Zero Covid = Zero Growth

Jul 15, 2022

Largely in response to China’s so-called “dynamic zero-Covid” policy, official government statistics just revealed that the Chinese economy slowed to a virtual standstill in the second quarter of this year.  The increase of +0.4 % in real GDP is reported on a year-over-year basis, which masks the weakness in the quarter just ended; on a sequential quarterly basis, the Chinese economy contracted by 2.6 % in the quarter just ended (or -10% at an annual rate, as it would have been reported in the United States).  Unsurprisingly, declines were concentrated in Shanghai and in the lockdown-impacted services sector.

The big question: What does this implies for the future?  Based on China’s post-lockdown rebound in 2020 — when real GDP growth (on a year-over-year basis) went from -6.8% in the first quarter of 2021 to +18.3% four quarters later — there may be reason to hope for a similar outcome later this year.  Three reasons argue to the contrary:

First, the global economy is in much worse shape today than in 2020. The IMF has already embarked on a major downward revision cycle to it global growth forecast — slashing its 2022 world GDP projection by 1.3 percentage points in April to just 3.6% from its forecast made in October 2021; this is the IMF’s third largest forecast revision and there are strong hints of more cuts to come.  Second, with inflation and interest rate pressures playing out with a vengeance in the developed world, downside risks to global growth are likely to intensify, placing more pressure on export-dependent economies like China. Third, China’s zero-Covid policy is not a sustainable recipe for a sustained snapback in the economy; the high transmissibility of the Omicron BA.5 variant does not point to a Wuhan-like all-clear sign that fueled the post-lockdown snapback of 2020.  Covid re-infections are likely to be the rule rather than the exception — leading to the echo-effects of sporadic disruptions over the foreseeable future. With China now reporting a sharp increase in Covid infections in Guangxi province, this is hardly idle conjecture.

With China facing a broad range of structural issues (discussed in Accidental Conflict) — severe demographic headwinds, productivity pressures stemming from regulatory actions aimed at once dynamic private sector Internet platform companies, worrisome stress in its labor market, and a determined deleveraging campaign — the ongoing pressures of a zero-Covid policy are especially problematic. Against this backdrop, the traction of China’s infrastructure-centric policy stimulus is likely to be far more limited than was the case in 2020.  While Chinese GDP growth will undoubtedly accelerate in the second half of this year, the economy will be lucky to grow 4% for the year as a whole — far short of the government’s official 5.5% target and a tough sell for Xi Jinping when he faces the 20th Party Congress later this year.

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