China's recession, and how it'll fight it

Implications for the country's future.

China’s economic data are never particularly reliable, but even less so in an economic downturn. The country’s official growth rates did not go negative after the Tiananmen Square massacre, the Asian financial crisis of 1997, or the global financial crisis of 2008, but some economists believe the country went into recession in one or more of those episodes. What China does, economists have found, is to smooth out its official growth numbers to make things look more stable than they are. The easiest way to do this is just to misreport prices, so that inflation gets over-reported in booms and under-reported in busts. (Theoretically this doesn’t have to lead to an overstatement of long-term growth — you can “borrow” growth from the booms and pretend that it happened in the busts — but in practice this does mean the size of China’s economy is a bit exaggerated.)

Officially, China is still growing, but just barely. China reports year-over-year numbers, meaning they compare the current period to a year earlier. And the official year-over-year real GDP growth number for the second quarter of 2022 was 0.4%, meaning that official Chinese GDP is just 0.4% higher than in the second quarter of 2021. But as I explained in an earlier post, year-over-year numbers also smooth things out. Since China’s growth rate has been slowing down over the last few quarters, the fact that GDP for the most recent quarter is just barely higher than a year ago means that the number shrank over the past three months. On top of that, retail sales and industrial output paint a grimmer picture than the headline GDP numbers, suggesting that a little data manipulation is going on and the real numbers are, as usual, a bit worse.

Certainly, China’s government is behaving as if the country is in recession. The People’s Bank of China cut interest rates unexpectedly, and the government is increasing its budget deficit. These small moves are not really going to change the macroeconomic situation, but they do provide independent confirmation that the government is deeply worried. And with China, that’s usually as reliable an indicator of recession as we’re going to get.

(Note that that’s not necessarily bad news for the world — in fact, since reduced Chinese demand will lower commodity prices and help restrain inflation, it’s probably good on balance from a developed-country perspective.)

So how long will China’s recession last? Goldman Sachs and Nomura anticipate that the country will quickly return to growth — their growth forecasts for all of 2022 are 3.3% and 2.8%, respectively. But looking at the fundamental drivers of the recession — the real estate bust and China’s Zero Covid policy — it’s hard to see why this slowdown would only last a single quarter. Especially since the tools that China usually uses to fight recessions are going to be less effective this time around.

Why China’s traditional recession-fighting tool won’t work this time