Has China’s Economic Growth Been Greatly Overstated?

When we look at all of the evidence, we cannot have confidence because there is plenty of evidence in both directions.

Tyler Cowen recently linked to a study of China’s economic growth, which suggests that official figures (roughly eight percent) overstate the real GDP growth rate by about 1.8 percent/year between 2010 and 2016:

Using publicly available data, we provide revised estimates of local and national GDP by re-estimating output of industrial, construction, wholesale and retail firms using data on value-added taxes. We also use several local economic indicators that are less likely to be manipulated by local governments to estimate local and aggregate GDP.

The estimates also suggest that the adjustments by the NBS were insufficient after 2008. Relative to the official numbers, we estimate that GDP growth from 2010-2016 is 1.8 percentage points lower and the investment and savings rate in 2016 is 7 percentage points lower.

Low Error Rate

That might be correct, but I suspect the errors are actually much smaller. Here, it’s useful to start with some data that we can have more confidence in, average yearly nominal wage rates (divide by about 6.5 to get the dollar equivalent):

This matches all sorts of information from a variety of non-governmental sources. When I speak with people who live in China, I get the same impression of very fast rising nominal wages—both for professional jobs and low-skilled jobs like maids. When I read articles in the western media about wages in China, they tell the same story—very fast rising wages leading to many low-skilled firms moving to countries such as Vietnam.

It’s much harder to fake nominal wage data than GDP data because China’s a huge country and local citizens are quite willing to talk about their personal financial situation (unlike during the Maoist era when they would have been terrified to offer truthful information to reporters). To summarize, we can be almost certain that nominal Chinese wages have grown at explosive rates over the past decade, roughly 10 percent per year.

The second piece of evidence is China’s explosive growth in infrastructure, the sort of growth you’d normally see in a fast-growing economy like South Korea during the 1970-2010 period, not a Brazil or Mexico. Again, this is easily observed by visitors.

Explosive Growth

We also see explosive growth in various segments where western firms play a major role, such as auto production. This would be hard to fake. Ditto for China consuming a huge share of the world’s key commodities such as steel, coal, copper, cement, etc.

You might argue that the wage data is nominal and tells us nothing about real wages. That’s true, but we also have very good data on the dollar/yuan exchange rate, which has not changed much since 2009.

And note that the dollar itself is currently quite strong. If we combine the relatively reliable nominal wage data with the extremely reliable exchange rate data, we see that Chinese wages are also rising at very fast rates in US dollar terms. In addition, Chinese wages have grown much faster than wages in other East Asian countries, economies that are also growing fairly fast.

The developing countries in Southeast Asia have recently tended to grow at rates closer to 5%/year, which is roughly the rate that China would have been growing if their official GDP growth rate was overstated by 1.8%/year. But look at Chinese wages compared to those of other Asian economies. Does it seem plausible that China is growing at the same rate as Indonesia?

Is China’s Growth Understated or Overstated?

If China’s growth rate is consistently overstated, then China should be much poorer than what the official figures show. But if we compare China’s official GDP/person data to places such as Thailand and Malaysia, then the wage data makes it seem like China’s growth has been understated.

Then there is casual empiricism. If China’s growth were overstated, then visitors to China would be telling people, “Hmmm, this doesn’t seem like a country with a per capita GDP of $9600.” But if visitors do offer that opinion, it’s usually because China seems much richer than that figure. At one time, one could point to the fact that most Chinese lived in poor villages, but now most live in the cities. At one time one could argue that while the coastal cities were doing well, the interior remained poor. But now interior cities like Chongqing look quite affluent, as evidenced by this excellent NYT story.

But when we look at all of the evidence, we cannot have confidence because there is plenty of evidence in both directions.

I visited Chongqing in 1994, and recall a muddy, drab city full of crumbling grey cement buildings, with lots of poor people carrying heavy loads on their backs.

Again, it’s likely that the Chinese growth numbers are at least somewhat flawed. But when we look at all of the evidence, we cannot have confidence in the claim that Chinese growth has been greatly overstated. There is plenty of evidence in both directions.

PS: In my view, the Chinese boom has been caused by a huge shift of labor into the private sector, where the vast majority of workers are now employed.

PPS: People sometimes cite the fact that a Chinese leader once “admitted” that China’s growth was overstated. That’s not true. He admitted that the provincial growth rates are overstated, a point on which everyone agrees. The national statistical bureau scales back those local estimates before deriving a national growth rate. The issue at hand is whether their downward adjustment is large enough.

Chinese Real Estate Collapse Throws Economy Into Crisis

China’s collapsing real estate market could throw the world’s second largest economy into chaos and worsen a global economic slowdown.

Chinese developers have lost at least $90 billion in the last year, according to reporting from Bloomberg, as home prices have gone down for the last 11 months. Dozens of developers have defaulted on their debts, and many of them have stopped work on unfinished housing, which has sparked mass outrage and even protests as more than 80% of Chinese homebuyers take out mortgages and begin paying them down before their prospective home is completed.

This arrangement, which was once a source of easily accessible capital in a red-hot housing market, has left countless Chinese consumers holding the bag on half-finished homes that may never be fully constructed. Thousands of homebuyers are refusing to pay mortgages on unfinished properties in a mortgage boycott that has spread to nearly 100 cities and has affected over 320 development projects.

“It’s gotten to the point where no one is taking care of it. So we naturally also have to defend our own rights,” one boycotter, who remained anonymous to avoid retribution, told The LA Times. “If we the people are not happy, it’s difficult to have a stable society.” She also told the outlet that some homebuyers who demanded answers have been threatened or detained for their trouble.

Over half of household wealth in China is reportedly tied up in housing, so the reversal of fortunes in real estate could have wide-reaching economic consequences.

“We are seeing it everywhere,” said Michael Pettis, finance professor at Peking University’s Guanghua School of Management. “You get these spreading waves, and the bigger the sector is, the more powerful those waves are. And in China, unfortunately, the property sector is huge.”

Beijing has reportedly signaled that whatever rescue efforts take place are to prioritize protecting homeowners over developers, although much of the response has been left to local governments.

“The aim of the rescue measures is to save the property market and household confidence, but not the developers,” said Gary Ng, senior economist at Natixis SA. “As it is unlikely to see significant policy changes, the golden age of fast revenue growth and high leverage for property developers is probably over.”

