Things are getting cheaper in China. Here’s why it’s bad for everyone

Prices are falling in China, which means people can buy more stuff for less money.

And yet it’s bad news for not only China but also the rest of the world that imports Chinese goods for domestic consumption.

The idea may seem counterintuitive to those untutored in economics. But a persistent fall in the prices of everyday items is the definitive death knell for growth and general prosperity.

For example, if you know that the bag of flour you need to buy today will be available at a lower price tomorrow, won’t you postpone your purchase for later? Now extrapolate this simple example to a macro level, and you’ll get why an economy-wide decline in prices – known as deflation – leads to delayed spending, lower production, unemployment, and slower economic growth.

In other words, a drop in demand for goods and services causes a fall in prices, which further fuels the downward spiral.

China’s consumer price index, which is a key measure of inflation, fell -0.8 percent in January from a year ago. This constituted the steepest annual drop in the benchmark of consumer prices in 15 years. January was also the fourth consecutive month of price declines in China.

“Many economists cheered for China's (post-Covid) opening last year, but the cyclical momentum does not mask the structural problems in confidence,” Gary Ng, senior economist for Asia Pacific at Natixis Corporate & Investment Banking, tells TRT World.

Most economies suffered months of reduced spending during Covid-19. But the pent-up demand spurred economic growth as soon as they lifted Covid-related restrictions.

However, the post-pandemic recovery in China has been slower than expected. The economic growth rate has been lower than the historical average largely because of an extended slump in the real estate sector, which accounts for an estimated 20 percent of China’s GDP. Property is the preferred form of collateral and household wealth in China.

In addition, a stock market meltdown coupled with weaker export revenue have also slowed down China’s return to the pre-pandemic growth trajectory.

“China’s post-Covid recovery has been slow due to the weak sentiment among households and corporates as well as the impact of regulatory changes, such as in real estate,” says Gary, noting that the deflationary pressure is expected to continue for a few months.

In the long term, inflation in China may remain lower than usual because of the “probable over-investment in manufacturing” and weakening domestic demand, he says.

Deflation is different from disinflation, which means prices are rising but at a pace that’s slower than before. Of the 42 economies for which The Economist publishes key indicators every week, China and Thailand are the only countries that have witnessed deflation on a year-on-year basis in the most recent month.

Deflation in China is bad for everyone outside of the country because the Asian juggernaut is a net exporter to the world. Analysts expect made-in-China goods exported to the rest of the world at reduced prices will drive out manufacturing businesses in those countries, cause unemployment and hurt investment.

Battling deflation

Governments and central banks use a number of tools to fight deflation. The most popular of these tools is government spending. The government increases money circulation for newly launched large public infrastructure projects. The technique generates employment and puts more money in people’s pockets that they eventually use to buy stuff. Prices rise subsequently as more money chases the same amount of goods and services.

Another way to push back against deflation is the lowering of taxes, which leaves people with more disposable income and higher spending capacity.

A relatively new tool in the fight against deflation is the fancy-sounding quantitative easing. Central banks buy government bonds in the open market, which increases the volume of cash in the economy that people can spend on new products and services. This tool gained popularity following the 2008-09 global recession because central banks around the world had no room at the time to further reduce interest rates to spur spending.

“The (Chinese) government can use fiscal stimulus with demand-side policy as the economy loses momentum due to weak consumer and business sentiment,” Gary says, adding that inflation will likely reach 1.5 percent in 2024 – a level that’s lower than the average of above 2 percent in the past.