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China economy
OpinionComment
Aidan Yao
Aidan Yao

Macroscope | How US and European recession risks could play out for China

  • Given China’s close trade ties with the US and Europe, weakening demand in those markets will have an obvious impact on the Chinese economy
  • Also, China’s financial markets will not be immune to the external volatility induced by US recession fears

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An employee works at a toy factory in Yangzhou, Jiangsu province. Export trade trade remains the most obvious channel through which weakening demand in the US and Europe can affect China. Photo: EPA-EFE
Aidan Yao
The US and European economies have staged impressive post-pandemic recoveries, but both are now showing signs of significant fatigue. The slowdown has been driven in part by food and energy price shocks that required their respective central banks to withdraw policy stimulus to quell multi-decade high inflation. With the Federal Reserve and European Central Bank now undertaking tightening in slowing economies, fears of policy overshoot and economic hard landings have risen.
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Slowing demand in two of the world’s major economies could have far-reaching ramifications. China is particularly vulnerable, given its still close trade ties with the United States and Europe – despite the US-China tariff spat – and a growing dependency on foreign capital thanks to its recent financial market liberalisation.
From an economic standpoint, trade remains the most obvious channel through which weakening external demand can impact China. An examination of China’s exports to the US shows that all three US recessions in the past two decades – the recession in 2001 after the dotcom bubble burst, that in 2008-9 during the subprime crisis, and that in early 2020 immediately after the pandemic broke out – have coincided with sharp declines in China’s shipments to the US.

Looking at the Organisation for Economic Cooperation and Development’s trade in value added (TiVA) data, which traces one country’s true export exposure to another’s adjusted for supply-chain effects, one can estimate the quantum of impact that several landing scenarios for the US and Europe will have on China. In the case of a soft landing, in which the US and European economies slow down but avoid recession, China’s exports to the two markets will weaken accordingly but also avert an outright contraction. This will see its export contribution to gross domestic product growth fall by half relative to 2021 levels.

In the case of a hard landing, with the two economies slipping into mild recession, China’s exports are likely to contract, shaving 0.3 per cent off gross domestic product in the next 12 months. But if they crash-land into deep recession – like during the global financial crisis – the export shock alone could cost one percentage point of China’s GDP.

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It is important to note that the above estimates assume all else being equal. In reality, this is unlikely to be the case. In the face of a severe external shock, the Chinese authorities can hardly be expected to stand idly by. Indeed, movements in China’s “credit impulse” – which measures the change in new financing as a share of GDP and is a proxy for the effectiveness of monetary policy – have historically been in lockstep with the rise and fall of export growth, easing when activity slows and tightening when it is strong.

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