China is the world’s second-largest economy, after the United States, and it’s been growing so rapidly for so long that rapid Chinese economic growth has become part of the landscape for an entire generation.
Yet in recent years, people have been warning that the model underlying that rapid growth is unsustainable. And it now looks like the summer of 2015 is the time at which the unsustainable trend finally came to an end.
1) China’s economy is in a lot of trouble
China has been experiencing a stock market crash all summer, but since that crash was preceded by a ridiculous months-long stock market boom it wasn’t initially obvious that this had enormous implications for the real Chinese economy.
More recently, however, it has become clear that there are serious issues in terms of China’s real output of goods. You can see this in a sharp contraction in shipping through Singapore, a general decline in the volume of world trade, and the falling price of the Australian dollar, all of which are ripple effects of China importing fewer raw materials and seemingly exporting fewer finished goods.
Meanwhile, China has been furiously cutting interest rates in an effort to stimulate its economy. So far, however, that hasn’t seemed to have generated much growth. (It’s not yet clear if this monetary stimulus is at least generating inflation, which would have implications for the possible effectiveness of further rate cuts down the road.)
2) Chinese economic data is low-quality
One very serious issue in writing about the Chinese economy is that to understand what’s going on you often need to make inferences based on data out of Singapore, Hong Kong, Australia, or other places that enjoy strong economic links to China. The problem is that China’s authoritarian political system makes it very difficult to regard any of its economic data as reliable.
Back in 2007, Li Keqiang — now the number two figure in the Chinese government — observed that Chinese economic statistics are “man-made” and therefore unreliable. Some progress has been made since then in improving their rigor. But these statistics are not just man-made, they are the product of a closed and opaque political system with no press freedom, so it would be very difficult for abuses and problems with the data to come to light. What’s more, since the Chinese government clearly engages in censorship and information control to maintain its authority, there is no reason to believe it would be forthright about releasing bad economic news.
Even market-based Chinese data like stock prices is unreliable because the government has taken to intervening forcefully to manipulate share prices. You can infer broad trends from the more reliable foreign data, but to have a finer-grained sense of what’s going on you would really need accurate Chinese data, and it simply doesn’t exist.
3) Chinese growth was based on unsustainable levels of investment
For the past five or six years, Chinese economic growth has been powered by a mind-boggling level of investment spending — both public and private sector.
Investments are things that produce an ongoing flow of services in the future. That means everything from new highways and subway tunnels to new apartment blocks and factories. And, to be clear, investment is good! All else being equal, a nation that spends a large share of its income on investment goods is better positioned for long-term growth than a nation that spends a large share of its income on short-lived consumption goods.
But in practice, there’s only so much useful investment than can be made in any given span of time. In a very poor country, there should be tons of opportunities for investments with high payoff. But over time, you expect diminishing returns to set in and the level of investment to fall. In China, however, investment had been accelerating even as the country got richer — a trend that pretty clearly needed to reverse.
4) China needs to switch to “consumption-led” growth
It’s also been clear for some time now that to put itself on a sustainable basis, China needs to shift to a more conventional consumption-based growth model. In other words, it needs a smaller share of its population employed in things like building roads and factories and a larger share of its population employed in things like driving cabs and selling cars.
This is not a particularly controversial idea, in theory. Indeed, it’s been the official policy of the Chinese government for years now. The problem is that the practical implications of actually doing it are tricky.
5) Even if China’s reforms work, growth will slow
In a very short-term sense, you can always swap out a dollar of investment for an extra dollar of consumption. But because useful investments lay the groundwork for future production, this switch has implications for medium-term growth. As economist Tyler Cowen writes, “There is no simple way to switch to a ‘consumption-driven’ economy without the growth rate both falling and staying permanently lower.”
As long as there are useful investments to make, then growth fuels more growth. You build a mine to dig for coal, then you build a power plant to burn the coal, then you build a cement plant to use the electricity, then you build a factory to manufacture more mining equipment, and so forth. Once you start running out of investments, however, this accelerator process is going to collapse, and the sustainable rate of growth will slow dramatically — even if you pull off the switch to consumption.
6) Inequality and a weak welfare state hurt Chinese consumption
China is a nominally socialist society run by a self-proclaimed Communist Party, but it actually features sky-high inequality and a weak welfare state.
