What's up with China's economy?
- J Hoenderdos
- Dec 4, 2023
- 13 min read
Updated: Dec 28, 2023
On October 27th, former Chinese prime minister Li Keqiang died from a heart attack while vacationing in Shanghai. Li had retired just a few months earlier, when Li Qiang was selected as his successor and put in charge of daily government. Li’s death gained much attention in international news media. In China, it resulted in an outpouring of mourning and support for his relatives. Similar to the period after the death of former president Jiang Zemin, both online comments and physical gatherings were strictly monitored by the Chinese government, afraid of any social unrest.
Most analyses described Li as a prime minister who was “sidelined” during his tenure, while others wrote that he was simply “eclipsed” by president Xi Jinping’s dominance. An analysis in Foreign Policy concluded that Li “lived and died in Xi’s shadow.” It is all true. Premier Li was in charge of the economy, but Xi’s accumulation of power meant that he was increasingly unable to put his own stamp on policies.
To some extent similar to Jiang, Li was considered a reformer who was in favour of opening the economy and giving more space to private enterprises—something that came into increasing contrast with the direction of his president. In his final years as prime minister, Li oversaw a tightly controlled economy. He also oversaw the continuation of the Trump-era U.S.–China trade war, continued and intensified under U.S. President Biden. Not only did the economic conflict scare foreign investors and hurt trade relations, it also resulted in more state intervention in the economy. Of course, the same happened during the Covid-19 pandemic.
The way in which Li Keqiang was considered an open-minded reformer and his legacy was celebrated by parts of Chinese society says a lot about contemporary China under the leadership of Xi. Ranging from the ever-diminishing space for its civil society to its flagship projects in global governance (BRI, BRICS+), and from environmental degradation to a rapidly aging population, there are a lot of question marks about the current state of China, and its outlook in the (near) future. But there probably is no bigger question mark than the condition of the Chinese economy, about which a lot of concern has permeated global media in recent months. I want to highlight some key issues below.
Economic growth as the pillar of China's social contract
If it is anything that Chinese people, the Chinese government, and international analysts all are concerned about, it is the trajectory of the Chinese economy. Serious, long-term problems in the Chinese economy, by several metrics the world's largest, could send shockwaves throughout the global economy and damage the economies of China's partners. It would obviously also hurt average Chinese people.
Of course, economic growth is of vital importance for China. For decades, the Chinese people have been accustomed to high growth rates. Continuous economic growth meant that China under leadership of the Communist Party was able to lift more than 800 million people out of poverty, according to the World Bank—an accomplishment unparalleled in world history. Two years ago, Xi Jinping celebrated a "complete victory in eradicating absolute poverty" in China, an important milestone in a nominally Communist state.
Continuous economic growth meant that for regular Chinese families, each new generation had a more promising future: there was more money, more technological development, and life standards improved steadily. As this happened under Communist Party leadership, many had no reason to question Party rule. There emerged a tacit understanding between state and society: as lives of regular Chinese people kept on improving, the Party did not have to fear for serious challenges to its authority.
But after decades of improvement, growth of the Chinese economy has been stagnating in the last few years. This began with the trade war between China and the United States, initiated by Donald Trump (or, some argue, by Xi Jinping) in 2018, which tested the resilience of China's trade and supply chains. Beginning in early 2020, the Chinese economy was hit by the severe lockdowns that were put in place to prevent the spread of the Covid-19 virus. In 2021, the economy was further challenged as the real estate sector began to struggle, especially because of liquidity problems at the Evergrande Group.
Crises of the Chinese economy
The current problems in the Chinese economy consist mainly of three immediate crises: (1) a crisis in the real estate sector, (2) a crisis in local government debt, and (3) a crisis in public consumption. Problematically, these crises are interconnected to a considerable degree, and there are no easy fixes.
First, the previously booming real estate sector is now stagnating, with large companies (most notably Evergrande) in financial trouble, unable to repay their debt and finish their construction projects. Real estate, like infrastructure investment, is one of the most important drivers of the Chinese economy, accounting for roughly 30% of Chinese GDP. For decades, China's economic growth depended for a significant part on an endless number of housing projects, which catered to the immense growth and modernization of China's cities.
