Unit 3 Aggregate demand and the multiplier model

3.13 Application: China’s post-COVID-19 aggregate demand problem

When China suddenly dropped its zero-COVID policy in late 2022, many observers expected a rapid bounce-back in economic activity. Having been locked down so tightly for so long, wouldn’t Chinese households respond to the policy change with strong consumption spending as had been observed elsewhere? This did not happen.

Interpreting data for China is different from the high-income countries—China’s growth rate is much higher and it was expected to grow by 5% per annum following the lifting of the zero-COVID policy. Nevertheless, there were signs of seriously weak aggregate demand. In particular, youth unemployment was 20% and weak consumer confidence so worried the authorities that they ceased publishing the data. The models in this unit help explain China’s post-COVID aggregate demand problem.

In the high-income countries, governments provided generous income support to workers who were unable to work because of government-mandated stay-at-home orders and their knock-on effects throughout the economy. Think, for example, of the multiplier process operating through a central business district due to the sudden absence of office workers.

The data for the US in Figure 3.25 shows that GDP dropped dramatically in the second quarter of 2020 (by 30% compared with the previous quarter, reported at an annual rate) with most of the effect coming from consumption. It rebounded in the following quarter because of the generosity of unemployment benefits (note that those transfers show up in ‘C’ and not ‘G’ in aggregate demand and in the table).

China does not have a co-insurance scheme (Section 3.10) like the ones in high-income countries, which provided unemployment benefits or furlough payments that replaced a large proportion of an employee’s wage in the pandemic. The result was that when China’s zero-COVID policy resulted in lockdowns, households had to draw down their accumulated savings. Chinese households relied on self-insurance. Having experienced severe job insecurity for two years and run down their savings, many Chinese households were very cautious when the restrictions were lifted. The priority was to rebuild their buffer of savings rather than to go on a consumption splurge.

Reports of very high investment in electric vehicles and other parts of the renewables supply chain in China obscure the weak investment elsewhere. This is partly the consequence of US export controls affecting semiconductors, which, in line with the model, created great uncertainty and delayed investment spending.

When weak aggregate demand had threatened the Chinese macroeconomy before COVID, the response was higher government investment spending on infrastructure and housing. However, neither was viewed as a solution to the post-COVID aggregate demand deficit.