Local governments are likely to be somewhat handicapped in their response to the crisis, as their budgets were already strained during the COVID pandemic. Furthermore, 40% of their revenue has come from land sales, which have dried up in the cratering real estate market that is driving this crisis.

Other economic indicators seem quite grim. Chinese youth unemployment has reached nearly 20%, consumer confidence has hit record lows in recent months, and, in a sign that the Chinese government may believe the economy in more dire straits than they’re letting on, the People’s Bank of China (China’s central bank) has lowered interest rates while most of the world is raising them to combat inflation; inflation in China is not as severe as many other major economies, but it is still at a two-year high. Less than a week ago, Chinese state media indicated that the PBOC would prioritize combating inflation for the remainder of 2022.

Interference from Beijing has put further stress on the Chinese economy — crackdowns on private industry to combat “income inequality” and curb “unscrupulous business practices” have reportedly damaged the tech sector and private tutoring companies. China’s aggressive “zero-covid” lockdowns continue to disrupt day-to-day life for millions of its citizens and have created widespread despair and uncertainty. Efforts to increase economic investment via greater liquidity may fall flat when Chinese consumers are increasingly determined to save whatever money they can rather than spend it.

“In this economy, cash is king, having money on hand is most important,” a 32-year-old construction worker, identified only as Gu, told The LA Times.

“China is definitely in a very desperate situation,” said Xingdong Chen, an economist at BNP Paribas. “The problem now is no effective demand. If you don’t allow people to come out and consume … there is no demand.”

A key sign of flagging Chinese demand is the sharp decline in imports, with commodities like iron and copper ore dropping drastically. China is a leading consumer of commodities on the global market, and a drop in demand for industrial materials could have major ramifications in developing countries in Africa and Latin America.

The world economy is already in a fairly precarious state: supply chains for vital resources such as gas, oil, and grain have been disrupted by the ongoing Russian invasion of Ukraine, food shortages and famine are expected in much of the developing world, and by all reasonable definitions, the U.S. is in a recession. The potential fallout from an economic catastrophe in China is difficult to gauge.

The ongoing conflict over the independence of Taiwan, for example, could be affected in myriad ways. On one hand, Xi Jinping, who is widely expected to seek an unprecedented third term as president to become the longest-serving ruler of China since Mao, may ratchet up tensions or even invade Taiwan to gin up nationalist support and distract from domestic woes. Alternatively, a flailing economy might convince him that China is not in a strong enough position to take the island or risk further disrupting its economy by destabilizing a major trading partner.

The Only Five Paths China’s Economy Can Follow

There is increasingly a consensus in Beijing that China’s excessive reliance on surging debt in recent years has made the country’s growth model unsustainable. Aside from the economy’s current path, there are only four other paths China can follow, each with its own requirements and constraints.

The first quarter GDP numbers that China’s National Bureau of Statistics released last week have renewed what was already an aggressive debate about whether or not China would be able to meet the 5.5 percent GDP growth target it set for itself this year. Two weeks ago, for example, for the second time in three months, the International Monetary Fund lowered its GDP growth forecast for the country to 4.4 percent from 4.8 percent in January 2022 and 5.6 percent last October. Given the serious headwinds the economy is facing, many analysts question whether China can achieve even this rate of growth.

But it’s a mistake to view China’s growth in terms of whether it can or cannot achieve a particular GDP target. China’s GDP growth is not a measure of the country’s economic output and performance in the same way the statistic is for other major economies. China’s GDP growth target is an input decided by Beijing at the beginning of the year. Its fulfillment depends on the extent to which the economic authorities are able and willing to use the country’s resources and debt capacity to achieve the required amount of economic activity.

Higher GDP growth for China, in other words, doesn’t mean a better economic outcome than lower GDP growth, as it does for most other economies. It just means that the authorities were more willing to employ resources for creating economic activity, whether or not that activity is productive or sustainable. System inputs cannot indicate anything about the performance of that system. Because GDP growth in China is such an input, it cannot be a measure of how well the economic system performs. Only an output measure can gauge its performance.

That being the case, what matters is not the level of GDP growth China manages to reach in 2022 but rather the way in which that growth, whatever its level, is achieved. Beijing has already long distinguished between “high quality” growth and “other” growth, a distinction that seems to be reflected in an important essay last year by President Xi Jinping in which he calls for more “genuine,” not “inflated,” growth:

I said that we needed to shift the focus to improving the quality and returns of economic growth, to promoting sustained and healthy economic development, and to pursuing genuine rather than inflated GDP growth and achieving high-quality, efficient, and sustainable development.

Broadly speaking, genuine growth can be thought of as sustainable growth generated largely by consumption, exports, and business investment (with the last of these elements aimed mostly at serving the first two), whereas “inflated” growth consists mainly of nonproductive, or insufficiently productive, investment in infrastructure and real estate. The purpose of inflated growth is to bridge the gap between genuine growth and the GDP growth target deemed necessary to achieve the Chinese leadership’s political objectives.

To simplify matters, a better economic outcome for China is not more GDP growth but rather more genuine growth and less inflated growth, whereas a worse outcome is the opposite. In that sense, whether or not China achieves a GDP growth target that exceeds the economy’s underlying genuine growth only reveals how determined Beijing is to achieve that level of economic activity, and how much debt it is willing to allow and how many resources it opts to sacrifice, to achieve a politically acceptable level of economic activity as measured by GDP. This GDP target says little about how healthy the economy is.

The rise in debt itself is not necessarily a problem, but while an accurate measure of the problem of wasted resources in the Chinese economy would be fairly complex, a disproportionate share of Chinese debt goes to fund investment. This means that, in principle, the country’s debt-to-GDP ratio is a reasonable proxy for the amount of inflated growth in China’s GDP numbers. For example, in 2020, when the onset of the coronavirus pandemic caused consumption to collapse, which in turn drove a contraction in genuine growth, more than 100 percent of China’s GDP growth was explained by the consequent surge in investment in infrastructure and property. It is therefore perhaps no surprise that China’s official debt-to-GDP ratio rose that year from about 247 percent to 270 percent.