But property developers like Evergrande went too far, borrowing excessive amounts of money (sometimes in dubious ways) and spending similarly excessively. This went well for a long time, as consumer demand kept up and projects were delivered mostly on time and to consumers' satisfaction. The developers' revenue was steady and enabled the companies to repay many loans without much difficulty. But in the case of Evergrande and several other big developers, debt still reached dangerous amounts. When, a few years ago, the central government decided to restrict the virtually limitless ability to borrow money, there was no way out for these companies. Evergrande filed for bankruptcy in August 2023. Country Garden, another developing giant, defaulted on its debt in October 2023, with other property developers also publicly struggling with their debt.
These collapses of property developers have not only posed macro-economic challenges, but also challenges on a smaller level: construction workers and countless third-party companies involved in construction projects are left unpaid, and people who invested in real estate see their investment go up in smoke (first image). According to TIME, real estate accounts for "up to 80% of household wealth", as housing projects are the go-to investment for Chinese families instead of pensions or stocks. Speculating with housing has also been incredibly popular in recent times, although Xi Jinping has come out strong against that tendency. In other words, the instability of the housing market has directly put the financial wellbeing of many ordinary Chinese households on the line.
Local government debt
Second, local governments are in serious financial trouble. Because of a partial decentralization of governance, local governments have held a responsibility over a broad range of (expensive) tasks, including social security, infrastructure projects, and Covid-19 measures. Containing the spread of the virus alone cost local governments tens of billions of euros. While these tasks may be justifiably attributed to local governments, they stretched resources thin. Debt piled up during the pandemic. And when local administrations were additionally tasked with bailing out suffering local banks in 2023, debt climbed to dangerously high levels.
Usually, local governments can rely on a steady source of income. For the most part this comes from the sale of land. Land sale revenue and subsequent land-related tax revenue accounted for 31% of local government income in 2022 (PIIE). This reliance on land sale to maintain spending levels by the local governments is not sustainable, however. The crisis in the real estate market led to a sharp decrease in housing projects, which meant a sharp decrease in land sales. In other words, while local governments' spending has sharply increased in recent years, at the same time, their income has decreased. Hence, debt is swelling.
In 2022, local government debt reached 92 trillion yuan, or about 12 trillion (!) euros. While the number for 2023 is not yet known, this amount poses a big risk to the stability of the Chinese financial system, especially because there are no easy ways to repay parts of the debt, let alone large sums. Even more, total debt is difficult to quantify, since large amounts of debt are "hidden": they are stowed away in public-private financing entities—the so-called local-government financing vehicles (LGFVs)—that are used to raise funds for investment in local projects, mostly by issuing bonds and obtaining loans from banks. Inability of LGFVs to repay their debt and unwillingness of borrowers to restructure debt have put local governments in an even more precarious situation. Additionally, as banks play an important role in the financing of the LGFVs, large-scale defaults of these vehicles could be dangerous for China's broader financial sector.
In the last few months, the central government has implemented more measures to confront the debt crisis. In October 2023, Beijing asked state-owned banks to renew their loans with local governments, on longer terms and at lower interest rates. The State Council also forbade certain heavily-indebted municipalities of taking on more debt, and appointed a new finance minister. In November, the Chinese government updated its directions for local administrations, which included a stricter policy of engaging with 'problematic' private projects. Relatedly, it of course also enacted measures aimed at reinvigorating housing projects, which could stimulate landsales again, at least for some time.
These measures show a willingness to address the issues that caused the ballooning of debt. At the same time, the decision to renew loans for local governments and provide subsibies for the real estate market might suggest that the central government is also willing to kick the enormous problem of local government debt down the road—again.
Consumer confidence
Third, the Chinese government so far has not found a solution to low consumer confidence. As happened globally during the Covid-19 pandemic, public consumption diminished sharply (a few sectors excluded, such as telecommunications). In most economies, consumers by now have picked up where they left off pre-pandemic. But Chinese people, who are already traditionally prone to saving more money than people elsewhere, have still not fully returned to their consumption habits from before the zero-Covid lockdown.
During the first week of October (Golden Week), data showed that spending of Chinese consumers remained below pre-pandemic levels, even if Golden Weeks typically are "peak season for local spending". Similarly, this year's Single's Day (11 November) failed to register an uptick in spending: Reuters reported an "anemic growth in transactions, despite steep discounts by retailers," pointedly adding that consumers will need to "do more" in order to improve China's economy. Even e-commerce giants Taobao (Alibaba) and JD.com have reportedly noticed weak consumer confidence; this year, they did not even disclose their sales figures, a rather ominous sign. (Nevertheless, Chinese state media reported "record figures", eager to claim that the retail sector is back on track.) And, to come back to the aforementioned real estate crisis, the public's interest in buying new property has also decreased significantly, both out of concern about the implications of making large investments and distrust in property developers. Be all that as it may, more consumption is what the Chinese economy desperately needs.
