Challenges for China’s Economy

Most commentators on China fall into one of two categories. There are permahawks (like Gordon Chang) for whom China is always on the verge of collapse and, simultaneously, threatening to start World War III. And then there are the permadoves (many among business leaders and in the U. S. State Department) For whom the 21st century will be the Chinese century and China is a model for other countries to emulate.

I don’t think Michael Pettis is either a permahawk or a permadove but rather I think he provides frank and informed assessments of China. I encourage you to read his most recent offering at Carnegie Endowment for International Peace on the challenges facing the Chinese economy. So much of it is so excellent it’s hard to find representative snippets. Here’s an example:

This means, among other things, that even if the property market recovers next year as a consequence of the end of pandemic lockdowns, the recovery can only be partial and temporary. In the medium term, property prices will continue to decline, and insolvencies will keep on emerging. Until the systemic problem is addressed and resolved, there can be no permanent stabilization of China’s property market or of its economy more generally.

At the heart of this credit-deterioration process is the way in which the form and structure of economy activity in China has evolved over the past ten to twenty years. In most countries, GDP is a measure of the output delivered by economic actors over a specified period, whereas in China GDP is an input determined politically at the beginning of a time period. Once China sets its GDP target, local governments (and, until recently, the property sector) have had the responsibility of delivering enough economic activity to bridge the gap between the GDP growth target and what Beijing usually calls “high-quality growth”—that is, the underlying growth rate delivered by the private economy, consisting mainly of consumption, exports, and business investment.

Bridging the gap between the two was not a problem for the Chinese economy during the first thirty years of the period known as reform and opening up (the late 1970s until the late 2000s), mainly because China was seriously underinvested in property, infrastructure, and manufacturing capacity, so the investment that the GDP growth target required was, for the most part, productive.

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This has always been the hardest part of rebalancing (as I discuss here). China, like other counties that have followed this model, found itself politically and institutionally unable to manage the transfers. It did, however, keep investment growth rates high and—again, like nearly every other country that has followed this model—China began to overinvest systematically in projects that contributed less to the economy than they cost. The result was a sharp increase in the country’s debt burden: it is only when debt is used to fund nonproductive investment that debt rises faster than a country’s debt-servicing capacity, for which GDP is a proxy.

I encourage you to read the whole thing. He predicts that the strategy used in China to address its economic problems is likely to result in increased centralization of political power.

Although I think I’m pretty closely aligned in my views with Mr. Pettis. My own view is that I think that what has happened in China over the last 40 years has been widely misunderstood in the West. IMO the Chinese have largely followed the Soviet model—growth by moving unproductive labor assets from the agricultural sector to the manufacturing sector. To their credit the Chinese authorities managed to do so without the decrease in productivity in the agricultural sector that happened in the Soviet Union. However, like the Soviet Union they have reached the limits of that process without becoming a rich country like the United States, the UK, France, or Germany.