In 2021, however, there was a major reversal of the previous year’s collapse in consumption, along with a surge in exports, a combination that also caused business investment to rise. At the same time, Beijing came down hard on the property sector and restrained growth in infrastructure investment. The result was that most, if not all, of the growth that year represented genuine growth and, not surprisingly, China’s debt-to-GDP ratio did not rise. This reinforces the idea that the surge in China’s debt burden in the past decade, among the fastest in history, is a result of the economy’s overdependence on nonproductive investment in property and infrastructure to balance out its structurally high savings rate and to bridge the gap between genuine growth and the GDP growth target.

FROM PRODUCTIVE TO NONPRODUCTIVE INVESTMENT

Investment in property and infrastructure doesn’t inherently cause an economy’s debt burden to rise. If the investment is broadly productive—that is to say, if the direct and indirect economic value it creates exceeds the cost of the investment—then any increase in debt will be more than matched in the short term to medium term by an increase in GDP, which is usually a proxy for the value of goods and services produced by the economy. If the created value outweighs the cost of the investment, the country’s debt-to-GDP ratio will not rise.

This was the case in China from roughly the late 1970s until the mid-2000s, when Chinese debt rose sharply, but GDP rose at least as rapidly. The relationship changed between 2006 and 2008, after which there was an observable acceleration in debt and a deceleration, gradual at first, of GDP growth.

While it is possible for productive debt to rise faster than GDP for short periods of time, when the growth benefits associated with the investment are postponed, this is unlikely to be the case when debt surges relative to GDP year after year for many years—as happened for the past fifteen years in China’s case. When that happens, it becomes obvious that the value of resources employed in the investment, for which debt is a proxy, is less than the value of productive capacity generated by the investment, for which GDP is a proxy. This creates a strong case for a claim of systematic malinvestment.

Investment in China can broadly be divided into two categories that mirror the distinction between genuine and inflated growth.

private business investment: investment by entities that operate under hard budget constraints, activity that tends to be productive because nonproductive investment eventually lead to insolvency
investment by entities without hard budget constraints: investment by local governments, state-owned enterprises, and, until recently, the property sector—whereby loss-causing activities can be subsidized or ignored for long periods

It is mainly this latter category that accounts for the surge in China’s debt-to-GDP ratio. To the extent that much of China’s investment in property and infrastructure in recent years cannot be justified economically, in other words, it explains the sharp rise in the country’s debt burden.

It is worth repeating that China’s overdependence on investment by entities that operate under soft budget constraints hasn’t always resulted in a rising debt burden. China began its reform period in the late 1970s after five decades punctuated by the Second Sino-Japanese War, civil war, and Maoism, all of which left the country hugely under invested in infrastructure, logistics, and manufacturing capacity for its level of social development. Until the mid-2000s, while the Chinese economy remained underinvested relative to the capacity of Chinese businesses and workers to absorb investment productively, most investment tended to be productive.

Even with a substantial and rising amount of wasted investment, which showed up in the staggering amount of nonperforming loans in China’s banks that were cleaned up between 2000 and 2010, China’s high investment levels were nonetheless productive in the aggregate and resulted in rapid, sustainable growth. By 2006 to 2008, however, like every other country that has followed a similar high savings, high investment growth model—most notoriously the Soviet Union in the 1950s and 1960s, Brazil during those same decades, Japan in the 1970s and 1980s, and perhaps a dozen other countries—China seemed to have closed the gap between its level of capital stock and the level that its workers and businesses could productively absorb, after which China’s debt burden began to rise rapidly.

CHINA’S FIVE PATHS

The problem with this stage of the development model—and it is worth repeating that this also happened to every other country that followed a similar approach—is that the continued high levels of growth generated by systemic investment misallocation are not sustainable. Once it reaches that stage, such a country must shift to a new growth model, perhaps a much more bottom-up one in which the authorities abandon their previous supply-side orientation in favor of income redistribution and demand-side support.

Until the country begins its difficult adjustment, it can continue to grow rapidly only with the piling on of more nonproductive investment, creating more inflated growth. Because this fictitious growth isn’t sustainable, it must eventually be amortized, and in every previous case the period of adjustment reversed much of the previous growth. Unfortunately, the more fictitious growth that is created, the more politically difficult and economically costly the amortization of this growth tends to be.

Once it is recognized that China’s surging debt burden is a function of nonproductive investment, and that this investment must eventually be curtailed, it turns out that there are a limited number of ways the economy can continue growing. Any economy broadly speaking has only three sources of demand that can drive growth: consumption, investment, and trade surpluses. For that reason, there are basically five paths that China’s economy could take going forward.

China can stay on its current path and keep letting large amounts of nonproductive investment continue driving the country’s debt burden up indefinitely
China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with productive investment in forms like new technology
China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with rising consumption
China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with a growing trade surplus
China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with nothing, in which case growth would necessarily slow sharply

These are the same five paths, by the way, faced by every other country that has followed the high savings, high investment model. Each of these paths creates its own systemic difficulties and each, except for the first, implies substantial changes in economic institutions that, inevitably, must be associated with substantial changes in political institutions. This may be why in the end every previous country followed the last of the five paths.

It is nonetheless worthwhile to examine each of the five paths in turn. Doing so will underscore the constraints that Beijing must accept or overcome in pursuing each path.

PATH 1: CAN CHINA KEEP DOING WHAT IT HAS BEEN DOING?

For China to stay on its current path of high-level growth fueled by nonproductive investment, the country would need to allow a persistent, indefinite increase in its debt burden.

There have been many attempts to argue that rising debt isn’t a problem for China. Some commentators argue, rather foolishly, that debt is only a problem if it involves external debt and is not funded by domestic savings. But surging debt funded by domestic savings rather than foreign savings just means that the country accumulating the debt is running a current account surplus. It should be enough to point out that the surge in U.S. debt in the 1920s and the surge in Japanese debt in the 1970s and 1980s—both countries with persistent current account surpluses, high domestic savings, and no external debt—turned out to be among the two greatest debt-related calamities of the past century.

Others argue that as long as China is monetarily sovereign, there is no limit to the amount of debt it can create and absorb. This is basically the same argument as the one above, couched in slightly different terms, but (as I’ve discussed elsewhere) it is based on a naive misunderstanding of modern monetary theory. An expansion in debt that results in an expansion in demand relative to supply must be resolved by implicit or explicit transfers that, in turn, always undermine economic growth, whether the debt is funded domestically or externally.

