International reports on the Chinese economy state, said to be in sad shape, are juxtaposed with recent Chinese government policies intending to bolster the economy in the short term, in ways that benefit, not sacrifice, the economy in the long term.
First, the challenges. A slowing economy, not achieving the anticipated post-COVID “rebound”. Manufacturing activity has been contracting and prices have been falling. Low consumer confidence and thus low consumer spending; people are worried about the future and expect prices to fall further.
Real estate is troubled, and the real estate sector is about 30 percent of China’s economy, the foundational asset of the financial sector, and a major source of revenue for local government. Local government debt is estimated by the IMF at over $9.3 trillion, roughly half of China’s GDP. Fixed-asset investment is becoming less productive. Youth unemployment hit record highs before reporting was stopped. International demand has fallen and international tensions have risen. Direct investment by foreign companies has plunged. At the same time, the population is ageing and shrinking.
How is the Chinese government addressing these challenges?
The first thing to say is what the government is not doing. It is not injecting a massive, blanket stimulus, the way it did in the financial crisis of 2008-2009. Leaders know that the benefits of short-term boosts are not worth the cost of even larger long-term debt and diminished productivity. Moreover, President Xi Jinping emphasizes the importance of high-quality development, which cannot be achieved with fast money. So, no massive stimulus is a good sign.
What the government is doing is making multiple, targeted policy adjustments. These include: addressing challenges of consumer confidence, real estate and the industrial system. Although the list goes on, let’s focus on these three issues.
Consumer Confidence
The only way the Chinese economy can achieve sustainable growth long-term, is by shifting economic activity away from investment to household consumption, which at 38% of China’s GDP is much lower than the 60% global average and about 70% in the US.
Looking longer term, last December, China released guidelines on expanding domestic demand to promote its development extending to 2035. To achieve the 2035 goals of new industrialization, informatization, urbanization and agricultural modernization, the country aims to boost investment in consumption, optimize distribution, bolster the quality of supply, and improve the market system.
The slowdown in China’s economy and the risks in China’s financial system have grown as China’s long successful model of growth, export-driven and fixed-asset fueled, has reached its retirement age. China’s new growth model, emphasizing high-quality development and domestic consumption, is the vision for the future. Key, of course, is consumer confidence: people need to spend today, not worry about what may happen tomorrow.
This is a current conundrum.
The readout of a Politburo meeting in July was blunt in its assessment that the economy is facing new difficulties, mainly insufficient domestic demand, but optimistic that “the economy has tremendous resilience and potential for development, and its long-term sound fundamentals remain unchanged.”
‘Policy toolbox’
China’s real estate sector has been battered by huge debt, weak demand and falling prices. It is hard to overstate the importance of real estate in China’s economy. Real estate accounts for about 30 percent of China’s GDP (up from about 10 percent in 2000); it is the primary collateral securing loans, and land sales are a major source of revenue for local governments. Moreover, real estate now accounts for almost two-thirds of China’s household wealth.
It is no state secret that China’s growth has been excessively reliant on infrastructure investments, which are diminishingly productive, and real- estate, which is hyper-leveraged and vulnerable. According to the Wall Street Journal, in the 1990s, it took China about $3 of investment to produce $1 of GDP growth; it now takes about $9 — a reduction in productivity that cannot be sustained.
Leadership certainly recognizes the critical need to stabilize the real estate market — without providing blanket guarantees that would distort markets. They advocate making good use of the “policy toolbox” to better meet residents’ housing needs and to promote the “healthy development” of the real estate sector. Measures include: increasing affordable housing, transforming urban villages, constructing “both leisure and emergency” public infrastructure, and revitalizing various types of idle properties. “Derisking” the financial sector by reducing local government debt and protecting financial institutions, small and large, is part of the plan.
Peak China
International analysts claim that China has reached the pinnacle of its relative economic power, especially with respect to the U.S. — hence the catchphrase, “Peak China.” At the same time, China is focusing on high-quality development to bring about a modern industrial system. The two things are related.
A “Peak China” now, or soon, could mean that China’s economy would never overtake America’s economy (at market exchange rates), as commonly assumed for years, even though China’s population is four times that of America’s.
The Economist magazine no longer forecasts China to zoom past America and retain a commanding lead but rather to end up closer to economic parity. Yet, The Financial Times headlined, “We shouldn’t call ‘peak China’ just yet. Yes, there are deep structural problems in the economy, but this is also a country with significant strengths” — noting 1.4 million graduating engineers a year, the world’s busiest patent office, a highly entrepreneurial population, and impressive world-leading potential, such as in electric vehicles and information technology.
China has a big vision of high-quality development creating a modern industrial system, which optimizes the market playing a decisive role and the government playing a smart role. This is far more relevant, and far more sustainable, than the old, high-growth, energy-intense, heavy industry model. To highlight this transformation, President Xi Jinping has put forth a new term of art, “new productive forces.”
It means new forms of economic growth derived from continuous sci-tech breakthroughs in a more intelligent information era. Xi promotes “Integrating scientific and technological innovation resources, leading the development of strategic emerging industries and future industries, and accelerating the formation of new productive forces.” Especially important are the commercialization of technologies in IT, AI, robotics, semiconductors, new materials, e- commerce, ocean and space technologies, advanced manufacturing, and certainly green technologies, like lithium batteries, photovoltaic power, and new energy vehicles. Look for new policies to promote these “new productive forces.”
Bottom Line
The bottom line is that there is no perfect policy, no magic solution. Many specific, targeted programs are being tried, tested, monitored; correcting course when needed; always seeking to optimize and improve, recognizing that conditions are always changing.
***
Robert Lawrence Kuhn is a long-time advisor to China’s leaders and the Chinese government. He is an international corporate strategist and investment banker who advises multinational corporations on formulating and implementing China strategies. He received the China Reform Friendship Medal from President Xi Jinping.