Image Credit: Profit
Introduction
The Chinese Miracle
Over the past four decades, China has introduced a series of market reforms to open trade and investment flows, ultimately lifting hundreds of millions of people out of poverty. The Great Leap Forward was Mao Zedong's attempt to rapidly industrialise China's predominantly agrarian and rural economy, but it failed miserably. Between 1959 and 1961, nearly 10 to 40 million people died. This was the worst famine toll in human history.
Thus, the 1950s saw one of the greatest human crises of the 20th century. This led to the economic crisis that was caused by the Cultural Revolution in the 1960s. Mao Zedong began to eliminate his opponents from the Communist Party but ended up destroying much of the social fabric. But after Mao Zedong's death in 1976, Deng Xiaoping's reforms began to rebuild the economy. Farmers had the right to cultivate their own land which improved livelihoods and reduced food insecurity. When the United States and China resumed diplomatic relations in 1979, the door was opened to foreign investment. Investors put money in to take advantage of lower labour costs and rents. In the 1990s, China began to record rapid growth rates and suddenly joined the World Trade Organization (WTO) in 2001. Trade barriers and tariffs were lowered so as to facilitate overseas trade and soon Chinese manufactured goods flooded the global markets. Check out the figures from the London School of Economics: In 1978, Chinese exports reached $10 billion, less than 1% of world trade. By 1985, China's exports had reached $25 billion, and less than 20 years later, they had reached $4.3 trillion, making China the world's largest exporter of goods. Economic reforms have improved the lives of hundreds of millions of Chinese. According to the World Bank, more than 850 million people have been lifted out of poverty in China. Meanwhile, the education rate has increased. Standard Chartered estimates that about 27% of China's workforce will have a university education by 2030. This is about the same as Germany today.
The Emerging Crisis
The economic data which is coming out of Beijing over the past few quarters indicates that all is not well with the world’s second largest economy, which was expected to rebound and drive global economic growth after three years of restrictions under President Xi-Jinping’s zero-COVID policy. When the strict pandemic curbs were lifted in late 2022, economists expected the Chinese consumers to engage in a spending spree, and the private businesses to pump in resources resulting in a rebound to pre-pandemic growth levels and a ripple effect on the global economy. Notably, the Chinese economy did show initial signs of recovery in the first quarter of 2023 with pent up demand manifesting in local tourism, retail and export growth. However, the economic indicators, by the end of the second quarter of 2023, have been telling a different story. The country suffered its biggest fall in exports in more than three years. China’s exports diminished from a record high of $340 billion in December 2021 to $284 billion in May 2023. The July 2023 export numbers were even more alarming, having plunged by 14.5% compared to the year-ago period. The Custom’s data showed that the exports fell to $281.8 billion as the decline widened from June 2023’s 12.4% fall. Imports too tumbled 12.4% from a year earlier to $201.2 billion in a sign of weak domestic demand, widening from the previous month’s 6.8% contraction. The country’s global trade surplus shrank by 20.4% from a record high a year ago to $80.6 billion. Then came the grim Consumer Price Index (CPI) figures. China slipped into deflation as consumer prices contracted in July 2023 for the first time in more than two years with the CPI falling 0.3% after flatlining in June 2023. Deflation refers to falling prices of goods and services and is caused by a number of factors, including dwindling consumption. While the cheaper goods might appear beneficial for the purchasing power of the consumers, a lack of demand in the market forces the firms to reduce production, freeze hiring, lay off workers, and agree to new discounts to sell off their existing stocks.
Another sign of the slowdown was evident when youth unemployment hit a record high of almost 21% in June 2023, which is almost four times the national urban rate of unemployment. For decades, foreign direct investment has poured into China at steadily rising rates as the investors and companies have looked to ride the wave of its economic boom, but it has fallen off a cliff recently when we look at last year’s FDI into China which fell to just $33 billion which is a 30-year low. Of all the grim economic data that is coming out of China these days, this is especially revealing. Confidence is a key ingredient in any economic success story and right now it looks like it has drained away from China.