More importantly, however, it has become clear that the majority of economic policymakers and economic advisers in Beijing do not believe that a persistent increase in the country’s debt burden is sustainable. They have stated many times that they are determined to get off this particular path and have tried to implement policies seeking to restrict nonproductive investment and the growth in the country’s debt burden, even if none of these attempts have been successful. That is because of how difficult it is, or how unwilling they are, to accept the consequences of any of the four remaining paths.

PATH 2: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH PRODUCTIVE INVESTMENT?

Beijing could bring debt under control while maintaining high growth rates by replacing nonproductive investment with investment in more productive economic sectors. Chinese authorities have been proposing this for many years as the most likely path to follow, but they have been unable to fulfill these promises.

This shouldn’t be a surprise. Every country that has followed this growth model has, in the model’s later stages, proposed the same solution, but there are at least three important reasons this solution is difficult to implement.

The first hurdle is the sheer size of the required transfers relative to the potential size of the would-be recipient sectors of the economy. China currently invests 40 to 45 percent of GDP every year, the highest figure ever recorded by any country, even if this number is down from earlier levels; a little more than roughly 30 percent of this amount has been channeled into infrastructure investment and a little less than 30 percent has been allocated for property investment. In contrast, the Chinese economy’s high-tech sectors, in which so many place their faith, represent less than 10 percent of GDP according to the most generous of definitions. The idea that there are highly productive sectors in the Chinese economy that can easily absorb even a fraction of the investment in nonproductive or low-productivity sectors is pretty far-fetched.

That leads to the second problem. It is not at all obvious that these presumably more-productive sectors are starved for capital. China’s private-equity and venture-capital sectors have grown explosively in the past two decades, and it is widely mentioned by practitioners that raising capital to fund new ideas is far easier than finding profitable new ventures to fund. This is not just an issue in China—Apollo CEO Marc Jeffrey Rowan recently noted, for example, “Our market sometimes loses sight of what’s in short supply; capital as a general matter is plentiful, and it is assets that offer appropriate risk rewards that are in short supply”—but it has been a bigger concern in China than elsewhere. That being the case, diverting large amounts of additional investment into these sectors is likely to replace one kind of nonproductive investment with another.

The third problem, one that crops up in any discussion of how the Chinese economy is to adjust, is probably the most difficult to resolve. An economy that has invested between one- quarter and one-third of its GDP in property and infrastructure for three decades or more, and one that has seen the amount of wealth accounted for by property and infrastructure investment soar, will have developed social, economic, financial, and—most importantly— political institutions that were constructed around this method of investment. Such a tradition of investment misallocation is also likely to result in a household sector for whom home ownership is a disproportionately large share of total household savings—up to 70 percent by some measures.

Such a radical transformation of a country’s investment process cannot help but disrupt these social, economic, financial, and household institutions. It is hard to imagine that such shifts would not also require or result in fairly radical transformations of political institutions in ways that have historically been extremely difficult to absorb and predict. While economists rarely—with few exceptions, like Albert Hirschman or the dependencia theorists of the 1960s and 1970s—discuss these institutional constraints, historically they have always been the most important constraints that have prevented successful adjustments.

None of this means, of course, that it is impossible for China to follow this path, but it does indicate that doing so would be extremely difficult and would inevitably require institutional changes that are hard to predict. At the very least, such a path would require that the authorities in Beijing have a clear understanding of why other countries that followed this growth model found this form of adjustment so difficult to implement.

PATH 3: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH RISING CONSUMPTION?

Beijing could bring debt under control while maintaining high growth rates by replacing nonproductive investment with a rising consumption share of GDP. This is what Beijing has been proposing since at least March 2007, when (during his closing press conference at the Two Sessions parliamentary meetings) then premier Wen Jiabao announced that the rebalancing of domestic demand toward consumption would be a top priority of Beijing’s economic policymakers.

Household consumption composed less than 40 percent of China’s GDP as of 2020, versus a global average in other countries of roughly 60 percent. With other consumption (such as government consumption) adding 10 to 15 percentage points, an amount in line with the figures for other countries, China has by far the lowest consumption share of GDP of any economy in the world.

There’s no mystery as to why the Chinese consumption share of GDP is so low. Chinese households retain a very low share—in the form of salaries and wages, other income, and transfers—of what they produce, so they are unable to consume more than a low share of what they produce. Beijing’s new common prosperity policies focus on redistributing income from the wealthy to the poor and the middle class, but even if the program is successful, this will only help at the margins.

That is why there is also no mystery about how to sustainably raise the consumption share of GDP: Chinese households must retain a larger share of what they produce, which of course also means that some other sector of the economy—either businesses, the government, or foreigners (although this last category is too small to matter)—must retain a reduced share.

With businesses in China retaining roughly the same share of GDP as in other countries, it would be costly for Beijing to force businesses to absorb the extent of the necessary transfer, which leaves only the government sector (mainly meaning local governments). The only way to rebalance consumption in China meaningfully and sustainably, in other words, requires substantial transfers from local government to households.

But this is also why it has been so difficult for Beijing to manage the rebalancing process and why, the consumption share of GDP has only risen a few percentage points, even fifteen years after Wen first promised to rebalance demand. It is inconceivable that a transfer of 10 to 20 percentage points of GDP from local governments to households wouldn’t also imply a huge shift in the relative political power of different sectors of the economy and a major transformation in the country’s relevant social, political, and economic institutions.

Again, none of this means that it is impossible for China to follow this particular path, but recall Hirschman’s insight that the constituencies that have benefited disproportionately from the older model—and have amassed a disproportionate share of political power in the process—are likely to block an adjustment to this model that requires them to absorb a disproportionate share of the adjustment costs. Put differently, it is easy to figure out the arithmetic of the rebalancing adjustment, but it is difficult to absorb the political consequences.

PATH 4: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH A RISING TRADE SURPLUS?

Another way that Beijing could bring debt under control while maintaining high growth rates would be by replacing nonproductive investment with a rising trade surplus. While this option is possible in theory, in practice it isn’t.

