[EAI Special Commentary Series - The COVID-19 Shock and China] ② Will China's Economic Standing Be Strengthened by the COVID-19 Pandemic?

[Editor's Note]

EAI is publishing a special commentary series of four articles titled “The COVID-19 Shock and China,” featuring expert analyses and forecasts on China, which stands at a crossroads of crisis and opportunity due to the COVID-19 pandemic.

1. Lee Dong-ryul: The Impact and Outlook of COVID-19 on China's Foreign Relations and Korea-China Relations [Read Report]

2. Choi Pil-soo: Will China's Economic Standing Be Strengthened by the COVID-19 Pandemic?

3. Ha Nam-seok: COVID-19 and China's Societal Response[Read Report]

4. Yang Gap-yong: The Dual Nature of the State-Party System Transformed by COVID-19[Read Report]

This is the second report in EAI's special commentary series “The COVID-19 Shock and China.” It features a special commentary by Professor Choi Pil-soo of Sejong University, who analyzes China's response and outlook regarding the COVID-19 pandemic and its expanding global standing. While initial public attention during the early stages of the COVID-19 outbreak focused on China's crisis, as the pandemic spread globally, the United States and Europe faltered in their containment efforts, whereas China successfully controlled the virus's spread and even minimized its economic repercussions, demonstrating an ability to turn crisis into opportunity. China has a history of leveraging global crises for relative ascent, and it remains to be seen whether it can capitalize on an unprecedented disaster like the COVID-19 pandemic to enhance its standing. In this commentary, the author analyzes the economic shock China experienced and its economic resilience, concluding that China possesses policy response capabilities even amidst a global pandemic and presents a positive outlook for its future economy. Furthermore, the author discusses future Korea-China relations, stating that while it is uncertain to what extent South Korea will participate in China's Belt and Road Initiative and Western-led WTO reforms, it is crucial to adopt a balanced perspective and approach when faced with choices.

I. Introduction: China's Rise in 2009

Up until March 2020, the focus was on the crisis China faced due to the COVID-19 pandemic. However, as of mid-April, with the virus spreading globally, the Chinese economy has begun to appear relatively stable. If the current trend continues, China's influence in the global economy will likely increase.

We experienced a similar situation around 2009. As the United States reeled from the subprime crisis and subsequently the Eurozone from its sovereign debt crisis, China emerged as the sole engine of global economic growth. The RMB appreciated and became a regional settlement currency. Chinese capital swept through the global M&A market, acquiring numerous companies. China even proposed making the IMF's Special Drawing Rights (SDR) a key currency to rival the dollar and achieved a rebalancing of its shares in international organizations, which had been undervalued. In this climate, the Xi Jinping administration, which came to power in 2012, announced grand plans such as the Belt and Road Initiative (BRI).

Will a similar scenario unfold in 2020? To assess this, we will compare the economic shock China experienced from the pandemic with that of other countries, analyze China's economic resilience, and then evaluate its policy response capabilities.

II. Comparison of COVID-19 Shocks

China's economic lockdown lasted approximately three months. On January 20, Xi Jinping declared a total war, and on January 23, Wuhan was placed under a complete lockdown. The intensity of control was extremely high. Residential complexes checked entrants by block, and inter-city travel was almost entirely prohibited. Even Mahjong, requiring a group of four, was banned. Thanks to such stringent controls, production resumption began around March 10. The lifting of the Wuhan lockdown on April 8 served as a symbol of the pandemic's end.

Meanwhile, the duration of the lockdowns in the United States and the EU, which are just beginning, remains uncertain. New York declared a work-from-home policy on March 20, but as of mid-April, it is unclear if the situation has peaked. Furthermore, simply comparing lockdown durations is complicated by differing circumstances. At the time of the Wuhan lockdown, China had fewer than 1,000 confirmed and suspected cases (598 confirmed, 393 suspected). In contrast, when New York announced its work-from-home policy, the United States already had 26,900 confirmed cases. Currently, the number of deaths in New York City alone exceeds China's total death toll. The US appears to have responded late and suffered greater damage.

