China at a crossroads: the rise of an economic giant hitting the wall of challenges
Over the past few decades, China has been an unmissable star on the international economic stage. With its rapid growth rate, industrial development and exports, it has become one of the biggest players in the global market. China’s economic boom has inspired many countries and has also been the subject of much debate about what the future of the global economy might look like.
However, in recent years it has become increasingly clear that China is at a crossroads. The era of explosive growth for which it has become synonymous seems to be coming to an end. China is now facing a number of economic challenges that raise questions about the direction its economy will take in the coming years.
China on the road to become an economic colossus
China has undergone impressive economic growth, which we need to explain more to understand. Overall, China’s economic growth has been based on five key periods. Economic growth in modern China can be dated back to the early 1980s, when key reforms were initiated (more specifically in 1978) under the leadership of Deng Xiaoping. These reforms included market liberalization, opening China to foreign investment and foreign trade. These policies led to an increase in productivity and economic growth (Garnaut, Song & Fang).
Another key period was the 1990s to the early 21st century, when the Chinese economy was rapidly industrializing. The country became a “world factory” and began to produce a wide range of products for export abroad. This period was characterized by significant GDP growth and massive investment in infrastructure. China’s entry into the World Trade Organization (WTO) in 2001 was another key milestone. This opened up new markets and brought foreign investment and trade into the country. China has become a key player in the global market and a world leader in certain sectors, especially manufacturing and exports (Garnaut, Song & Fang).
Infrastructure investments turned into a debt burden
China continued to invest massively in infrastructure and the state sector in the early 21st century. However, this growth was increasingly dependent on investment and exports, raising concerns about sustainability. China began to focus on building large-scale infrastructure, including highways, railways, airports, ports, and energy facilities. These projects aimed to promote rapid economic development and facilitate the movement of goods and people across the country. Another important feature of this period was the growth of the construction and real estate sectors. In some cities, new neighbourhoods and urban complexes were built literally from scratch, and in some years construction growth reached as much as 20%, resulting in the recent bursting of the real estate bubble and problems with the collapse of property developers.
Chinese regions (government) are heavily indebted after years of investment in large infrastructure projects, as are private developers. Borrowers are defaulting, and unpaid debts are causing losses for banks, funds and other investors. Moreover, it turns out that demand for housing has not matched reality at all and has been significantly lower than supply. The majority of the population already owns some property that is even fairly new.
During this period, the state sector played a key role in managing and financing projects. State-owned banks and enterprises were the main players in infrastructure and industrial investment. To realize these projects and sustain growth, China was forced to import large quantities of raw materials such as iron, copper and oil. This demand had a significant impact on the world commodity market (Garnaut, Song & Fang).
After the global crisis of 2008, China began looking for ways to diversify its economy and reduce its dependence on exports. The drive to shift from investment-led to domestic consumption-led growth became a key objective and has continued to this day. The Government of the People’s Republic of China has begun to actively promote the development of domestic consumption as the main engine of growth. The government launched a series of reforms, including liberalization of the financial sector and efforts to improve social security.
The growth of domestic consumption was fuelled by the rapid rise of China’s middle class. This middle class had greater access to products and services and was able to spend more money. The development of services also became an important element of the new growth model. Services such as retail, tourism, healthcare and financial services began to play a larger role in the economy (Garnaut, Song & Fang).
Will China follow in Japan’s footsteps?
But China is now facing several challenges, more specifically, missing economic boom points to slowing post-COVID growth, rising debt, an aging workforce and deflation. This Prompted many observers to question whether the world’s second-largest economy could be facing a fate similar to Japan’s in the 1990s. During this period, economic stagnation and price deflation transformed Japan’s bustling economy of the 1980s into an economy that grew at a little more than 1% annually over a decade (Morgan Stanley).
A string of weak economic data released recently, and the indication that the country’s economy grew by only 3% in 2022, has further shaken confidence in China’s prospects. In July, consumer prices fell for the first time in two years, raising the spectre of deflation, while credit growth fell to its lowest level since 2009. In mid-August, the government announced that it would no longer publish unemployment data by age group. This came after youth unemployment reached a record 21.3% in June (Nikkei Asia).
China’s economy is hitting a wall after years of optimism, former Treasury Secretary Larry Summers says (Business Insider). China’s struggling economy has become a worry factor for investors amid fears that the Asian nation’s deepening slowdown could have spillover effects for global markets. US President Joe Biden went as far as to say China’s economy could be a “ticking time bomb” as the nation also suffers from sluggish growth and high unemployment (Business Insider).
Banks, businesses and consumers are struggling
When China ended its COVID-19 controls late last year, many economists expected a boom in consumption fuelled by pent-up demand. But while the country showed some signs of recovery in the first quarter of this year, growth has since been disrupted by a global economic slowdown, tepid domestic demand and banks increasingly vulnerable to the ailing real estate sector.