For the government, China’s elderly population is a logical target for boosting consumption. They have been so for years, amidst a demographic transition that shifts spending power more and more to seniors. Yet one of the other big challenges currently facing the Chinese central government—large youth employment—does not help at all. First and foremost, it hurts consumption because young people have less money to spend (and the money they do have, they will likely want to save because of the unfavourable economic outlook and unavailability of affordable housing in China’s big cities); but it also means seniors will want to save money for their offspring.
Beijing has been attempting to stimulate consumption for some time. For example, in July 2023, it put in motion a “consumption-stimulation plan”, although both the plan and its scope remained vague and did not appear to be very ambitious. Instead, economists like Yu Yongding have argued that Beijing needs to more fundamentally alter its fiscal policies in order to "reverse the trend" of deflation and weak consumer demand, something Xi's government has been unwilling to do so far. Besides, the problem of lacking consumption is largely psychological: as long as people do not feel like it is safe to spend much money, they won’t. And as long as the other systemic issues in the Chinese economy are not sufficiently addressed, consumer confidence will not return, either.
Doom or gloom
Most economists and analysts agree that the economic challenges the Chinese government faces are daunting. There are no easy fixes. At the same time, there remains disagreement amongst experts about the prospects of the economy in the (near) future. There are numerous experts who are pessimistic and foresee continuous economic stagnation or even decline. Some have even already pronounced that China is over. Still, there are also some experts who are more bullish on China's ability to recover.
A somewhat pessimistic analysis by the Carnegie Endowment has pointed to China's debt as its main obstacle for continued economic growth. By calculating several scenarios, they show that the government's high levels of investment in the economy have to be adjusted, in order to prevent the debt from reaching a catastrophic amount; but this adjustment cannot but severely limit GDP growth. In other words, the economy's overreliance on state investment has hurt its growth potential in the long-term. It does not help that "consumption growth must outpace GDP growth"—which, as noted above, seems rather unlikely at the moment. Michael Pettis similarly argues that "[o]ne of the most venerable and compelling explanations [of the worsening economy] is that China is simply reaching the limits of its investment-heavy, export-driven growth model." It means that the emphasis on exports has to end, and China needs to transition from a predominantly manufacturing economy to a service economy. Pettis is doubtful whether that is achievable under Xi, however. He is not alone: numerous analysts think that Xi's Marxism, authoritarianism or desire for global power are obstacles to an improved Chinese economy. As long as he is in charge of the country and its economy, they see little room for a strong recovery.
Still, other experts think that concerns about the prospects of the world's second-largest economy are overblown. For example, Nicholas Lardy has interpreted macro-economic data differently, writing that they do not show a permanent slowdown, but rather a temporary set-back with already some early signs of a rebound. Reshma Kapadia emphasizes the size of the Chinese economy, which is such that it can surely absorb a small decline of GDP. She and others also point out that historically, Beijing's economic leadership has proven innovative and resourceful, and it has plenty of options left to solve the current (short-term) problems. While these solutions may not solve the larger, systemic issues in China's economy, they might at least bring back consumer confidence and kick-start a larger evolution of the economy's pillars, including the dominance of the property and manufacturing sectors.
Silent killers are the most violent
In any case, the Xi government needs to urgently find solutions to the three main crises in order to stabilize the Chinese economy. That, by itself, is already an enormous task. But there is more. China faces several systemic challenges that either are much more difficult to tackle than these current crises, or that are simply unsolvable.
Some of these systemic challenges are well-known. The rapidly aging Chinese population, for one, is a known problem. Not only does it mean that the productivity of the Chinese people will drop significantly in the coming decades; it also leads to a range of other challenges, including facilitating a healthcare sector that can accommodate hundreds of millions of elderly. Economists like to discuss this mostly in the context of the threat of Japanification, referring to the end of the Japanese economic boom in the 1990s and subsequent economic stagnation. Other challenges include the politicization of international trade (both by the West and China itself) and large-scale youth unemployment, including the growing disconnect between graduating students and suitable job opportunities.
