 Shortfalls in private investment and human capital development as well as credit misallocation due to COVID-19 may slow potential growth by 0.6ppt over the next three years…  …but gains from faster digitalisation should gradually offset the negative impact  Policies such as reform and opening up also help to further minimise the medium-term shock to growth 

In this report, we look at the medium-term impact of COVID-19 on China’s labour productivity growth, which is likely to face a negative shock. Potential growth is expected to fall by roughly 0.6ppt on average over the next three years due to a slowdown in private investment, lost human capital gains, and credit misallocation. Private sector demand has lagged behind in the recovery, holding back private investment. In particular, after an unprecedented 12.7% y-o-y contraction in the first seven months, the recovery in private investment in manufacturing is likely to remain muted. This much weaker private investment means slower growth in capital stock per worker and, as such, labour productivity in the years ahead. Meanwhile, the COVID-19 crisis caused a large negative shock to labour markets, leading to the displacement of workers and delays in the career development for 8.7m fresh university graduates. Additionally, the pandemic has hit the private corporate sector harder than state-owned enterprises (SOEs). This has made state banks more reluctant to allocate credit to private firms, even though these firms are a more efficient user of credit, weighing on overall productivity growth. 

That said, the COVID-19 shock has also spurred an acceleration in digitalisation and automation, helping partially offset the negative impact on productivity growth. Online retail sales of goods have jumped by 15.7% y-o-y YTD, while the domestic production of industrial robots has surged 10.4% y-o-y in H1. We expect this trend to continue in the coming years, helping to lift productivity growth. Moreover, Beijing’s infrastructurecentred stimulus package has led to a V-shaped recovery in infrastructure investment (including utilities) from a 16.5% y-o-y contraction in Q1 2020 to growth of over 9% in July. We expect infrastructure investment growth to accelerate to over 15% in coming quarters. In particular, what makes this round’s infrastructure push different is the focus on 5G and other ICT (e.g. AI, electrical vehicle infrastructure, and big data) basic facility building. This will likely foster innovation and, therefore, amplify the positive spill-over effect on productivity in the years ahead. 

The implementation of structural reforms and opening up policy measures should also help to lessen the medium-term negative shocks and accelerate the rebound to prepandemic levels. In our view, further structural reforms and opening up are needed to help increase private sector confidence and boost private investment. Increased investment into human capital development, household registration reform, and measures to support job security can also help mitigate medium-term labour productivity losses. 

This report replaces the version of the same date and title published earlier, to clarify the first bullet on the front page (it should refer to shortfalls in human capital development). 

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