China’s trade surplus, at roughly 4 to 5 percent of China’s GDP at the end of last year, was already equal to nearly 1 percent of the GDP of the rest of the world, and by my calculations it would need to increase the surplus every year by at least 3 percentage points of Chinese GDP to replace domestic nonproductive investment. This is a possible strategy for a small economy, but China’s trade surplus is already unacceptably high for such a large economy. The rest of the world would not (and probably could not) accept a system in which China depends for growth mainly on its ability to absorb a larger and larger share of scarce global demand.

PATH 5: WHAT HAPPENS IF CHINA DOES NOTHING TO REPLACE NONPRODUCTIVE INVESTMENT?

Given that investment accounts for 40 to 45 percent of GDP in China, with investment in infrastructure and property accounting for nearly two-thirds of that amount, it is clear that a significant reduction in nonproductive investment—if it is not replaced with another equivalent source of growth—must result in a sharp contraction in China’s GDP growth. My back-of-the-envelope calculation suggests that the upper limit of GDP growth for many years, should that prove to be the case, would likely be 2 to 3 percent.

Unfortunately, historical precedents suggest that such adjustment costs tend to be underestimated. This growth model is highly pro-cyclical, with massive infrastructure spending causing rapid growth, and rapid growth in turn justifying more infrastructure spending. If the adjustment is not carefully managed, an initial slowdown can become—and has become in every previous case—self-reinforcing. That may be because the more the economy slows, the more it undermines the value of previous investment in infrastructure and manufacturing capacity, which only increases the amount of fictitious wealth (bezzle) that must ultimately be written down, a process that in turn depresses growth further.

Historically, there have been two ways (or some combination of ways) in which the adjustment to much slower growth occurs. One way is for this shift to happen rapidly, usually in the form of a financial crisis along with a sharp contraction in GDP. The other way is through lost decades of very low growth. The first way may be more costly in the short run but less costly over the long run, unless it leads to political and social disruption.

Whether the Chinese economy is likely to adjust in the form of a financial crisis or in the form of lost decades of sluggish growth is probably mainly a factor of the stability of the country’s domestic balance sheets and the financial system and the ability of financial authorities to control and restructure systemic liabilities. In my opinion, domestic financial conditions are such that China is still unlikely to have a financial crisis or a sharp economic contraction. It is much more likely, in my opinion, that the country will face a very long, Japan-style period of low growth.

THE OUTLOOK FOR THE REST OF 2022

Beijing is trying to reduce nonproductive investment as rapidly as it can while trying to make progress toward the second, third, and fourth paths outlined above. But for political reasons, Chinese policymakers have never been able to accept the extent of the necessary slowdown, which is why debt continues to surge. As long as increases in fixed asset investment continue to be Beijing’s main lever for maintaining politically acceptable growth rates much above 2 to 3 percent, there is no way to prevent the country’s debt burden from ballooning.

While Chinese economic policymakers and advisers increasingly recognize that China’s existing growth model is reaching its limits, the political importance of the year 2022 for the country’s leadership is likely to mean at least one last year of rapid growth driven by investment excesses, even though the economy has been badly hurt by the March and April 2022 pandemic-related lockdowns of significant parts of the economy.

Once the decision has finally been made, however, to regain control of the country’s balance sheet, eliminate or sharply reduce nonproductive investment, and accept the consequences in terms of slower growth, the question then becomes how much slower growth can Beijing accept? My best guess is that growth must slow to below 2 to 3 percent, but I suspect that even the Chinese policymakers and advisers that most agree with my analysis don’t expect the sustainable growth rate to drop much below 4 percent, in which case they will have trouble accepting the required adjustment and debt will continue to rise for many years even as growth slows sharply.

Whatever Beijing decides, one way or another China will be forced to shift from the first path to one or more of the other four paths listed above, although because of the size of the Chinese economy the fourth path (replacing bad investment with surging current account surpluses) is extremely implausible. But at the same time because the first path isn’t sustainable, this also means that either Chinese policymakers will find some way to overcome the historical difficulties associated with the second and third paths, or they will be forced eventually onto the fifth path. Historical precedents suggest that the longer it takes for Beijing to make this decision, the more economically difficult and politically disruptive the ultimate adjustment is likely to be.

Why Is China’s Growth Rate Falling So Fast?

Although China’s economy remains on track to post strong growth for 2021 as a whole, its recent deceleration is striking. Reversing the slowdown will require policymakers to reform the ways in which they debate, vet, and implement new regulations and pandemic-control measures.

NEW YORK – In early 2021, the consensus forecast for Chinese GDP growth this year among 25 major global banks and other professional forecasters was 8.3%. In contrast, the Chinese government’s own growth target was around 6%, lower than the best guesses of 24 out of the 25 institutional forecasters. Did the government know something that outsiders had missed? Did it plan to do something that it regards as desirable even though it might compromise growth?

More recently, international banks have revised down their full-year growth projections for China as the economy’s expansion has slowed. Third-quarter growth was only 4.9% year on year, down from 18.3% and 7.9% in the first two quarters, respectively. The high first-quarter year-on-year growth came in large part because of the negative growth in the first quarter of 2020 due to pandemic-induced lockdowns. The low third-quarter growth is raising concerns about the growth prospects in the fourth quarter and next year.

Some of the reduction in growth stems from China’s zero-tolerance policy toward COVID-19, which calls for more frequent lockdowns than in most other countries. A spate of local COVID outbreaks in the summer has triggered lockdowns or travel restrictions in multiple Chinese cities. These have not only reduced manufacturing output but also severely affected many service-sector jobs just as tourism was beginning to boom.

But the pandemic is not the only factor behind the slowdown. The government’s green industrial policy, tighter regulation of the property sector, and blacklists of online platforms also have collectively curtailed growth.

Following its pledge to halt the rise in China’s carbon-dioxide emissions before 2030 and achieve net zero by 2060, the government has forcefully and often abruptly reduced electricity generation in coal-fired power plants, sometimes by 20%. The resulting power outages disrupted production at affected factories.

In addition, the “three red lines” policy, initiated in August 2020 and intensified this year, sets ceilings on property developers’ debt-to-asset ratio, debt-to-equity ratio, and debt-to-cash ratio. Because many of these firms could not meet one or more of the red lines, and banks and capital markets are reluctant to provide new financing, they must sell assets, scale down operations, or both.

Evergrande may be the most prominent Chinese property developer to have run into financial trouble, but it is not the only one. Moreover, a real-estate downturn can easily spill over to industries such as steel, cement, and home furnishings and appliances.