The issue of youth unemployment can be considered a silent killer because, according to some analysts, it is leading to "diminishing aptitude for entrepreneurship and risk-taking spirit among young people." They refer to the lying-flat movement (tang ping), the causes of which are diverse and difficult to solve. In any case, if the government is unable to sufficiently motivate younger generations to fully participate in the economy (specifically, in ways that the government prefers—recall the aforementioned healthcare sector), it has a very big problem.
"In July [2023], the National Bureau of Statistics revealed that youth unemployment had hit a record high of twenty-one per cent, nearly twice the rate four years earlier. Then the bureau stopped releasing the numbers. Zhang Dandan, an economics professor at Peking University, published an article arguing that the true rate might be as high as forty-six per cent, because she estimated that up to sixteen million young people have temporarily stopped looking for jobs in order to lie flat."
— Osnos in The New Yorker
But when it comes to silent killers of the Chinese economy, it mostly comes down to one: China's demographics. It has to do with the low birth rate, which seems unfixable, and the very rapidly aging population, which seems unfixable, too. Even more, it has to do with the enormous gap between city and countryside, and specifically, rural underdevelopment. In their book Invisible China: How the Urban-Rural Divide Threatens China’s Rise, Scott Rozelle and Natalie Hell have argued that actually, the underdevelopment of China's countryside and thus the underdevelopment of China's 'human capital'* constitutes the biggest threat to the Chinese economy in the long-term. I actually found their analysis pretty alarming and will come back to the topic later.
Conclusion
Economists, both Chinese and foreign, are making good efforts to understand China's economic challenges and suggest pragmatic solutions. At the same time, the days of pragmatism-over-ideology in China's economic governance have long been gone. In the 1990s, Deng Xiaoping famously said that "it does not matter whether the cat is black or white, as long as it catches mice": if China had to adopt market economics to achieve economic growth, that was justifiable. For Xi, that is not an option. Ideology has become much more important again, also in the economy.
From the perspective of Xi—who, as a true Marxist, has never been fond of laissez-faire economics—the current problems in the Chinese economy can easily be considered the result of Beijing's looser control over the economy, local governance, and society. In his view, China has wavered too much from socialism, either with or without Chinese characteristics. Whatever an economic recovery would require, under Xi's leadership there is only one direction: towards more state control. And if his tightening grip over the economy would bring more hardship to China's workers, his message is clear, and it is a classic: eat bitter (chiku).
Personally, I think the Chinese government has been right to turn away from neoliberalism and take back more control. Letting the market run free has brought China much welfare and has helped make it a global power; but at the same time, socioeconomic inequality has skyrocketed and environmental degradation has cost much suffering. It would be naive to think that neoliberalism would fix the issues that challenge the economy today.
Be that as it may, there is much worry within China about the economic outlook. As noted before, this has hurt consumer confidence; for that reason, one would expect clear communication from the government, explaining which problems it identifies and how it will solve them. But the central government's decision making has always been very opaque, and its use of language is notoriously vague (leading the China Media Project to exclaim "Speak Plainly, Mr. Chairman", earlier this year). For ordinary people, it is a guessing game what is the reasoning behind key decisions, whether it comes to the real estate market, youth employment, or the country's demographic transition. That does not help.
As such, building confidence by communicating clearly and convincingly proves to be an additional challenge for Beijing. Unclarity and pretending everything is fine is not working: it leads to young people lying flat, businessmen leaving the country, investors pulling out, and people not spending their money. Subsidies and regulations can go a long way, but without the confidence of the Chinese people in their own economy, these problems will surely remain.
* I don't like the term 'human capital', because it implies that humans are some form of capital—and need to possess that capital in order to be considered 'of worth'—and because it suggests that laborers are just as much capitalists as the real (financial) capitalists, which they obviously are not.
Image references
- Man overlooks unfinished construction in Nanchang: https://www.nytimes.com/interactive/2023/01/24/world/asia/china-unfinished-apartments.html
~ Single's Day in Shanghai: https://www.parool.nl/nederland/een-mailbox-vol-korting-gaat-nederland-mee-met-singles-day-acties-geef-het-vijf-jaar-en-je-ziet-het-overal~bec4f644/
~ Livestreaming in rural schools: https://news.cgtn.com/news/3d3d774e3467544e31457a6333566d54/share_p.html
~ Xi Jinping before the Communist Party flag: https://www.journalofdemocracy.org/for-xi-jinping-the-economy-is-no-longer-the-priority/
