sat down in Shanghai three years ago to listen to an unusual request from her Chinese buyer: couldn’t the fluffy white balls of mozzarella be a bit more colourful? “They thought it was a bit boring — so we mixed it with some red cheddar,” she said. “It’s things like this — understanding your market — that really make a difference.”

These efforts to accommodate Chinese dairy tastes were successful: each month, before Covid, her Durham firm, Prima Cheese, was sending about six shipping containers (each holding 20 tonnes of produce) to China. “I thought at one time that it would far surpass all the other markets we have, just because of the size of the population,” Ebanks-Beni recalled.

It was not to be: cheese orders from China dried up last year, something she attributes to soaring post-lockdown shipping costs. And Prima Cheese is far from alone in that disappointment: official data shows that since the start of the pandemic, British exports to China have fallen by 36 per cent. Imports to the UK from China, on the other hand, are up by 42 per cent.

The dream long dangled in front of British companies by politicians ranging from George Osborne to Boris Johnson to Liz Truss has been the opportunity to grab a piece of the world’s biggest and fastest-growing consumer market.

Yet this dream has crumbled for many in recent years, and part of the reason is that Chinese households are still not spending as much as hoped.

As far back as 2007, the then Chinese prime minister Wen Jiabao was lamenting what he described as China’s “unstable, unbalanced, unco-ordinated and unsustainable” growth model. He stressed the need to shift the country away from its overwhelming reliance on exports and infrastructure investment for growth, and towards greater consumption by Chinese households.

In simple terms, the problem was that a huge share of total economic activity was accounted for companies spending on property development and infrastructure construction, rather than households buying goods and services — be that clothes, cars or meals in restaurants.

Yet in 2022, the Chinese economy remains heavily skewed towards investment. Household consumer spending as a share of GDP — about 40 per cent — is barely higher than it was a decade ago, and still very low by global standards.

“That’s a big disappointment,” said George Magnus of the Oxford University China Centre. “It’s a structural problem I don’t think they really want to address because [they think] ‘We don’t want to follow the Western model.’ ”

Whether that is the case or not, Beijing’s approach to Covid has not helped with a rebalancing to consumption.

Ever since a cluster of mysterious illnesses were detected in Wuhan in late 2019, Beijing has imposed strict lockdowns on whole cities where even a single case of the virus is detected. And analysts say this “zero tolerance” approach is unlikely to change when Beijing hosts the Winter Olympics next month; close observers of the Communist Party leadership reckon they will be determined not to “lose face” by allowing a Covid outbreak while the world’s eyes are on them. Some even expect the hardline policy to remain in place until after the 20th Communist Party Congress in the autumn.

Expect another year of rolling lockdowns, if it does happen, to have economic consequences. In the final three months of 2021, China’s GDP grew at an annual rate of just 3.6 per cent — the feeblest quarterly expansion since the height of the pandemic — with growth hit by weak consumer demand.

The familiar bearish case is that it is, in effect, a giant bubble, pumped up by excessive property investment and artificially cheap lending from state-owned banks. The recent debt default of Evergrande, a gigantic Chinese property company with $300bn of liabilities, has been portrayed in some quarters as akin to a Lehman Brothers moment for the Chinese economy — a yanked thread that will unravel more than a decade’s worth of bad loans and capital misallocation. The impact on growth of a property crash could certainly be profound, with real estate-related activity accounting for almost a third of GDP by some estimates — higher even than the share in Spain before its 2008 property meltdown.

But the wealth impact of such a slump could be even more economically destructive. With Chinese banks paying interest lower than the rate of inflation, the Chinese middle classes have been injecting their copious savings into buying new apartments in recent decades. The result is that housing wealth accounts for 80 per cent of Chinese assets.

If property values tumble, the paper wealth of the Chinese middle classes will collapse with them, further suppressing household consumption.

The US is also seen by the bears as a brake on China. The rhetorical ferocity of Donald Trump towards it has given way to the moderation of Joe Biden, yet trade analysts note that the China policies of America have remained remarkably constant, with access to US technologies, particularly semiconductors, increasingly choked off. And that antagonistic course has dragged allies in its wake, with the UK removing Huawei from 5G networks — a decision taken on national security grounds, but heavily influenced by pressure from Washington.

Some, though, believe that the economic threat from within China is just as significant as that from without. A fierce regulatory crackdown last year on home-grown consumer internet companies such as Jack Ma’s Alibaba and the ride-hailing app DiDi is seen as evidence of a regime finally turning its back on the liberalised approach that has delivered such stunning economic advancement over the past 40 years.

The country’s sharp authoritarian turn under President Xi Jinping will, in the end, stunt its growth potential, some say. Others, of course, view it all very differently. They see the Chinese economy, chivvied by an activist state and boosted by an entrepreneurial population, continuing to surge ahead in areas such as 5G and artificial intelligence — not least because of the absence of domestic data-privacy regulations. “The West is watching China’s tail-lights disappear over the horizon,” said Henry Tillman, co-founder of Asia Investment Research.

And on net zero, some see China’s state-driven system — with its ability to direct vast financial resources rapidly and with a single purpose — as conferring a development advantage. Environmentalists marvelled last week at the news that China had managed to build more offshore wind capacity in 2021 than the rest of the world had managed in the past five years put together.

Some also argue that the US tech embargo will end up helping China to advance economically, by forcing its private sector to innovate and develop components, such as semiconductors, that it can no longer readily source from abroad. “By imposing restrictions on American products, the US government has inadvertently done more than any party directive to incentivise private investment in China’s domestic technology ecosystem,” wrote Dan Wang, a Shanghai-based tech analyst, last year.

And on the property imbroglio, some see the Evergrande default, which was brought on by Xi’s restrictions on property developer leverage, as a sign that he, unlike his predecessors, is prepared to grasp the twin nettles of wealth inequality and financial imbalances. “This is a very healthy thing,” Ray Dalio, the Bridgewater Associates hedge fund boss, told BBC Newsnight last month.

Dalio takes the view that China is now “winning” in the economic race against the West, and that any fallout from Evergrande will be containable because of Beijing’s firm control of the domestic financial system. Corporate and household debts in China are overwhelmingly denominated in the national currency, meaning the government can, if necessary, supply copious liquidity to prop up tottering lenders and borrowers.

“Their growth rate at a slow level is about twice the Western world’s growth rate at a fast level,” said Dalio. “It has a likelihood of being larger and stronger in most ways.”

So which will it be? Is China on the verge of stagnation or triumph? The truth is that it’s impossible to predict with any confidence. There are vulnerabilities and strains in the Chinese model, yet the Communist regime has managed to keep the show on the road much longer than the bears have predicted in the past.

In the meantime, it is not gloom for all UK exporters to China. Rowan Crozier of Brandauer, a metal-stamping company in Birmingham, has been exporting materials to China for a decade, most of which ultimately return to the UK embedded in white goods such as kettles. Crozier senses change: “I think their ambition is more aggressive. There’s a huge push to earn more or do better all the time.”

Perhaps the key question — and one that looms large for UK companies trying to get into this market — is whether that ambition will be sufficient to propel the country through the latest crop of doubts about the China growth story.

This article was published by the Sunday Times on 30 January 2022


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