This perspective is reflected in the IMF's World Economic Outlook released on April 14. According to this report, China, along with India, is one of the few major countries expected to avoid negative growth this year. In terms of the difference in growth rates between 2019 and 2020, a measure of the relative impact of COVID-19, China's projected decline (-4.9 percentage points) is considerably favorable compared to India (-2.4 percentage points) and South Korea (-3.2 percentage points). In contrast, the US and Germany are projected to experience growth rate declines of over 7-8 percentage points, while Spain and Italy are expected to see drops of 9-10 percentage points.

III. Characteristics and Changes in China's Economic Structure

1. Employment Structure - The Migrant Workers Who Did Not Return

Let's examine the reasons for China's relatively favorable economic outlook. First is its unique employment structure, represented by migrant workers. Migrant workers, defined as rural hukou holders residing in cities, number 290 million. Of these, 130 million returned to their hometowns for the 2020 Spring Festival, and 40% of them, or 52 million, had not returned by early March.[1] Unlike unemployed individuals in cities, the situation for migrant workers staying in their hometowns is relatively secure, and the government does not need to allocate financial resources for them. China's surveyed urban unemployment rate in February increased by 0.9% to 6.2% compared to the previous month,[2] but this is still considerably better than the unemployment rates in the US, which are estimated to be between 15% (Oxford Economics) and 30% (Federal Reserve Bank of St. Louis). However, this implies not necessarily good employment conditions, but rather that the social safety net (i.e., hometown) for unemployed migrant workers, hidden within the statistics, is favorable.

2. Industrial Structure - Low Service Sector Share, Strength in Promising Industries

China's service sector, which is vulnerable to COVID-19 shocks, has a lower share compared to major developed countries. China's service sector has grown significantly due to government support policies. However, it still stands at 54%, considerably lower than the US (80%) or Europe (71%). Among China's manufacturing industries, daily necessities such as toiletries, stationery, cosmetics, and basic apparel are less affected by economic fluctuations. For durable consumer goods, deferred consumption is likely to increase with economic recovery, with home appliances and automobiles being prime examples. Heavy and chemical industries are also likely to recover with the economy, albeit slowly, including steel, petrochemicals, and construction materials. However, service sectors such as aviation, tourism, accommodation, and dining are more severely and prolongedly impacted by COVID-19. While consumption may recover as the economy rebounds, it is uncertain whether it will exceed previous levels.

The growth-promising industries that will benefit from the spread of the untact economy are all areas where China holds a strong position, such as semiconductors, displays, batteries, robotics, 5G, and artificial intelligence. China plans to significantly expand investment in these areas, designating them as "New Infrastructure" (新型基础设施). This is appropriate investment that will lead global trends and offers significant potential for future system exports and overseas orders. Meanwhile, South Korea also has strengths in these fields and is intertwined with China in the value chain, which will positively contribute to future economic recovery.

3. Fiscal Conditions and Debt Structure Reform

All countries are planning large-scale fiscal injections due to the COVID-19 pandemic. Comparing the increase in fiscal deficits in 2020 relative to 2019 allows for a comparison of the relative scale of fiscal injections by country. According to the table below, calculated based on IMF estimates, China is expected to see a 4.9 percentage point increase in its fiscal deficit compared to 2019, while the US is expected to see a 9.7 percentage point increase. China's fiscal expansion is relatively modest compared to other developed countries. For reference, South Korea also plans a very conservative fiscal operation with a 2.7 percentage point increase. This relatively conservative fiscal management by China is even more significant given its originally low total government debt. While Japan's debt-to-GDP ratio is 238% and the US's is 107%, China's is 50.5%. This means China's relative fiscal health will improve further due to the COVID-19 pandemic.