The Chinese Real Estate Market Bubble
The unflinching conviction of Chinese domestic buyers that real estate was a can’t-lose speculation impelled the country’s property segment to become the spine of its economy. But over the last two years, as firms have filed bankruptcy and liquidated under the weight of enormous debts and as sales of new homes have plunged, the Chinese buyers have illustrated a similar relentless conviction i.e., Real estate has become a losing speculation. The inconveniences of the country’s real estate sector were laid uncovered when China Evergrande had to wind up operations and liquidate. The firm had accumulated a debt of over $300 billion. The downturn, as of now, is the longest on record, and is not only dragging on but it is accelerating. In December 2023 alone, sales in the real estate market were down 17.1 percent from a year prior. Investment for new ventures slowed as well. Real estate development fell to 9.6 percent in 2023. In 2023, even when China’s economy was anticipated to take advantage of the pent-up buyer demand after the lifting of pandemic confinements, the property market still lingered. Real estate accounts for almost one-quarter of China’s economy. The property sector began to stall after Beijing, stressed about a housing bubble and its impact on the financial system, rolled out a series of laws and regulations in 2020 which pointed at checking the intemperate borrowing of real estate developers. Without easy access to debt, the developers battled to pay off credits and finish building properties that were sold in advance to domestic buyers. Nomura Securities evaluated that there are still 20 million units of pre-sold homes waiting to be finished, which would require $450 billion in financing to complete. Since 2021, more than 50 Chinese property firms have defaulted on debt, including the two firms that once ruled the country’s housing market: Evergrande and Country Garden. Once Evergrande’s fundamental rival for industry leadership, Country Garden effectively defaulted in October 2023. The company’s circumstances have worsened since its sales have collapsed. China’s housing market faces extra weights in coming years from structural variables, in specific, the demographic change. The need for additional new housing will diminish in coming years as the populace decreases and urbanisation slows down. Such demand will likely be more restricted as depressed land sale revenues have tightened the local government’s financial constraints. Confronting these cyclical and structural adjustment pressures, housing speculation is expected to drop further and likely remain subdued. Recently, the IMF projected new real estate investment into the medium term, based on a few scenarios for the evolution of fundamental demand as well as the effect of the overhang of inventories and other supply-side pressures. In these scenarios, the IMF's analysis shows that the real estate investment will likely drop by 30 percent to 60 percent underneath its 2022 level, rebounding very gradually. This would be comparable to major housing downturns in other nations with similarly sizable slowdowns.(1)
Image Credit:International Monetary Fund
Zero-COVID Policy and its Implications
The legacy of zero-COVID will not soon be overlooked. For three years, almost each city was under different forms of lockdown, with as many as 370 million individuals confined in their homes at the policy’s peak. Shanghai, China’s financial hub, was among the cities subjected to the most extreme lockdowns. When it was shuttered for two months in 2022, economists said that national GDP would contract with the economy exhibiting a negative growth rate. Today, the torment is felt more broadly, with remuneration and jobs being cut across the urban economy. Pay rates in regularly high-paying tech and finance occupations have been cut by 40 percent, and even civil-service jobs, which pay less but are considered steadier, are encountering significant pay cuts. Such decreases are particularly difficult in a nation with an already low standard income level. In 2022, urban China’s median per capita disposable pay (after taxes) was $6,224, compared with $55,832 within the United States. Of course, prices are higher within the U.S., but not by a multiple of 8.97. Worsening the situation, the mass layoffs that started within the Chinese tech sector in 2021 have increased over time, with more than 200,000 tech jobs eliminated between July 2021 and March 2022. This figure does not account for the knock-on impacts in closely associated segments such as finance or law, let alone the broader impact on consumption and wealth aggregation, where these jobs have a disproportionately huge impact. China’s much poorer countryside has apparently suffered even more. In 2022, rural per capita disposable wage was an insignificant $2,777. By and large, rural families supplement their agrarian income by working as vagrant labourers in cities, opening their hometowns to visitors from urban regions or overseas, and offering high-value commodities like tea or blooms in urban markets. But amid the zero-COVID period, the countryside was cut off from urban markets and visitors, leaving their occupants to squeeze out a job as subsistence agriculturists. Making things more awful, zero-COVID’s demands on public spending increased local government debt. These economic issues come at a time of intense personal suffering for numerous Chinese citizens.