However, bank loans that are difficult to judge are shown in the table below. The new lending data is highly volatile, and while the July new lending data was indeed the lowest since 2009, it is not clear that this is a downward trend. Comparing new lending with new savings, however, shows that the gap between these is increasing, as the growth of new savings outstrips the growth of new lending. The last time this happened was during the crisis year of 2015, when the Shanghai stock exchange fell by more than 40% in a matter of weeks over the summer. In mid-2023, with this boom still non-existent, Chinese businesses and consumers appear to be in crisis mode, saving rather than borrowing anew (Nikkei Asia).
Trades and debts are the leading fear(mongers)
China’s foreign trade, especially exports, saw strong growth of more than 20% almost every month in 2021, when many countries were struggling with lockdowns, and consumer spending was partly boosted by pandemic relief money. However, from the second half of 2022 onwards, China’s trade growth began to weaken due to uncertainty in global and domestic markets. In July, the decline in exports (14.5%) exceeded expectations due to subdued demand from major trading partners in the EU, the US and Southeast Asia. Imports fell by 12.4% due to a decline in commodities and semiconductor products (Nikkei Asia).
But China has another challenge in the form of rising debt, which shows possible macroeconomic similarities with Japan in the 1990s. China’s debt has risen sharply, from 270% of GDP in the last quarter of 2019 to 300% of GDP as of the first quarter of 2023. In 2023 the main drivers of debt are the government debt that will increase by 3.9 percentage points. This has been the front-runner in total debt cumulation, in particular due to local government activity. Then corporations will add 3.7 percentage points. Despite this relatively large contribution, corporate debt shrunk from 64% in 2019 to an average of 60% during the first three quarters of 2022. And also households will add 2.2 percentage points. The growth rate of household debt has been higher than that of corporate debt since 2015, aside from a reversal in the third quarter of 2022 during a housing downturn (JP Morgan).
Aging population means slowing productivity
Another question is how China will be able to handle the demographic trends that have benefited its economic growth for many years. The vast labor reserves that have been the basis of China’s low-cost industry are shrinking as China’s population ages rapidly. China wants to partly solve this problem by massively robotizing its manufacturing, as confirmed by a recent report that China has a plan to mass produce humanoid robots that could “change the world” within two years (Finance Yahoo).
The decline in the country’s population in 2022 follows years of slowing birth rates, due to the long-standing one-child policy. China’s total factor productivity — a measure of how much output the economy actually produces relative to inputs — is no longer growing as it used to. China will be replaced by India this year as the most populous country in the world amid an accelerating shift by multinationals to move more manufacturing to other parts of Asia, such as Vietnam, Malaysia, India and Bangladesh.
The risk od deflation is hitting hard
Finally, deflationary pressures are widespread in the economy. The risk of deflation in China is partly due to the downturn in the global commodity cycle, including the unwinding of supply chain pressures, but more important are unique domestic factors. First, government policy has been focused on boosting production and investment rather than consumption, leading to tepid domestic demand. In addition, households have maintained high precautionary savings in an increasingly uncertain economic situation. “Also, China’s high unemployment — especially youth unemployment — suggests that it lacks the upward pressure on wages seen in other countries.
Looking across sectors, the Chinese economy is being hit hard by the slump in real estate, which is reflected in a renewed weakening of property prices. In addition, falling car prices and the decline in pork prices due to oversupply are adding further pressure to the risk of deflation. Deflation in China could aid near-term global disinflation, as declining export prices out of China translate into lower import prices for trading partner countries (JP Morgan).
Not yet in the Japan’s footsteps
However, although there is a risk that China could fall into a debt-deflation spiral similar to Japan’s, with persistent deflation, the debt-to-GDP ratio is still rising and GDP per capita is stagnating. But China seems to be in a better position today than was Japan for four reasons:
- Asset prices in China have not run up as much as they did in Japan during its 1980s boom.
- Although per-capita income in China has increased significantly over the last few decades, it’s still low relative to most developed nations, implying there is room for catch-up growth in productivity.
- Unlike Japan, China’s currency has not appreciated significantly, with less impact on its competitiveness.
- China’s real interest rates are below its real GDP growth, whereas the Bank of Japan kept real interest rates higher than real GDP growth between 1991 and 1995.
The last point is perhaps the most important. We know from history that ensuring a reasonable gap between real interest rates and real GDP growth is a key element when economies seek to stabilize or reduce debt. With hindsight, it is clear that the key to debt reduction is to keep real interest rates below real growth by maintaining expansionary monetary and fiscal policy. Why? Simply put, it is impossible to pay down debt if the interest rate on that debt is rising faster than income growth. So far, China’s growth is outpacing interest rates by more than 2 percentage points. However, growth has fallen significantly in the past three months, suggesting that Chinese policymakers will need to take decisive action to prevent a debt deflationary loop (Morgan Stanley).
China at the crossroads of economic development and its future
In conclusion, it can be said that most economists seem to believe that China’s previous growth model has run its course. But with the country’s economy in the midst of a fundamental transformation, the future is unclear. According to some estimates, China’s growth rate will slow to between 2% and 5% over the next few years. In the medium term, we believe that the Chinese economy will be slowed down by, among other things, uncertain export growth due to rising labor costs compared to other emerging markets (especially in Southeast Asia), the trend towards de-globalisation and geopolitical rivalry, mainly with the US.