Lastly, the authorities’ decisions to blacklist online-education companies, ratchet up antitrust enforcement, and enact a broadly worded data-protection law have helped to halve the stock prices of many listed digital-economy companies over the last 12 months. And falling equity valuations are merely the tip of the iceberg, as many digital firms and their suppliers have had to scale back their ambitions and plans. Hundreds of online-education providers have folded and laid off their employees.

The goals of the policies are sensible, but the manner of implementing them is exacerbating their economic costs. A zero-COVID strategy was arguably reasonable in the pre-vaccine stage of the pandemic, and helped China to achieve a positive economic growth rate last year. But as new variants continue to emerge, all countries will eventually have to learn to live with the coronavirus. Luckily, the cost of doing so is becoming more manageable as rates of vaccination and natural immunity rise.

If China is to use its strong implementation capacity, then pushing for universal COVID-19 vaccination would seem well justified (as individuals who decline the jab may end up harming others). On the other hand, periodic lockdowns and border closures are highly disruptive to the economy and people’s lives, and not a sustainable strategy in the pandemic’s post-vaccine phase.

Regarding green industrial policy, power generation is the most carbon-intensive sector in China, accounting for about 40% of the country’s energy-consumption-based emissions. So, reducing reliance on coal-fired electricity makes a valuable contribution to national and global emissions-reduction efforts. But there are different ways to manage the change.

China’s own experience with economic reforms suggests that using price signals and market forces tends to minimize the costs of structural change. In particular, raising China’s carbon price to a sufficiently high level and announcing a predictable price path with a sufficient lead time could enable electricity producers and users to adjust and adapt better, thus helping them to achieve the same amount of emissions reductions with much less foregone GDP growth. Such an approach would also be less disruptive for Chinese households, including many in the northeastern part of the country who may be worried about heating and power supply as a cold winter arrives.

Likewise, while moderating speculative price increases in real estate is a desirable goal, constraining property development does not necessarily help to achieve it. Given that roughly 30% of the Chinese economy rises or falls with the real estate and construction sectors, an alternative path could cushion the adjustment pains. For example, promoting more affordable housing for low-income families and migrants from rural areas could create offsetting demand for furniture, appliances, steel, and cement.

Restricting after-school learning programs can free up time for children to engage in activities that nurture creativity and athletic ability, and alleviate the financial burden for families that previously felt pressured to purchase online-education content for their children. So, there is a laudable social rationale for the new regulation. Its relatively sudden implementation, however, not only reduces online-education firms’ profits, stock prices, and employment, but also highlights the risk of abrupt policy changes in other sectors, affecting broader investor sentiment.

China can restore investor confidence and return to its potential growth rate. To do that, the country will benefit from reforms affecting how new regulations and pandemic-control measures are debated, vetted, and implemented.

Rethinking China’s Economic Future

China’s economy is clearly contracting sharply under the weight of “zero COVID” policies, even though Q1 GDP growth beat expectations and April data showed only a modest decline in industrial output. Consensus expectations have not fully factored in the degree to which China’s economy is weakening this year, or the probability that slower growth will extend into future years. As the gap between this economic reality and rosier expectations closes in the months ahead, we are likely to see significant downgrades to consensus views on global inflation, commodity demand, future carbon emissions, and both direct and portfolio investments in China.

The Direction of Travel is Clear

The events of the past few months in China’s economy have been difficult to comprehend, even for experienced analysts. The years that are supposed to be politically “stable” in China—the Olympic year of 2008, the political transition of 2012, this year—always carry some turbulence, but 2022 represents a watershed in questioning long-held perceptions of China’s technocratic competence and capacity. We are seeing China’s leadership abandon long-term economic and political objectives for transitory, politically motivated gains against an indefatigable foe—the Omicron variant of COVID-19. More than the futility of the exercise, it is the inflexible commitment to sustaining the attempt, despite its dramatic consequences, that is generating a new wave of concerns about China’s economic future, and its position within the global economy. Financial markets have reacted accordingly, selling Chinese assets in large volumes, while corporates reassess the importance of China within their global strategies.

Today, even Premier Li Keqiang was forced to observe that economic “difficulties in some aspects and to a certain extent are greater” than in the epidemic’s first phase in 2020, while urging cadres to keep economic growth in positive territory in Q2. The recent data releases—both official and unofficial—unequivocally point to a contracting economy, possibly by larger margins than in Q1 2020, when GDP contracted by 10.3% q/q within the official data. Goldman Sachs just revised their own expectations of Q2 q/q growth to -7.5% annualized; UBS and JP Morgan made similar adjustments on Tuesday. It goes without saying that China’s 5.5% real GDP growth target this year is impossible to meet—in fact, we doubt we will hear Chinese officials mention the target for the remainder of the year. Our views on China’s growth rate in 2022 are clear—we are headed for very low growth this year, at the most 2% if there is a dramatic rebound in the second half, and a recession or economic contraction for the full year is becoming increasingly probable.

Freight and passenger traffic volumes nationwide have fallen by around 39 percent y/y in China in May as a result of lockdowns and COVID restrictions, based on Gaode data. Official industrial value-added fell by 2.9% in April, and will likely decline by similar margins in May. Property sales officially fell by 39% y/y in April, car sales declined by 47.6%, and excavator sales fell by 61%. Consumption is falling sharply as a result of COVID restrictions, with headline retail sales down 11.1% in April and even online sales from Alibaba’s Taobao and Tmall (undoubtedly hurt by delivery problems) are down 25.6% y/y. These are not small declines—they reflect a massive disruption to the regular operations of China’s economy, and they have continued in May from the declines in April.

Nor is there much evidence that policy support is starting to right the ship. China’s policy support has emphasized infrastructure construction, but this activity is being limited by lockdowns and restrictions just like other sectors. The evidence can be seen in continued drops in production for raw inputs: asphalt output has declined 33.6% so far this year, cement production fell by 18.9% in April, and capacity utilization rates for unsaturated polyester resin (UPR), a key polymer in building materials, are down 42% in April and 65% so far in May.