The elimination of opaque debt crisis factors through the allowance of local government bond issuance since 2015 is another factor that has strengthened China's economic resilience. In the past, 80% of public investment in China was channeled through local governments, but lacking bond issuance capabilities, various opaque financing platforms (so-called LGFVs, Local Government Financial Vehicles) were rampant. As the risks associated with these platforms became apparent, the Chinese government initiated reforms to allow local governments to raise investment funds by issuing bonds. This reform, after years of preparation, bore fruit in 2015, and since then, the amount of local government bonds issued has surpassed that of national bonds. This represents a groundbreaking change that has eliminated the opaque debt crisis factors present during the era when local bond issuance was prohibited. In other words, fiscal injections can now be made much more stably than in the past.

4. Monetary Policy Conditions

As countries engage in interest rate cuts and quantitative easing, the higher the interest rate, the greater the effect of such monetary policies. Since the global financial crisis, real interest rates in Europe and Japan have been negative, falling into what is known as a liquidity trap, where further rate cuts are difficult and do not stimulate economic expansion. China's interest rates are higher than those in major countries, suggesting that interest rate cuts could have a more significant impact.

5. Political Conditions and Economic Recovery

China has no immediate political imperative to urgently stimulate the economy, such as through elections. The economic slowdown caused by COVID-19 is not acting as a political burden; rather, it is serving as an opportunity to promote the government's efforts. The 20th Party Congress, where Xi Jinping will conclude his second term, is scheduled for late 2022, and there is still time until then.

Furthermore, China's economy is already showing signs of rebound, with an operational resumption rate of 60-70% across various sectors (however, the 'operating rate' was already low before COVID-19). Activity levels in major cities like Beijing are increasing, and school closures are expected to be lifted soon. In essence, China's COVID-19 situation began earlier and ended earlier, thereby resolving much of the uncertainty.

6. Risk Factor – Private Enterprise Debt

However, if the debt problems of private companies worsen, it could pose a serious risk to the Chinese economy. Service industries and (private) small and medium-sized enterprises are expected to be hit harder than state-owned enterprises, and regional banks with significant lending to these sectors could face a crisis. The overall soundness (BIS capital adequacy ratio) of Chinese banks is very good by international standards. However, this is not the case for smaller regional banks. Bank runs have already occurred in localized areas. Fortunately, the scale of these events is still negligible compared to the total size of the banking sector's assets.

IV. Future Outlook

1. Retreat of Globalization and WTO Reform

The retreat of globalization, which is expected to accelerate after the COVID-19 crisis, will be a greater test for China than the pandemic itself. Since 2011, global trade growth has lagged behind economic growth, indicating a decade-long trend of globalization's retreat. China has also pursued policies to reduce its export share and expand domestic demand over the same period, but its status as the greatest beneficiary of global value chains remains unchanged. For China, maintaining the current WTO system and expanding globalization is preferable.

The COVID-19 crisis has dealt a fatal blow to the international exchanges that contributed to the formation of global value chains. Buyer meetings, industry-specific exhibitions (EXPO), and travel-driven consumption are all expected to contract. It is difficult not to be pessimistic about the future operation of the Canton Fair, known as the world's largest trade fair, or the Yiwu market in Zhejiang Province, the world's largest complex for daily necessities. International trade, conducted face-to-face and through direct product inspection, will shrink. Furthermore, with many countries imposing export restrictions on essential goods such as masks, medicines, and even food, the trust and confidence that form the basis of the free trade system have been shaken.

Recently, anti-globalization forces have coalesced politically and are exerting influence. This is the core background of the US-China economic conflict. Reshoring, supported by these political forces, is also expected to increase. This implies a decrease in Foreign Direct Investment (FDI). Notably, China's reputation has been severely damaged as the origin of COVID-19, and a reduction in foreign investment due to this is inevitable. However, the essence of reshoring is not a return to the mother country but a "back to the market" phenomenon, so China's attractiveness as the world's largest market will partially offset the negative reputation stemming from COVID-19.

