Why Britain won’t escape the fallout if China’s economy stagnates

China has slipped into deflation and could be headed for ‘lost decades’ of stagnation but its weakness also threatens the UK’s economic prospects, says Sean O’Grady

Heading for the scrapheap? A recycler drives a cart loaded with cardboard along a street in Beijing (AP)

News that China has slipped into deflation – falling prices –  has led to fears about the prospects for global growth. Although China’s economy is still expected to expand by around 5 per cent this year, that impressive-looking figure is one of the weakest in recent decades and insufficient to create enough jobs for a still-booming population; China needs to create about 16 million new jobs every year for its school and college leavers in urban areas.

Gloomier practitioners of economics even suggest China could be headed for the kind of stagnation and ‘lost decades’ that gripped Japan for many years, with prices, output and wages static. China’s Communist party politburo has admitted the country’s post-pandemic recovery is making “tortuous progress” and has pledged to “actively expand domestic demand”. Exports and imports have been weakening, and President Xi Jinping will have to approve measures quickly to reverse what could be a catastrophic slide.

Why should we worry about China?

Depending on how you measure it, China is the largest or second-largest single economy in the world. It’s a nuclear power with a vast military, an industrial superpower, enjoys technological superiority in areas such as electric cars, has linked diplomatic and economic interests spread across the globe, and a newly assertive foreign policy. The old saying was that, when America’s economy catches a cold, the rest of the world gets pneumonia; something of the same may be said of China these days. A strong China has kept the world economy out of prolonged recession or even slump since at least the global financial crisis in 2008. A weakened, stagnant China means a less ready market to fund America’s giant town budget and trade deficits. It also means a loss of export orders from the rest of the world, and will be especially bad news for Germany, which has greatly benefited from its trade with China. Despite recent moves towards de-globalisation, “on-shoring”, and reducing dependency on Chinese manufactured goods, our world is still interconnected enough to mean that what’s bad for China isn’t necessarily good for the West.

What are the politics of this?

Provided the Chinese economy doesn’t suffer a complete tailspin, the political impact is on balance positive, at least in the short term. The slowdown may remind China of how important trade and growth are to its wellbeing, and how much of that actually relies on Western markets and investment in both directions and not on a corrupt and malfunctioning Russia. Thus Beijing might take a position of enlightened self-interest and encourage Russia to ease off in its war in Ukraine, which has proved so demoralising economically. The same goes for North Korea, where Kim Jong-un continues to create regional tensions. China may also conceivably feel less emboldened to pursue its claims on Taiwan and in local territorial disputes while it concentrates on fixing the economy.

How would a prolonged deflationary episode play out inside China?

It would be unpredictable, and probably dangerous. The property market, and thus the banking system, is said to be badly overstretched, and China’s semi-command economy makes any necessary adjustments more difficult to manage.

In such circumstances, it’s difficult to know how the CCP might react, and regimes in trouble often turn to foreign wars to strengthen their domestic position. It’s one reason why Vladimir Putin finds himself in his current mess. A more optimistic view would be that these pressing problems might push China towards market liberalisation and a more Western and efficient style of capitalism – but that seems unlikely given the fondness the CCP has for control.

What does it mean for Britain?

As a power that still makes much of its living from oversea trade and investment, what happens to the world economy is of intense interest to the UK. Despite the best efforts of past governments, the British export drive in China was never all that spectacularly successful, and recent concerns about spying have taken the edge still further off Chinese investment in 5G and civil nuclear power. Even so, Britain will not prosper from a newly-enfeebled China, and there’s no reason to believe that an economic slump would help those in Hong Kong. China may be a rival and a challenge to the UK, but Rishi Sunak mustn’t be seen to characterise it as a “threat”. Ironically, if China’s economy collapses then it would become a threat to Britain’s economic prospects, but out of weakness rather than strength.