The Diplomat author Mercy Kuo regularly engages subject-matter experts, policy practitioners, and strategic thinkers across the globe for their diverse insights into U.S. Asia policy. This conversation with George Magnus – a research associate at China Centre, Oxford University and the School of Oriental and African Studies in London; former chief economist and senior economic advisor at UBS Investment Bank; and author of “Red Flags: why Xi’s China is in Jeopardy” (Yale University Press 2018) – is the 381st in “The Trans-Pacific View Insight Series.”
Identify the underpinnings of China’s economic malaise.
The malaise in China’s economy isn’t just or specifically a case of economic “long COVID,” as some suggest, but is the product of an economic development model that has long required a reboot. The trouble is that the political and institutional changes China needs to do that are not compatible with the CCP’s philosophies and strategy.
People talk a lot about China’s poor demographics, and there’s no question that rapid aging is an important challenge and cumulative drag on China’s economy. The key problem, though, is that China’s high-saving/high-investment and mercantilist growth model is now presenting with an array of systemic and awkward problems that are channeling government’s natural inclinations towards controlling and repressive behavior and anti-growth measures.
China’s local governments and state enterprises are riddled with debt, and many are experiencing acute debt service problems. The real estate sector of course is also, as evidenced by the financial stress in leading private sector firms like Evergrande and Country Garden. As in Japan, China’s real rate and construction sectors face years of shrinkage because of past overbuilding, indebtedness, and poor demographics for household formation. Further, productivity growth has stalled. The labor market structure is changing as low-pay/low-skill jobs in the informal sectors and gig economy have now displaced higher pay and skilled jobs in manufacturing and construction.
China’s trade surplus is soaring because of weak demand for imports but this is hardy endearing it to the rest of the world, and the external environment for China is as bad as anyone can remember. On top of all this, the governance structure under Xi Jinping has undercut the confidence and risk appetite of private firms and entrepreneurs.
Basically, growth in China halved between the 2000s and the 2010s, and is halving again in the 2020s to about 2-3 percent per year. The government could make such growth a positive experience or a bad one, depending on whether or not it is inclined to embrace market, social, and tax reforms and how it chooses to implement them.
Analyze Beijing’s policy efforts to revive China’s economy.
So far, China has been reluctant to implement the kind of measures it has often done in the past, which press on the credit growth accelerator and sanction large scale borrowing for real estate and infrastructure. Nowadays though, there isn’t much credit demand, certainly in the private sector, and the government is rightly wary about over-leverage.
That said, the easing of policy so far has included a relaxation of mortgage and home ownership regulations, measures to ease financial and regulatory pressures on firms, accelerated borrowing permission for local governments, and looser interest rate and liquidity policies. Zhejiang and Jiangsu are among provinces that have eased or abolished urban registration rules to try and encourage the incorporation of migrant workers. The government has also embarked on a campaign to encourage people to think that the government is becoming more pro-private sector and more pro-consumption.
The next weeks and months, including the much awaited Third Plenum of the 20th CCP Central Committee, may present opportunities for the government to put some flesh on the bones of this rhetoric, but few analysts are holding their breath.
Compare and contrast China’s current economic state with that of Japan’s stagnation in the 1990s.
Japan’s 1990s stagnation happened in the aftermath of a real estate and asset bubble that burst, and exposed the extremes to which balance sheet liabilities, mainly among firms, had become excessive. Monetary and fiscal policies were unable to resolve the economic problems, which became hard to address partly because the appetite for reforms was blunted by politics and by the interlocking relationships of the ruling Liberal Democratic Party, the state, banks, and corporations.
Like Japan, China has a mercantilist economic development model featuring high savings and high investment, and repressed consumption. For a few years it has also featured over-investment, misallocation of capital, inefficiency, and a tendency to deflation. Also, like Japan, it has reached a tipping point with a much larger real estate sector at a time when the population aging metrics for first-time buyers and household formation are starting to deteriorate.
The Japan template though, while similar, is not exact. Private sector balance sheets in China are not as stretched, at least yet. China’s real estate is adjusting so far mainly via large falls in transactions volumes, rather than prices, which was the case in Japan. China’s large banks won’t be allowed to fail, and it can sustain financial distress differently because of the greater incidence of controls, the role of the state in the financial sector, and the existence of tight restrictions on the outward movement of capital.
These, though, mean that the manifestations of Japanification will be different, not that China can avoid the same sort of economic outcomes and eventually the need for reforms.
Explain Japan’s resurgence as an alternative investment destination vis-à-vis declining investor confidence in China.
In terms of portfolio investment, Nikkei 225 has risen about 20 percent year to date, while the Shanghai Composite is unchanged, though it has been volatile. It’s a moot point whether China’s equity market tells us much about the economy anyway, but sentiment hasn’t been helped by the deepening problems in the real estate sector, and by the weakening yuan. That said the yen has fallen by 10 percent against the U.S. dollar this year and that hasn’t spooked the Tokyo market. I think investors simply see better value, and importantly transparency and improving governance in Japan, as China has become increasing political and opaque.
Assess the impact of China-U.S. geopolitical tensions on China’s weak economic recovery.
China is a $19 trillion economy now, and the geopolitics of the U.S.-China relationship would have to trigger some very big shocks to knock it off course. It’s possible that, say, export controls, constraints on the supply of advanced semiconductors and other technological know-how, and the early churn of supply chain and FDI recalibration are having some effects, but these are probably glacial and still marginal.
I would say that virtually all of China’s economic difficulties are “made in China.” Geopolitical tensions might, though, be helping to repress China, and strengthen the U.S. as a result of important pieces of legislation in the last year, such as the Anti-Espionage Law in China and the Inflation Reduction Act and CHIPS and Science Act in the U.S.