At the dawn of the 2020s, China is facing challenges that are perhaps the most serious since the death of Mao Zedong in 1976.
Until relatively recently, these were predominantly home-grown problems gathering momentum slowly over the last decade or so. They have become accentuated, though, by the emergence of a new, repressive governance system under President Xi Jinping, and, in the last two years by the so-called trade war and the eruption of instability in Hong Kong. In the 2020s, China’s growth is likely to continue to slow to about 3-4% a year. A ‘recession with Chinese characteristics’ is not out of the question.
We should pay close attention. Slower growth and the rising risk of a significant fall in the value of the yuan in the next few years could easily choke the narrative that China will become the biggest economy in the world. This would have a significant impact on how China, and we think about everything from economics to foreign and security policy in the global system.
China has become too dependent on credit creation and state industrial policy to drive growth. This is reflected in over-investment, and excess capacity and declining profitability in old industries like steel as well as in newer ones like solar energy and electric vehicles. Chinese consumers are no slouches but their potential is being sapped by high income inequality, an inadequately developed social security system, and rising mortgage debt.
While Chinese income per head is about the same as in Brazil, its consumption per head is no higher than in Peru. This speaks to distorted income and wealth distribution. Productivity growth has stalled along with the retrenchment away from market-orientated reform, with which it has historically been closely associated.
Debt as a share of GDP has tripled since 2000 to stand at over 320% of GDP, which is extraordinary for a country with China’s income per head of just over $10,000. Household debt accounts for 120% of disposable income, which is higher than in the US. The growth in debt and exceptional levels of financial risk-taking contrived to create a financial crisis in 2015-16, which torpedoed most of the prior reform-minded agenda, and resulted in a strong clampdown on some of the more egregious forms of financial risk-taking and malpractice.
This has dulled the dynamic of the private sector, contributed to slowing growth, and resulted in new forms of financial stress, necessitating several mostly smaller bank rescues in 2019. These remind us about the systemic nature of financial risk among many of China’s 4,500 banks and that that the government has no choice, in the end, but to lower the country’s debt dependency sooner or later, and allow the economy to decelerate significantly.
As this happens, we should pay close attention to the real estate sector, which now accounts, broadly speaking, for about 16% of GDP and about two-fifths of the collateral that backs outstanding loans. The real estate sector has been the most important in the world in past decades for good reasons. We should be wary about a similar accolade in the 2020s for bad ones.
Rapid ageing is another drag on the economy, or at least it will be in the absence of mitigating policies to try and prop up the size of the working age population. However, as things stand, China remains the fastest ageing country on Earth, and its age structure will rise as much in the next 22 years as it has done in the West over seven decades – but at much lower levels of income per head and with a much more immature social welfare system.
The trade war, so called, has quickly become an existential conflict between China and the US, and the West, over trade in goods, but also investment flows, technology and industrial policies, education and culture, and ultimately standards and values. It could spill over into finance and capital markets. In the US, hawks speak of ‘decoupling’. In China, they speak of ‘self-reliance’. Both sides will lose, the more this rhetoric becomes reflected in policies. Both have ‘entity’ lists, which detail commercial restrictions or bans on companies deemed to be prejudicial to national security interests.