How can the world’s growth engine do better?

NEW YORK — The global economy demonstrated remarkable resilience in 2023, as the United States defied expectations and managed to avoid a recession. India, Vietnam and Japan also achieved impressive economic performance given the circumstances. But while these countries have good reasons to be optimistic about 2024, China will most likely be the single largest contributor to global GDP growth this year.

This may come as a surprise to many, given the wave of increasingly gloomy forecasts for the Chinese economy. To be sure, China may not reach its full potential in 2024. Only by pursuing meaningful reforms and reaffirming economic openness (the two pillars of the country’s remarkably successful growth model over the past four decades) can it regain its lost momentum.

The relative contribution of a country to global GDP growth depends on both its share in the world economy and its relative economic growth. In purchasing-power-parity (PPP) terms, China’s share of the world economy was 18.8 per cent in 2023, compared to America’s 15.4 per cent. With the International Monetary Fund projecting that the Chinese economy will grow by 4.6 per cent in 2024, more than double the projected growth for the US, China, despite its ongoing slowdown, will likely account for a much larger share of global GDP growth than the US will.

After a quarter-century of stagnation, Japan seems to be experiencing an economic revival. Having finally escaped the deflationary trap that ensnared its economy for more than three decades, the country is projected to grow by 1 per cent in 2024. Nevertheless, its contribution to global growth will be more limited than that of either China or the US, owing to its smaller share of the world economy and slower growth.

Meanwhile, the outlook for the United Kingdom and the European Union appears bleak. Barring an unexpected and unlikely resolution to the war in Ukraine, the best-case scenario for Europe’s economy is that it will not impede global growth.

India, which is projected to grow by 6.3 per cent this year, is expected to be the only major economy to grow faster than China. Geopolitical developments have been favourable to India, enabling it to buy cheap Russian oil, get away with measures that would be impossible if they were undertaken by China, and assert itself on the world stage. These favourable developments, together with domestic reforms pursued by Prime Minister Narendra Modi’s government, have also led to a surge in foreign direct investment. But, because India’s share of the world economy is less than half of China’s, its contribution to global growth will be smaller than that of China as well.

Similarly, developing countries such as Vietnam, Tanzania, Guyana, Gambia, Ethiopia, Djibouti, Côte d’Ivoire and Burkina Faso are projected to grow rapidly in 2024. But all account for a very small share of the world economy.

Although China is expected to remain the largest contributor to global GDP growth, it could underperform relative to its growth potential, which I estimate to be around 5.1 per cent, in 2024. Moreover, the positive spillover from Chinese growth to other economies will also be more limited if the country’s import growth does not return to pre-pandemic levels.

China’s main medium-term economic challenge is its shrinking workforce. Even if productivity growth remains constant, this demographic shift would put downward pressure on GDP growth. Given the current slump in the Chinese property sector, slower-than-expected household spending, and private-sector investment, the chances of another real-estate-driven economic boom appear slim.

But the greatest threat facing the Chinese economy today is a fall into a debt-deflation trap. Because deflation increases the real value of existing debts, banks could become increasingly reluctant to provide loans to businesses and local governments. As indebted households and businesses cut their spending, the toxic combination of debt and deflation could trigger a vicious cycle of lower investment and reduced demand.

Chinese monetary authorities’ reluctance to adopt a more expansionary monetary policy is unhelpful. While the People’s Bank of China (PBoC) and the country’s banking regulator have set key performance indicators on loan scale to stimulate lending, state-owned commercial banks often meet these targets by providing loans to unproductive state-owned enterprises (SOEs) that do not require urgent financing as much as many non-state-owned enterprises.

In fact, SOEs typically receive loans at lower interest rates than the rates on the banks’ wealth-management products. Instead of investing these funds in productive projects, they often redeposit them for a higher interest rate, allowing the banks to re-lend to the same SOEs. While this process inflates the banks’ reported loan and deposit figures, creating the appearance of effective monetary policy, such practices do little to boost production, employment, and tax revenues.

To avoid a deflation-debt spiral, Chinese policymakers must urgently inject more liquidity into the economy. But for the lending channel to work effectively, China must reform its state-owned banks to ensure that financial institutions focus on profitability and lend to the most productive firms, rather than creating artificial money flows. Unfortunately, China is unlikely to undertake these critical reforms anytime soon.

There is an alternative policy package in the short run. Chinese policymakers could pair an aggressive fiscal policy with the monetisation of government debt. This would entail a three-step plan. First, fiscal policy should focus on building low-income housing, upgrading public infrastructure, and settling the outstanding debts of local and national government agencies to private-sector firms. Second, these expenditures could be funded through the issuance of new long-term government bonds. Lastly, the PBoC should purchase these bonds and hold them until maturity, or at least until the economy returns to its potential growth rate.

With more expansionary monetary policy in the short run and structural policy reforms in the medium term, the Chinese economy could move closer to its full growth potential, which would help lift global economic growth as well.

Shang-Jin Wei, a former chief economist at the Asian Development Bank, is professor of Finance and Economics at Columbia Business School and Columbia University’s School of International and Public Affairs. Copyright: Project Syndicate, 2024. www.project-syndicate.org