Is The Chinese Economic Miracle Over? These Five Key Signs Say It Is

-Analysis-

SHANGHAI — What does China’s party leadership do when it cannot get a persistent economic crisis under control? For example, it makes sure that economists who point out the seriousness of the situation “disappear.”

This is exactly what happened with Zhu Hengpeng, vice director of the Economics Institute of the Chinese Academy of Social Sciences. In April, Zhu was believed to have made derogatory comments about the state of the Chinese economy and the economic expertise of party leader Xi Jinping in a private chat group. Since then, the scientist has not appeared in public, and his academy no longer lists him as an employee.

As Stalin once said: Man gone, problem gone.

Well, at least for the time being. Zhu is not an isolated case: the party is said to have recently urged other economists, in friendly or less friendly ways, to put the current economic situation in a positive light. However, this is becoming increasingly difficult. At the end of 2022, there was still great hope that China would quickly recover from the economically crippling pandemic years after the end of the strict zero-COVID self-isolation. But a longer-lasting lull has now emerged that raises fears that this is not a passing cycle.

The party has set itself a target of 5% growth for the current year. However, the sobering economic data of the past few months have made this target seem increasingly unrealistic. In September, the government pumped large amounts of money into the capital markets, and last month the Ministry of Finance announced further support.

In the short term, this lifted the mood among investors and international market observers, with the investment bank Goldman Sachs, for example, revising its growth forecast for the current year from 4.7 to 4.9% — which would still leave the party leadership just below its target.

In the long term, however, the country is facing five structural problems that are interdependent and reinforcing: Weak domestic demand, over-indebted local administrations, a real estate crisis, youth unemployment and trade wars.

1. Weak domestic demand

China’s growth model was primarily driven by investment in the past boom decades: high-rise housing projects, airports, high-speed rail lines and industrial plants were being built all over the country. This development is not yet over, but it is threatening to reach its limits in the foreseeable future — as the real estate sector is facing a serious crisis.

Economists have therefore long been advising the People’s Republic’s central planners to focus less on large-scale investments and to stimulate internal demand instead.

China’s population is extremely cautious when it comes to spending money.

To achieve this, however, the party leadership would need to give its people a greater share of the profits from economic growth, for example in the form of more extensive social security. So far, however, the government has been very reticent when it comes to expanding the health, pension and social security systems. That prompts typical Chinese citizens to put a large part of their income aside for emergencies or retirement provision, which means private households in China save much more and their consumer spending is much lower than the global average.

This trend became even more pronounced during the years of pandemic lockdown, and even after that, demand only picked up very slowly. To this day, China’s population is extremely cautious when it comes to spending money. The main reason could be a lack of confidence in the country’s economic future.

China’s consumer confidence index fell to a historic low during the zero-COVID era — and never bounced back. Another indication of the Chinese people’s lack of confidence in the future is likely to be the drastic drop in the birth rate: the number of children per woman fell from 1.5 to 1.0 between 2019 and 2023.

2. Local debt

The party leadership hesitated for two years before suggesting that it would stimulate the economy. The fact that it finally decided to do so was probably due to the dire financial situation of China’s local governments. In many provinces, there have recently been increasing reports of payment difficulties: civil servants who are no longer receiving their salaries and public contractors whose invoices remain unpaid.

The business model was simple.

China’s local governments are not only strapped for cash because the central government burdened them with the costs of the extensive pandemic control measures: they are also suffering from the collapse of the real estate sector, which reliably filled their budget coffers in the past decades. The business model was simple: the provincial governments gave land to real estate developers, who built new high-rise housing estates on it.

But since the construction industry has been in decline, the municipalities have been lacking income. This has brought some to the brink of insolvency, which is now forcing the central government to counteract this with interest rate cuts and other support measures.

3. Real estate crisis

For decades, Chinese real estate developers were extremely profitable: they took land from provincial governments and built apartment blocks on it, channeling the Chinese people’s savings back into the economy. At the height of this development, real estate contributed to 25% of China’s gross national product and represented around 70% of Chinese households’ savings.

The crisis is far from over.

But then, the bubble burst. Development giants like Evergrande began to falter, the construction companies they had commissioned stopped receiving money, major construction sites came to a standstill, and investors were left with half-finished apartments.

The crisis is far from over. Rather, it is spreading further and further as it undermines the investment-driven growth model, cutting off income to provincial governments, making the population fear for their savings and thus further dampening the general consumer climate.

4. Youth unemployment

Last year, unemployment among 16- to 24-year-olds in China rose to a record level of almost 20%. At the time, the government decided not to make the worrying labor market data public — and at the same time instructed its statisticians to revise the counting method. When data was published again a few months later, it was, as expected, a few percentage points lower.

Despite this optimistic calculation, youth unemployment has now reached a level of almost 20% again, meaning that one in five young Chinese people is unemployed. This is mainly due to the overall economic development: since many companies are skeptical about the situation, they are holding back on hiring new staff.

The tech sector has been particularly hard hit: the party leadership sees the large Chinese network companies as potential rivals for power, which is why it has deliberately restricted their monopoly position in recent years. In doing so, however, it is weakening a sector that has reliably recruited many young university graduates for the past two decades.

Trade conflict

When demand weakens, manufacturers’ selling prices fall. This deflationary effect is currently driving many Chinese companies into exports: They are pushing cheap goods into foreign markets. In some areas, they are doing excellent business with this: for example, international trade in Chinese electric cars, solar cells, batteries and other high-tech goods has recently boomed.

China’s party leadership likes to refer to these successful tech items as “new productive forces”. The neo-Marxist slogan has recently been appearing incessantly in party pamphlets and cadre speeches. It is a sector that the party is deliberately nurturing.

It reminds some economists of Japan in the 1980s

However, the successful industrial policy is bringing China’s companies into conflict with overseas manufacturers who cannot compete with China’s low prices. This is plunging the People’s Republic into international trade disputes, which have been dominating the headlines time and again recently. Not only are the U.S and the EU sealing themselves off from China’s exports with customs barriers, but protective tariffs have also been introduced in Turkey and Brazil.

If this trend continues, China’s industry is at risk of being left with excess capacity that no one at home will buy because of the weakening domestic demand.

All these factors create a situation that some are already calling the end of the Chinese economic miracle, of “Peak China.” It reminds some economists of the Japan scenario: after the economic boom of the 1980s, China’s island neighbor entered a long period of stagnation, in which it is stuck to this day. Still, at the time of its downturn, Japan had already reached a level of prosperity way greater than the one you see in today’s China.

In the chat message that was the downfall of the missing economist Zhu Hengpeng, he reportedly suggested that those in power are mortal. He may have meant that China would still have a chance of continuing the economic boom if economic policies were to change. It’s a shame that we can’t ask him.