Yet despite this economic carnage, forecasts of China’s growth in 2022, and beyond, have barely adjusted. After the release of Q1 GDP data, which put growth at 4.8% (well above the consensus view of 4.4%), analysts counterintuitively rushed to downgrade their full-year forecasts. The current Bloomberg consensus forecast (Figure 1), even after the release of the April data pointing to an economic contraction and some of the recent downgrades already discussed, is for a 0.2% q/q growth rate in Q2, still in positive territory, and for 4.7% GDP growth for the full year. The forecast for y/y growth in Q2 is 3.3%, only a moderate slowdown from 4.8% growth in Q1.

There are some reasonable arguments why growth might only slow modestly, particularly if China abandons its COVID restrictions altogether and provides significant cuts in interest rates and stimulus to the property sector. But this path seems highly unlikely. Restrictions are more likely to lift gradually and in response to local government subterfuge rather than central government diktat. The property sector is going to remain a significant drag on investment growth this year, and recent zero COVID measures have added to the sector’s woes. It is difficult to understand what sector will actually grow at all this year, given the dramatic disruptions that zero COVID policies have created for the economy.

The direction of travel is clear, even if the magnitude of adjustment is not. Companies, investors, and governments should be thinking about far slower Chinese economic growth, both in 2022 and in the future. Consensus expectations have not yet adjusted meaningfully—in part because of China’s excessively rosy economic data—but they will.

Telling the Truth is Dangerous

We described all of the pressures created by Beijing’s political reliance upon high and stable GDP growth rates in our 2019 note, “China’s GDP: The Costs of Omerta”. The code of silence among most sell-side institutions and global policymakers regarding the quality of China’s GDP data has consistently created false assumptions about China’s growth and the potential for policy mistakes in response to mistaken economic signals. The costs of refusing to engage with economic reality are rising because even onshore market analysts are reluctant to publish any bad news or negative forecasts. The key point is that consensus expectations as we are now seeing them—0.2% q/q growth in Q2, 4.7% full-year growth (according to Bloomberg’s survey)—are still wildly unrealistic, a fact that is acknowledged but unstated publicly by most forecasters. And when those expectations adjust, the scale of the downgrades to China’s expected growth could be large.

The reality of China’s economic distress has been clearly revealed in onshore and offshore equity markets, which have fallen to the lowest levels since the start of the pandemic. Naturally, this has generated considerable risk aversion within China’s financial markets. But actually talking about the woes of the equity market and the state of the economy has caused several mainland investors and commentators to seemingly have their social media access restricted in response, and some may have actually lost their jobs. In this climate, we should not expect significant downgrades of growth expectations from any analyst servicing mainland clients.

Even sell-side firms have been cautious. There is always pressure to remain within consensus, and an awareness that consensus on Chinese growth will remain heavily dependent upon Beijing’s official GDP growth target, unrealistic as it may be. Hence, even those that are downgrading Q2 GDP growth aggressively are seemingly cautious about how that will implicate full-year 2022 GDP growth rates, which may explain the more limited adjustments to full-year forecasts. If one assumes Beijing will continue to publish stable growth rates regardless of how the real economy performs, it makes little sense to go out on a limb with a sharp downgrade of GDP growth forecasts.

The Long-Term Constraints on China’s Growth

More problematic for Beijing is the fact that even after lockdowns ease, the economy is unlikely to spring back to the rates of growth seen before the pandemic. Lockdowns and restrictions on movement of citizens generate immediate economic costs—to production, consumption, services sector activity, employment, incomes, and in other areas as well. But even before the wave of new lockdowns was imposed, China’s economy was suffering considerably from the weakening property industry, a sector that represents around 25% of GDP.

Every cyclical recovery in China’s recent history has been led by either the property sector or local government spending. Beijing is trying to prop up infrastructure investment right now, but these efforts are useless as long as lockdowns and restrictions remain in place, preventing construction projects from launching. Credit growth to drive new investment is slowing, rather than accelerating, driving the PBOC this week to issue yet another set of instructions for banks to boost lending. And even if infrastructure investment picks up, this will only put a floor under activity, as it cannot compensate for the weakness in the property sector.

Over a longer horizon, China’s growth outlook is constrained by demographics, falling productivity, and more significantly, the failed structural reforms of the past decade. Our China Practice head Dan Rosen highlighted these dynamics in much more detail in a recent piece in Foreign Affairs. China’s potential growth rate at present is probably closer to 3% than 5%, and China is currently growing well below that potential rate. With the property market and the financial system in distress, it may take several years to close that output gap, even if policy is more supportive. Yet the current consensus expectations for GDP growth are 5.2% in 2023 and 5.1% in 2024.

There is a reasonable argument that economic conditions will improve due to a boom in pent-up demand in the months ahead, with April and May representing the worst months of lockdown-induced stress. High-frequency indicators of passenger and freight traffic are showing some modest improvements in late May, and the mere fact of passing the worst moment may even be sufficient to drive a rally in China-linked risk assets. But the uncertainty about the future, and the potential for additional lockdowns, are likely to keep a ceiling on any rebound in new investment by foreign firms or Chinese private sector firms. These types of disruptions to supply chains will take months to resolve, and the longer-term impact of lockdowns on employment, incomes, and consumption is likely to persist as well.

The Stakes: Implications of Downgrading China’s Economic Future

Once consensus expectations for China’s medium-term growth adjust meaningfully, this will have significant implications for several important global economic trends.

Commodity demand. One of the obvious transmission channels from slower growth in China into the global economy will be weaker demand—and probably lower long-term prices—for imported commodities, particularly those associated with construction activity, including iron ore, copper, aluminum and other base metals, and some refined petroleum products. The direct impact on China’s crude oil demand will probably only emerge over time, tied to overall trends in China’s energy consumption, since China also re-exports significant volumes of its refined product output. There can be some offsets to weaker demand and changes in development plans for individual commodities, and in some cases, lower commodity prices can actually incentivize lower-cost imports relative to higher-cost domestic production in China. But the probable implication of much slower growth will be a downgrade of China’s commodity imports in the coming years.

Global inflationary pressures. In the short-term, disruptions to China’s supply chains and outbound shipments are inflationary, as scarcities of key components will dominate. After that, in around six to nine months, rising corporate inventories of finished goods may create downward pressure on prices. As companies struggle to sell into flagging domestic markets, they may look to sell overseas, at lower prices (factoring in the recent weakness of China’s currency).