Falling CPI and Deflation woes
The consumer prices in China have been falling. A lot of economists are concerned that China is slipping into a period of deflation, which is often considered to be an even worse scenario than high inflation. To understand what's happening in China, let's take a look at Japan's recession in the 1990s or what many economists call, ‘Its last decade’. Japan in a way is considered to be ‘the poster child’ for deflation. In the 1990s, a huge sort of bubble in the stock market and real estate market in Japan burst which subsequently slowed down the economy. This led to a fall in the consumer prices over the time and the economy went into a deflationary spiral which proved really hard to escape. The reason behind this is simple: when consumer prices fall, people expect them to keep falling so they're more likely to wait to make that big purchase until sometime in the future when it's cheaper. Lower spending means that companies make less profit, that means they need less workers. So, when unemployment might go up, spending gets even lower and prices fall further which takes the economy into this vicious circle where the prices and spending are sort of chasing each other lower. One example of this phenomenon is the great depression in the US where deflation led to slow economic growth and then a big rise in unemployment. Japan, where working age population growth was turning negative, didn't really struggle with unemployment. There is also a very strong social pressure on firms in Japan not to lay people off in the way that there isn't in the US, other western economies and China itself. Japan's lost decade is also commonly referred to as a ‘balance sheet recession’, a term coined by Economist Richard coup which means, put simply, that everyone had kind of run into a lot of debt, particularly firms in the preceding decade or so, and every penny that these firms made went towards servicing that debt, so companies stopped spending, investing and hiring. The bank of Japan tried repeatedly over the years to stimulate economic growth from cutting interest rates to printing money but nothing quite got the economy back to where it was. It took 34 years for its stock market to record a new high and the country's GDP per capita hovered around $40,000 for a long time. Some economists say it's hard to pin down whether deflation is directly responsible for Japan's slower growth but deflation is more of a problem the longer it lasts and it is definitely a difficult problem to identify until possibly it's too late. This is what economists are afraid is happening right now in China. Deflation in China isn't just a problem for China, it's also a problem for the rest of the world. The weak consumer spending in China means that Chinese exporters have to ship goods overseas to find the optimal price paying buyers and that has led to the price of Chinese exports falling too. These cheaper prices are good for the consumers but they are putting a lot of pressure on the domestic manufacturers around the world.
Xi Jinping and Chinese Communist Party
From 1979 till around 2015, when Xi Jinping was consolidating power, the Chinese Communist Party basically left average Chinese alone to do their business, to save, to invest, but under Xi Jinping, the Chinese Communist Party has become so authoritarian that it has compromised Economic Development. We know that not every problem is resolved merely by liberalisation and just allowing more market forces to work. The Economic system needs some discipline, order and some extent of intervention. But the Chinese Communist Party under Xi Jinping has gone too far and made a challenging situation worse. XI Jinping’s consolidation of power within the Chinese Communist Party has made him even more controlling as the years have gone on, and the more the problems arose the more, he went back to his strategy of control and the pandemic really pushed those control impulses even further. Recently, when billionaire business magnet Jack Ma criticised the Chinese Financial regulation in October 2020 it directly led to the suspension of the IPO of his company “Ant group”, and a huge regulatory Crackdown on various tech companies was followed by this incident. Both people and businesses have become very careful about how they spend their money in China due to doubts over what kind of actions the government may take in the future because the party controls everything. It all feeds into a wider argument that while authoritarian regimes can spur economic growth at an earlier stage of development eventually, they run out of road if control is the primary goal of the leader. The historical record of authoritarian regimes sustaining economic growth is not good whether it's Orban, Erdogan or Putin or Chavez. The authoritarian regime gives an initial boost of growth but over time the temptation for authoritarians to exert their control and pick favourites and demand loyalty outweighs the market.
