OECD Economic Surveys: China 2022

Executive summary

Putting growth onto a sustainable and inclusive path

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.

Figure 1. Real GDP saw the sharpest fall and rebound on record

Source: OECD Economic Outlook 110 database.

Statlink

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.

Table 1. Economic activity has recovered

	2019	2020	2021	2022	2023
Real GDP (%)	6.0	2.3	8.1	5.1	5.1
Exports of goods and services (%)	1.5	1.6	16.7	2.4	5.5
Imports of goods and services (%)	0.4	-0.8	7.8	0.4	5.3
GDP deflator (%)	1.3	0.6
Consumer price index (%)	2.9	2.5	0.8	1.7	2.4
Terms of trade (%)	0.6	7.3	-8.8	-3.8	-0.4
Fiscal balance (% of GDP)
Overall	-3.7	-6.9	-6.4	-6.0	-6.1
Headline	-2.8	-3.7	-3.1	-3.0	-3.2
Current account balance (% of GDP)	0.7	1.9	1.7	1.5	1.5

Source: OECD Economic Outlook 110 database.

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.

Figure 2. Shadow banking is reined in

Source: CEIC database.

Statlink

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.

Figure 3. Corporate debt is high

Source: Bank of International Settlements database.

Statlink

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.

Figure 4. Income taxes make up a small share of revenues, 2019

Source: OECD Revenue Statistics and CEIC databases.

Statlink

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.

Reaping efficiency gains through product market reforms

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.

Figure 5. Prices remain controlled, 2018

Source: OECD Product Market Regulatory database.

Statlink

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.

Figure 6. Market access of foreign firms has improved

Source: OECD FDI Regulatory Restrictiveness Index database.

Statlink

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.

Figure 7. Corruption is widespread

Note: BRIIS is the average of Brazil, Russia, India, Indonesia and South Africa.

Source: Varieties of Democracy Institute; University of Gothenburg; and University of Notre Dame.

Statlink

 

MAIN FINDINGS	KEY RECOMMENDATIONS
Macroeconomic policy support and financial stability
Economic recovery is gaining momentum and policy support is being withdrawn. Private and small firms are hard hit by COVID-19.	Keep monetary policy accommodative by providing sufficient liquidity and not raising policy rates as long as inflation pressure is low and growth is moderate. Raise disclosure standards for private and small firms so that they will be able to finance their viable projects even after policies tighten.
Economic recovery is firming but spending needs towards inclusiveness and sustainability are large.	Emergency stimulus measures should be withdrawn only when recovery is fully on track, with spending increased on social security, health and education as well as on infrastructure investment (such as renewables, urban transit systems and environmental infrastructure). Then a consolidation plan should be announced.
Stress tests indicate that in a severe stress scenario many banks would have inadequate capital.	Abolish reduced loan loss provisioning ratios and disincentivise excessive risk taking by banks.
Generous tax exemptions and reductions continue to curb public revenues. At the same time, most SOE profits are recycled to the sector.	Increase SOE-related fiscal revenues in accordance with OECD SOE corporate governance guidelines, in particular for financial institutions, to better meet longer-term spending needs.
Enhancing economic efficiency
Administrative simplification is ongoing but there is still no one-stop shop everywhere, moreover, requirements vary across the country.	Unify market regulations across the country to create a single market. Implement a one-stop-shop for setting up a business all over the country and move procedures online.
State-owned enterprises and other public entities enjoy implicit guarantees and other preferential treatment. They accumulated large amounts of debt.	Gradually phase out implicit guarantees to SOEs and other public entities by not bailing them out upon their default.
Natural disasters and emergency situations oblige SOEs to provide support without adequate remuneration.	Implement accounting separation and pay fair compensation for SOEs for their services in emergency situations and make them face a level playing field. Adopt the OECD guidelines on SOE governance.
Administrative monopolies inhibit fair competition across sectors and across regions protecting local incumbents.	Strengthen the rule of law and restrict the power of administrative departments to prevent the creation of administrative monopolies. Dismantle existing administrative monopolies and apply the Fair Competition Review Mechanism rigorously.
Corruption mainly manifests in the form of embezzling of public funds.	Enhance transparency and accountability and reduce the concentration of power in managers’ hands. Sign up to the OECD Anti-Bribery Convention.
Market access for foreign companies improved, though joint-venture requirements still exist in some sectors.	Open up further sectors for foreign investment and abolish the requirement of joint ventures.
Many firms do nothing when their intellectual property rights are violated in a lack of recourse.	Strengthen intellectual property rights protection.
Industrial policy priorities make local governments blindly compete in directing public funds to favoured industries, often leading to low-quality, repetitious investment, overcapacity or project failure.	Apply the competitive neutrality principle in the allocation of subsidies and subject the use of public funds to rigorous cost-benefit analysis and third-party evaluation. Make subsidies more transparent.
There is no comprehensive and internationally comparable data in many areas, making it difficult to conduct evidence-based analysis.	Increase data disclosure in all areas of economic activity and report statistical data on an internationally comparable basis.
Strengthening inclusiveness
Income inequalities are large. Few people are subject to income taxes.	Once the recovery is fully established, revamp the fiscal revenue system by widening the base of the personal income tax and abolishing deductions.
Wealth inequalities are large.	Introduce a recurrent tax on the holding of real estate and an inheritance tax.
China has very high life expectancy and low retirement age.	Ensure sustainability of the pension system by linking the retirement age to life expectancy.
Pension contribution rates vary across the country and there are multiple schemes. Contributions are a high burden for the low-income.	Unify the pension system across regions and schemes and make it more redistributive by abolishing the floor and raising the ceiling for contributions.
Absolute poverty by the official definition has been eradicated aided by fiscal support.	Conduct and disclose comprehensive assessment of poverty-related spending and its outcomes to ensure that poverty eradication is sustainable.
Building a robust health system
COVID-19 highlighted the downsides of low reimbursement rates of healthcare expenses, pushing many people to the brink of poverty.	Reform healthcare by increasing the reimbursement rate of healthcare and medicine to avoid falling into poverty.
Centres for disease control are underfunded and are losing staff. A direct reporting system of infectious diseases to the central government has been established, but it can be blocked at the local level.	Ensure that local centres for disease control are well-funded and staffed so that they can help avoid future health crises. Clarify the mechanism for the infectious disease reporting system and information sharing and guarantee its smooth functioning.
Currently there does not exist a transparent and effective mechanism for global data sharing.	Increase transparency and data sharing with global health experts and organisations and undertake meaningful reforms to strengthen public health and disease surveillance systems.
Greening growth
As recovery gains momentum, pollution is back. Temporary halting of industrial production in polluting industries is not a sustainable solution.	Accelerate the energy transition including by significantly reducing the construction of coal-fired power plants in line with China’s climate commitments.
Pollution is taking a heavy toll on human lives.	Raise environmental taxes on fossil fuels to reduce pollution and strengthen climate mitigation action.
The electricity market reform pilot to sell energy by producers directly to users does include renewables producers.	Allow renewables producers to sell the electricity they produce through the grid.