The greatest risk facing China today is WTO reform. Major countries such as the US, Europe, and Japan are collaborating to reform the current WTO system and its provisions, while China is resisting. Reforms aimed at stripping developing country status and strengthening notification obligations regarding subsidies are a direct challenge to China's economic system. While the trade war with the US over tariffs may enter a lull due to COVID-19, the systematic attempt to reform the WTO, which operates on a timetable, is something China cannot easily dismiss.

2. Strengthening of China's Relative Standing

Based on the above analysis, it is reasonable to conclude that China's relative standing in the global economy will be strengthened. Premier Li Keqiang's assertion that China accounts for "one-sixth of the world's total economic output and one-third of global economic growth" will likely be heard for some time to come. With China's relatively small scale of quantitative easing, the value of the RMB will increase. China will likely seek to acquire overseas assets using its appreciated currency, but there will be resistance from various countries.

The Belt and Road Initiative (BRI), which China is vigorously pursuing, has both expansionary and contractionary factors. The essence of the BRI lies in the infrastructure construction needs of developing countries and China's financing. The demand factor is likely to decrease, as large-scale construction projects are difficult to decide upon and implement amidst an economic downturn. Conversely, infrastructure investment could be attempted to stimulate the economy. In such a scenario, China's financing, as a supply factor, will become relatively stronger. This is because initiatives like the "Indo-Pacific Strategy" or the "Asia-Africa Growth Corridor," promoted by the US and Japan to counter the BRI, may face difficulties in implementation. Many developing countries have already received medical assistance from China, and if this extends to infrastructure investment support, it effectively becomes the BRI.

V. Recommendations for Korea-China Relations

South Korea and China have both successfully contained the COVID-19 pandemic early on and possess relative advantages in terms of fiscal conditions and industrial structure. For the time being, the increased demand for information and communication products due to the activation of the non-contact economy will benefit both countries. Collaboration in these areas would be mutually beneficial. However, a strategy of non-exclusion and non-dependence should be employed to avoid the US sanctions on Huawei and similar entities from becoming a diplomatic dead end.

Post-COVID-19, South Korea's choices regarding its relationship with China will revolve around WTO reform and the Belt and Road Initiative. To what extent will South Korea participate in the WTO reforms being pursued by the West? It has already taken the lead in relinquishing its developing country status, but its response to the issue of industrial subsidies remains cautious, as South Korea is both a victim of Chinese government subsidies and a beneficiary linked to China's industries.

Furthermore, to what extent and how will it participate in the Belt and Road Initiative? South Korea has indirectly benefited from the BRI through exports of construction equipment and orders for LNG carriers. However, it has not achieved significant direct benefits such as overseas construction orders or broad economic expansion. It has also failed to create new transportation and economic corridors linked to the Korean Peninsula in Northeast Asia. As complex situations unfold, with growing antipathy towards China and increasing Chinese influence surrounding the BRI, a balanced perspective and approach are urgently needed.■

[1]78 million migrant workers have returned to work in cities, accounting for 60% of the total migrant workers who returned to their hometowns (March 7, 2020).

[2]The urban registered unemployment rate, excluding migrant workers, is 5.3%.

[3]2019 GDP is an estimate.

■ Author: Choi Pil-sooAssociate Professor, School of International Studies, Sejong University. He holds an MBA from Hitotsubashi University ICS and a Ph.D. from the School of Economics and Management, Tsinghua University. He previously served as the Head of the China Team at the Korea Development Institute (KDI) School of Public Policy and Management. His primary research areas include China's economic system transformation, Chinese corporate governance, and the Belt and Road Initiative.

■ Editor: Yoon Junil EAI Research Fellow

              Contact: 02 2277 1683 (ext. 203) junilyoon@eai.or.kr

[EAI Commentary] is a commentary series designed to provide a platform for experts from various fields to present in-depth analyses and policy recommendations on major domestic and international issues. Please cite the source when quoting. EAI is an independent research institution independent of any partisan interests. The claims and opinions expressed in reports, journals, and books published by EAI are not attributable to EAI and solely represent the views of the respective authors.

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