China\u2019s economy began running into tougher times in 2023. Some of the country\u2019s problems were new: slowing global demand could not but impact China\u2019s exports, which nevertheless remain well above their 2019 level. But other problems reflect the continuation of trends that were long underestimated or considered temporary. Covid and rigid confinement policies were thought to be an exceptional episode. Investors and analysts expected not only a strong rebound but also \u2013 at last \u2013 the turn to a consumer, service-oriented society. This would solve the imbalance in China\u2019s external accounts and provide a new lease on economic growth. The tree of the covid pandemic, however, hid the massive forest that is Xi Jinping\u2019s basic approach: security before growth, self-sufficiency sthrough innovation, heavy investments over household consumption, sweat and tears.<\/p>\n
Overall, China\u2019s leader thinks laziness is predominant in democracies, and that his people\u2019s \u201cstruggle\u201d over \u201clying flat\u201d will set the economy back on course. To the Chinese people, it has become apparent that Xi\u2019s politics have overridden previous policies. He has resisted calls for redistribution and for financial stimulus and hit the entrepreneur and middle classes hard, by doing things such as banning private tutoring, taking down star entrepreneurs, and pushing in an overbearing and intrusive way for political education and Chinese Communist Party (CCP) ideology. China\u2019s geopolitical drive abroad, incidents with neighbors and threats over Taiwan have doubled the perceptions of risk in China\u2019s middle classes, not to mention in foreign entrepreneurs.<\/p>\n
Internationally, media amplification and a new consensus around deflation, stagnation, youth unemployment, flagging demography and \u201cpeak China\u201d have reversed much of the previous consensus. There is significant backlash from the era of the \u201cChina miracle\u201d, which dominated the scene for decades. The truth is that the confidence crisis of the summer of 2023 and the persisting failure to kickstart the economy beyond small sectoral gains has long-term underlying causes,which many of China\u2019s economists and reformers had foreseen. The new consensus itself therefore needs to be unpacked.<\/p>\n
The facts: growth has slowed down, but not disappeared. This has been a trend since 2010. For several years \u2013 arguably since 2015, and certainly since 2019 \u2013 the actual breakdown inside China\u2019s growth has contradicted the previous consensus. China\u2019s export performance has consistently outstripped that of the domestic economy \u2013 before the covid pandemic and after it. The corollary to that fact, however, is that China\u2019s transition to a more mature consumption and service economy \u2013 expected by foreign observers to balance trade and financial relations \u2013 never materialized.<\/p>\n
China\u2019s trade surplus, at $1 trillion in 2022 and 2023, is now 2% of global GDP. At some point, China\u2019s exports were always going to hit a brick wall \u2013 that of global demand, with a dash of geopolitical reluctance, leading to decoupling\/derisking and deglobalization talks in the West. Since Trump set tariffs \u2013 kept in place by the Biden administration \u2013 the United States has diminished its relative dependency on Chinese imports; the European recession in 2022-2023 also put a limit on China\u2019s export drive into the EU. This is not so much an issue of competitiveness for Chinese goods as an outside demand constraint. A 398 billion euro trade deficit with China is hardly sustainable, in economic or political terms. Of course this has implications for China too, where exports have been the main engine of growth.<\/p>\n
Then comes the real estate and construction crash, gathering force since 2021. In this sector, again, growth had been phenomenal. The sector represents 30% of China\u2019s GDP and the key source of finance for local governments; it plays an outsize role for the urban population\u2019s prudential savings and retirement planning. The crash has harmed confidence, and therefore household consumption and investment. As it happens, infrastructure investment faces a glut of existing capacities in areas such as transport, and a rate of return in alternative energies that can hardly match that of King Coal. For years, it was exports, and a leading edge in digital hardware that propelled China\u2019s growth.<\/p>\n
Even with the losses from real estate, the crisis has still been a slow motion one: Xi Jinping and the country\u2019s leadership have been left with choices.<\/p>\n
\nAfter all, in absolute terms, China\u2019s economy still grows faster than most, including Europe and the United States.<\/p>\n<\/blockquote>\n
One is reminded of Japan\u2019s \u201clost decade\u201d talk in the 1990s: while there was then a very real debt trap and deflationary spiral, Japan\u2019s key industries never lost ground to their Western competitors, and the growth of Japan\u2019s GDP still surpassed that of the EU in that decade.<\/p>\n
SECURITY OVER GROWTH<\/strong><\/h3>\n
Of course, one can doubt the quality \u2013 and veracity \u2013 of this growth. Indeed, there has been a drive to rein in false statistics coming from local governments. Infrastructure investment has not accelerated, but it is still high. In fact, much of the investment aimed at self-sufficiency actually hinders productivity growth, which is better served with foreign technology and cutting-edge machinery. Post-lockdown entertainment and travel consumption has indeed rebounded, as opposed to consumption in durable goods. Even as youth unemployment has soared, such figures do not take into account what happens in rural areas \u2013 where, one must say, underemployment has been rampant for years, leading to a youth exodus.<\/p>\n
\nThe so-called \u201czombification\u201d of the economy, with transfer of local and state-owned enterprise (SOE) debts to ghost companies backed by implicit (not explicit) state guarantees, has been going on for years.<\/p>\n<\/blockquote>\n
Expedients that have worked in the past \u2013 that have saved the leadership from going through politically risky and painful reforms with short-term costs and long-term results \u2013 call for a vision that is different from Xi Jinping\u2019s. After all, his former associate, Wang Qishan, had cited Alexis de Tocqueville in observing that reform processes are most dangerous in their first phase. After Mao died, there was no other choice but profound change. Today, such difficult choices appear less evident to the CCP and especially to Xi. For example, postponing debt repayment and kick-starting an economic rebound has been a successful strategy that has helped to solve the issue of hidden debt in the recent past.<\/p>\n