Rich people spend a lower share of their income than poor people, and working-age people spend a lower share of their income than retirees. Consequently, a more robust social welfare state that did more to transfer economic resources from the wealthy to the poor and the retired would help bolster consumption and put the Chinese economy on more sustainable footing.
7) A sharp growth slowdown would be historically typical
China’s economic success story over the past 30 years has been incredibly impressive, and due to the country’s vast size it’s been incredibly important. But such success is far from unprecedented. A number of other countries have gone through the basic cycle of very rapid export-led industrialization — often leading internal and external observers to believe that the rapid pace of growth can be sustained indefinitely.
In their paper “Asiaphoria Meets Regression to the Mean,” Lawrence Summers and Lant Pritchett show that this has not been the case for earlier growth miracle countries. It’s not just that growth slows down from its peak blistering pace (which essentially everyone concedes). They find that growth slows all the way down to a global average level, with no persistence whatsoever of past excellent performance.
8) The big question: Will China undergo a slowdown or a recession?
A recession, in conventional terms, is when an economy actually shrinks — something that hasn’t happened for decades in China. But in countries like the United States, the baseline level of “normal” growth is pretty low — 2 or 3 percent per year — so it only takes a relatively modest decline in the growth rate to push you into negative territory.
China is different. Like most countries around the world, it had a bad year in 2009. But in Chinese terms, “a bad year” still meant a growth rate of more than 6 percent followed by a snapback to almost 12 percent. Growth has slowed considerably since then, and by all signs things are much worse in 2015. But one crucial question is whether China is simply going to slow down a lot — to something like 2 or 3 or 4 percent — or whether there’s actually going to be a recession.
9) High levels of debt could make the slowdown worse
One potential problem is that in recent years, Chinese businesses and households have taken on a lot of debt.
Going into debt isn’t always a bad idea. In fact, given the very fast growth rate of the Chinese economy between 1995 and 2015, most Chinese companies probably would have been better off borrowing more money in the 1990s.
But if you borrow money expecting an average 7 percent annual growth rate and only get an average 2 percent annual growth rate, then you could wind up in a world of trouble. Potentially, even, in a spiral of bankruptcies and financial crisis that lead to a recession.
10) Chinese politics hamper an effective response
The combination of rapid 21st-century economic growth in China, political crises in the United States, and China’s authoritarian political system sometimes leads Western commentators to dream hazily about the virtues of Chinese authoritarianism in cutting through the nonsense and letting leaders do what needs to be done.
The reality, however, is that authoritarian political systems still have politics. There are still interest groups, and public officials are still sometimes more loyal to particular interests than to the good of the nation. This is a crucial issue in China’s rebalancing process. It’s easy for an outsider observer to say that inefficient state-owned enterprises should be shut down. It’s harder for a government official who needs to worry about lost jobs. It’s easy for an outsider to say that China needs more income redistribution. It’s harder to defeat the political power of rich Chinese people who would rather the country not do that. It’s easy to say China needs to spend less on construction projects and more on social services. But to do that you need to overcome the entrenched interests of the contractors who benefit from the projects.
China’s leaders give every indication of being broadly aware of the nature of the country’s problems and the kinds of solutions that are needed. What’s less clear is that they can actually deliver these solutions.
11) This summer has shaken faith in China’s leaders
Much of this has been in the air for years. The reason it’s coming to a head now is that the stock market bubble and subsequent collapse have shaken faith in the Chinese government’s ability to form and execute coherent policy.
When the bubble was on its way up, the government tried — and failed — to slow it. Then when it started to pop, the government tried — and, again, failed — to slow the pace of the collapse. China devalued its currency to boost its economy, but didn’t go far enough. It’s cut interest rates repeatedly, only to find that it needs to cut them again. Now the government seems to be arresting people who express negative opinions about the stock market outlet.
This summer’s events have laid bare the reality beneath the incredible successes of the past 20 years. China remains a middle-income country with shaky economic institutions and an opaque and unaccountable political system. Three decades of stellar growth starting from a rock-bottom floor have landed China at a level of per capita prosperity that’s similar to Serbia or Peru or the Dominican Republic — places that nobody regards as obviously amazing investment opportunities even though in some ways their political systems are more solid than China’s.
Loss of faith has a self-fulfilling aspect to it. To the extent that people believe China can conquer its present-day challenges, actually conquering them becomes easier. To the extent that people begin to write China off, then it will have greater difficulties in pulling off the kind of transition the country needs.