‘The Chinese economy grew last year at its slowest rate since 1990, adding to the urgency for President Xi Jinping to reach a trade deal with the United States’, writes Anna Fifield, Beijing bureau chief for The Washington Post. The lowest growth rate in 28 years was officially reported at 6.6 per cent, a rate that if maintained would double China’s GDP in little over a decade. Nervousness about a drop in Chinese growth is called for but if that’s the measure of it, the doom-saying is somewhat premature.

But is that the measure of it? The headline growth numbers might be fudged, some commentators say, discounting real Chinese growth by as much as 2 or 3 percentage points. A growth rate of 4 per cent would still be respectable but a much more worrying drop than that officially recorded, and well below the target growth rate of 6.5 per cent set by the Chinese government for last year. Prominent Chinese analyst Yu Yongding gives credence to the idea that indeed ‘the real situation could be worse’ and calls for expansionary fiscal and looser monetary policy.

There has been steady deceleration of growth through 2018 in each successive quarter but growth remains robust and there was considerable sectoral variation in growth performance. Crude steel output was over 10 per cent higher in 2018 than the previous year. That’s expected to drop back this year but China’s main iron ore suppliers in Australia, for example, could have had little doubt about the continuing momentum of Chinese growth last year. As Yu notes, however, fixed investment growth has slowed sharply through the year, especially in infrastructure. Private sector investment went up 8.7 per cent, 2.7 percentage points higher than in 2017, while investment through state-owned enterprises edged up by only 1.9 per cent. Industrial output grew by 6.2 per cent with faster growth in services, at 7.7 per cent, down on the 8.2 per cent the previous year. Slowing Chinese growth is clearly associated with considerable structural change.

So what is really wrong with the Chinese economy and why does it matter?

In this week’s lead essay, Yiping Huang of Peking University’s National School of Development points out that ‘industrial upgrading, economic policy battles and trade friction with the United States all contributed to the slowdown’ in China last year. ‘If the government is able to fine-tune its economic policies and adopt counter-cyclical measures, China can still achieve a robust pace of economic growth this year — as long as trade friction risks remain under control’, Huang says.

In the past decade, Huang explains, China’s big challenge has been to navigate the ‘middle income trap’. As China’s per capita income has grown from US$3600 in 2007 to almost US$10,000 last year, income growth has begun to slow. Growing rich involves higher wage costs and China, having lost its low-cost advantage, has to upgrade its industrial structure and build new, innovative industries to achieve the transition through the next stage of its industrial development to advanced economy income levels. ‘Moderation of growth will likely continue until this battle between old and new industries ends’, Huang warns.

Huang sees two new developments as the cause of the recent weakening of growth momentum. ‘One is the government’s three economic policy battles — cleaning up the environment, controlling systemic financial risks and alleviating poverty — that were launched in early 2018’. The other is the fracture in investor confidence as a consequence of trade friction with the United States.

Huang acknowledges that all three policy strategies are necessary to improve the quality of China’s economic growth. China’s Vice President Wang Qishan emphasised that point in his speech at the World Economic Forum in Davos last Wednesday. ‘Speed does matter, but what matters more is the quality and efficiency of economic development’, Wang said.

Huang argues that policy battles to clean up the environment and ameliorate financial risks have slowed growth directly and sucked oxygen from China’s main growth engine in the private sector. ‘To clean up the environment the government abruptly shut down many high pollution production facilities, especially in northern China. To reduce financial risks, regulatory authorities took measures to control shadow banking transactions’, he argues.

‘Unexpectedly, these policies hit the private sector hard’, Huang points out. Policymakers may not have specifically targeted private enterprises, but because typically they have lower environmental standards and receive more funding through shadow banking, the private sector took a hit. That’s what prompted the nation-wide debate about the private sector’s role and the government’s reaffirmation of its importance in the Chinese economy.

While Chinese policymakers are shy of expansionary policies after the experience of reflation following the global financial crisis, Huang reckons that the economy’s looming downturn requires some modest counter-cyclical measures.

Whether the full effect of the trade war will materialise depends, as Huang says, on how long it drags on and how serious it becomes.

US President Donald Trump appears convinced that his trade war with China has already knocked the Chinese economy off course. A lot of US commentators talk about the current slowdown in growth as if he’s right. There’s not much evidence of that in the numbers yet but there’s no question that it’s the biggest strategic international policy issue with which China, the United States and the rest of the world presently have to grapple. As Vice President Wang said at Davos, the US and Chinese economies are in such a state today that ‘either side cannot do without the other’.

At Davos on Thursday, Fang Xinghai, vice chairman of China’s Securities Regulatory Commission, appeared to agree with Huang. ‘China has enough policy tools to cushion this slowdown both on the monetary side and the fiscal side. So I don’t worry about the short term’, he said. ‘What’s more important is: does China stop reform, in the process of trying to counter the slowdown of the economy? The answer is no: reform and opening up [must] continue’.

That’s where China’s strategic play in resolving the trade war with the United States will be the litmus test: not through providing some short-term fix through increased purchases of American goods to get Mr Trump off the hook but through reconceiving and renegotiating its place in the world trading system as the market economy which it aspires to be.

The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.