The very scale of public or quasi-public indebtedness is key to understanding Xi\u2019s proclaimed reluctance to bail out local governments and real estate companies.<\/p>\n
\nPreference goes to economic security over economic growth. This is a preemptive tactic that works if deflating the real estate bubble takes the form of a long fizzle; it will not work if panic breaks out.<\/p>\n<\/blockquote>\n
Fear of the latter helps to understand recent censorship of economic statistics, beyond the CCP\u2019s usual preference for opacity. Control is key for the CCP. China\u2019s year-on-year GDP growth is more impressive seen from a low 2022 base year than on a monthly basis. Conversely, the 2023 late spring and summer slowdown in exports followed a huge increase in 2022. China\u2019s \u201cfaltering growth\u201d delivered some 25 million autos in 2023, taking global first place for electric vehicle (EV) exports. This performance replicates what happened in the solar panel industry as well.<\/p>\n
THE FEAR CYCLE<\/strong><\/h3>\n
In macroeconomics and finance, two features stand out that explain the reluctance to change paths. First, the abovementioned trade surplus. Second, a positive current account balance (though exports are wildly undercounted by the official State Administration of Foreign Exchange because, for example, exports from Special Economic Zones are excluded). Foreign reserve holdings, particularly in US dollars, are also undercounted because purchases by state banks and other state-controlled entities are not included. Unofficial estimates place China\u2019s actual reserve holdings at $5 to 7 trillion, by far the world\u2019s first. A third factor, insecurity, also comes into play. Household savings and SOE cashflow increased during and after the pandemic.<\/p>\n
\nThis is part of the problem for growth: consumer paralysis and company caution, the reluctance of banks to serve private borrowers, and the fall of the real estate market all worked together to create a doom loop for investment \u2013 especially for local government budgets.<\/p>\n<\/blockquote>\n
The same sentiments also reined in a soaring consumer debt. Any financial stimulus from government is used to pay down debts rather than to create new investment.<\/p>\n
Technically, China is in a balance sheet recession, as described by Richard Koo, among others, in the case of Japan in the 1990s. Hyperabundant private savings are not a good sign for growth. But they do provide \u2013 at the expense of households \u2013 ballast against a massive accumulation of formal and hidden public debt; by most accounts, this exceeds 300% of GDP. Indeed, it is the fear felt by households and companies that provides a savings ballast for rigid government policies. These three factors \u2013 current account balance, size of currency holdings, private savings \u2013 could even allow monetization of much of China\u2019s bad debt, rather than simply postponing or parking it. It could even go beyond quantitative easing, Fed style, or the purchase of public debt, European Central Bank style.<\/p>\n
Monetization was the key to ending Japan\u2019s long crisis after a decade of attempts to restart the economy by more conventional spending means: ultimately, by printing excess currency, Japan\u2019s central bank extinguished bad debt instead of merely holding it. In China\u2019s case, it can happen without devaluation, if capital flight is contained, or with a controlled devaluation that would give an advantage to exports at the expense of international competitors. So far, however, Xi\u2019s global ambitions would seem to preclude that option. At present, he micromanages the renminbi to follow every move of the US dollar. But we have already learned to avoid assuming too much. On covid, after all, Xi finally ate his hat in December 2022 and made a 180\u00b0 turnaround of his previous lockdown policies.<\/p>\n
THE POLITICS OF DECISION-MAKING<\/strong><\/h3>\n
We know much less about politics than about policies. The narratives about the present gloomy prospects and the need for a new turn \u2013 or a return \u2013 to market should not be swallowed whole. China\u2019s economy boomed for decades under CCP and state management. That success was so real that it fueled an international turn towards subsidies, the return of state industrial policies, and ensuing protectionist tendencies. Several major economies have just as much public and company debt as China. India and some European southern countries have even more youth unemployment: China\u2019s demographic fall might be a solution if (and it is a big if) the country is able both to robotize (a real possibility given Xi\u2019s drive to innovation) and to build a healthy capital market (much more problematic). An audacious push for debt monetization \u2013 the answer to higher global interest rates \u2013 would create much inconvenience on global capital markets, but it is an option to offset financial panic.<\/p>\n
\nXi\u2019s politics will chart the course. His latest political appointees have less international experience and technocratic savvy than their predecessors. Temporary holdovers have been important as advisers and managers, but do not possess political clout.<\/p>\n<\/blockquote>\n
One can sense much unease in the public expression of Chinese economists. Actual policy changes are confined to a renewed accent on infrastructure investment, small moves on interest rates, and some support for embattled local governments, which are encouraged to launch new bonds and buy some of the hidden debt. There is a holding pattern for the general economic line. Public encouragement for private companies mostly falls on deaf ears because the intended audience has been shell-shocked by Xi\u2019s authoritarianism and reversals: the first problem of China\u2019s economy today is a credibility gap. Control and censorship are everywhere. When Mao encountered real problems, he moved from left to right, eventually reversing course when he could afford to do so. Xi, even with his personal power, does not live in such a political vacuum, and international constraints are much tighter.<\/p>\n
Unimaginative and protective management may turn dire predictions into a lasting reality. Let\u2019s hope for China that we are wrong, and that Xi has the potential to surprise us.<\/p>\n