Image Credit: Financial Times
Shrinking Populace and the Future
China is home to 1.4 billion people which means that about 1 out of every 5 people around the world lives in China. But the country is facing a population crisis. The Chinese population is shrinking for the first time since the Great Famine in 1961. China's population could shrink by 48% between now and the end of the century. China's population decline has really come faster than was expected. To maintain its current population, every woman in China must give birth to two children in her lifetime. But China's fertility rate has dropped well below that threshold. Urban households have even lower fertility rates. Shanghai's fertility rate in 2022 was 0.7, which is even lower than South Korea, the country with the world's lowest fertility rate. In past decades, China has really been dependent on this vast labour force for the economic boom. As this labour force is shrinking, will China still have the same driving force for its economic growth but also for global economic growth? China's working-age population already started to contract around 2015 or 2016. In the next three decades until 2050, the working-age population can further drop by 300 million. In the longer term, China would have fewer people working but supporting more people in retirement which means less demand and subsequently less output, thus the economy entering a vicious cycle. It could leave huge burdens for a lot of elderly people and their offspring who are not taken care of by the social security system. Beijing really needs to not only shift its growth model, but also it needs to rapidly increase spending on pensions and health care. If it fails, it could mean economic stagnation, and it could also mean that China may never eclipse the US as the world's largest economy. China's GDP growth can slow down from 5% at present to like 2% in 30 years. So, those who are relying on China's demand, including the foreign investors, will have to prepare for a slowing Chinese economy. This also means an opportunity for some emerging economies like India, who want to grow rapidly, trying to gain more share in the global economy. These countries, like India, still have quite strong population growth, which can be an important driver for their GDP growth. But for a long time, China wanted to keep its population growth under control. As shortage of resources was putting pressure on the developing country, the government introduced a policy in 1980 that limited families to have just one child. The government implemented the policy through fines. There was a potential loss of job if you were a government employee and did not follow the one-child policy. But also in many cases, forced abortions and sterilisations were also used as tools to implement this policy and curb birth rates. There is a saying in the traditional Chinese culture that explains how people view fertility. The saying goes like, “the most disrespectful thing someone can do to their family is to not have children”. But that doesn't include daughters, because only sons can inherit family names and family wealth. This has led to China's boychild-preference issue. As parents were allowed to have fewer babies, some people resorted to illegal means to determine a baby's gender. This led to more abortions when parents determined their child would be a girl. The most recent census suggests that there are over 32 million more men than women in China. With a lack of female population and decades of stringent birth control, the government has reduced the number of births in the last few decades by 400 million. The parents have to take the country's social security system and benefits into consideration while planning their family. Elementary education rates have gone so high that the cost for sending their kids to kindergarten is as expensive as college tuition. Even if both parents are working, they have to dedicate all of one person's salary to childcare. That's a huge burden on any ordinary family. China's homes have become notoriously expensive. It has almost become impossible for couples to depend on their income to pay for it. They either have to get help from their parents or resort to other sources to get that money. Some local governments have started rewarding parents with a few thousand Chinese Yen for having a baby. But this has made little difference for couples, because having a child is a lifelong commitment.
Conclusion
While we look at the situation arising in China and try to understand it, we might come to this conclusion that the nation has no turning back. But it is not easy to forget just how well the Chinese economy has performed on the whole over the last 40 years it may even be the case that the country has become a victim of unfair expectations because of all that success it has achieved and it is certainly not all bad news when it comes to China's economic potential. The Chinese leadership has talked of maintaining strategic focus which some economists interpret as trying to achieve sustainable growth by reducing the country's huge debt pile whilst also trying to develop technological Supremacy in various Fields. There are strengths in China that have to be recognized. They have cracked the ability to do medium Tech manufacturing and to produce better and cheaper electrical and electronic goods than anyone else in the world without horribly underpaying their workers. The manufacturing workers in China are reasonably well paid in China. We see this in their potential dominance of electric vehicles and related Industries like batteries. There is clearly a fundamental strength i.e., the tech sector. More Than 70 % of Chinese infants that were born last year were born in the rural areas. About two-thirds of those infants will never be able to finish high school looking at the current dropout rates. That is something which has to be considered as the biggest challenge for the Chinese economy: to help these people have better access to education and healthcare so they can become productive citizens. What happens to China's economy has profound implications not just for its 1.4 billion people but for the whole world. Its economic success has powered global growth for decades and its unravelling would be equally consequential. As much as China is dependent on the rest of the world, we are connected to China as well and certainly, if China suffers a significant economic crisis, they'll bear the biggest brunt of those challenges but the rest of the world will feel it in a variety of ways economically. Xi Jinping has spoken of the economic recovery being at a critical point and there is still time for the country's leadership to rebuild trust and crucially confidence. As 2024 is the year of the dragon in China, the symbolism will not be lost on a leader who desperately needs to fire up one of the world's most important economic engines and extinguish doubts about the part he has played in its struggles and destiny.
By: Aditya Goyat
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