These lower Chinese import prices may not have much of a direct impact on global inflation in the short term, particularly given all of the other inflationary forces and geopolitical factors driving prices higher. But the reassessment of China’s growth and downgrades from this year’s expectations of 4.7% have probably not yet been incorporated into global inflation and growth forecasts. If central banks underestimate the disinflationary pressures coming from a slower-growing China, expectations of the monetary tightening and interest rate hikes that are necessary should moderate.

Similar surprises have happened before. In 2014 and 2015, when China’s economy disappointed due to a flagging property sector while headline GDP growth remained stable at rates above 7%, emerging market central banks suddenly became far more dovish than expected. This was because the Chinese economy produced disinflationary surprises that spilled over into other markets even though headline growth in China was unchanged. The effect was pronounced in commodity prices (Bank Indonesia’s turnabout from hiking rates in November 2014 to cutting them in February 2015 is just one example). As expectations of China’s growth adjust, the same effect is plausible on a global scale, and central banks may look toward less severe tightening paths relative to current expectations.

Carbon emissions. Hundreds of billions of dollars are being invested now for a future of low-carbon energy production, requiring planning for mining of critical metals and raw materials. But all of these investments are likely based on current expectations of China’s own growth in energy demand and carbon emissions, which may simply fail to materialize. A change in the economic trajectory of the world’s largest emitter—at an estimated 14.1 billion tons CO2 equivalent in 2019—is bound to have an impact on global emissions projections. China’s industrial output has been heavily leveraged to property construction, and that sector alone is likely to see construction activity cut in half or more over the next decade.

But China’s own growth targets are set politically, and are likely to be disconnected from actual emissions levels on the ground. This can lead to significant policy mistakes around China’s energy mix as well, as the most important signals to China’s energy bureaucracy this year have been to avoid power disruptions such as those seen in September and October 2021. This has required China to double down on coal output, even though there are likely to be far smaller chances of a power shortage during a year in which China’s economy is slowing so significantly. But overall, slower Chinese GDP growth in the years ahead is almost certain to alter the medium-term trajectory of global carbon emissions as well.

Portfolio investments. Global investment portfolios have been dramatically underweight Chinese equities and bonds for years—and for good reason, because China’s financial markets had not undertaken sufficient reforms to provide confidence that investors could generate returns and reallocate funds out of China when they chose to do so. During the pandemic, portfolio investments into Chinese markets increased dramatically (Figure 3), as China appeared more stable than the rest of the world, investor-friendly reforms continued to advance incrementally, Chinese yields rose far higher than those in developed markets, and more global equity and bond indices started to include Chinese securities, providing investors more confidence in inbound portfolio investments.

The future of China’s position within the global financial system is now far less certain than at any point in the last two decades. Capital outflows have been building throughout the past four months, not only because of weaker Chinese growth, but because of newfound political risks attached to investments in Chinese securities, including China’s political alignment with Russia and Beijing’s zero-COVID crusade. Damage to China’s policy credibility is not easily repaired, and can severely weaken long-term portfolio inflows, along with the prospects of China playing a more important role within the global financial system.

Every time China has faced similar challenges maintaining investors’ attention, there have been concerted efforts from technocrats to reach out to the financial sector and signal some restart of reforms and opening—the 2020 liberalizations on foreign equity restrictions in key financial market segments are just one example. A renewed emphasis on stability in market regulations and relaxations of capital controls may help to stabilize medium-term passive bond market inflows in the coming years, as Chinese yields are likely to decline in the medium-term if growth slows.

Foreign direct investment. US foreign investment in China has averaged about $13 billion over the past decade, while investment from the EU-27 and United Kingdom has averaged roughly $9 billion over the period. Much of this investment was predicated on expectations of long-term growth in Chinese domestic demand. This is now in question. An April survey by the European Chamber of Commerce in China found that 23% of surveyed European companies, the highest share in the past decade, are considering shifting current or planned investments in China to other markets. A significant downgrade of China’s growth expectations could accelerate the debate over diversifying supply chains, particularly as the risk premium in China grows.

There are other consequences to slower Chinese growth which merit discussion. What is clear, however, is that expectations for a 4.7% expansion of China’s economy this year are untenable, and will need to be adjusted soon given the disruptions to the economy caused by the property market downturn and zero COVID policies. The direction of the adjustment is clear—the only questions are how much growth needs to be downgraded and how long the weakness will persist. If the credibility of Chinese data and policy responses suffers in this process, the rerating of growth prospects will become deeper. Beijing will struggle to maintain its narrative of economic stability as these unprecedented pressures grow.

Resources

dailywire.com, “Chinese Real Estate Collapse Throws Economy Into Crisis.” By Michael Whittaker; fee.org, “Has China’s Economic Growth Been Greatly Overstated? When we look at all of the evidence, we cannot have confidence because there is plenty of evidence in both directions.” By Scott Summer; carnegieendowment.org, “The Only Five Paths China’s Economy Can Follow.” By MICHAEL PETTIS; project-syndicate.org, “Why Is China’s Growth Rate Falling So Fast?” By Shang-Jin Wei; rhg.com, “Rethinking China’s Economic Future.” By Logan Wright; thebalance.com, “China’s Economic Growth, Its Causes, Pros, Cons, and Future: It’s Good That China’s Growth Is Slowing. Really.” BY KIMBERLY AMADEO; techtarget.com, ” Globalization Defined.” By Ben Lutkevich;

Addendum

China’s Economic Growth, Its Causes, Pros, Cons, and Future

It’s Good That China’s Growth Is Slowing. Really.

China’s economy has enjoyed 30 years of explosive growth, making it the world’s largest.¹ Its success was based on a mixed economy that incorporated limited capitalism within a command economy. The Chinese government’s spending has been a significant driver of its growth.

China’s economy is measured by its gross domestic product. In 2020, China’s economy shrunk by $4.2 trillion to $125.65 trillion.

Here is China’s growth rate by year, showing how it has slowed since the 10.6% growth in 2010:

2010 10.6%
2011 9.6%
2012 7.9%
2013 7.8%
2014 7.4%
2015 7.0%
2016 6.8%
2017 6.9%
2018 6.8%
2019 6.0%
2020 2.3%

Causes

China fueled its former spectacular growth with massive government spending. The government owns strategically important companies that dominate their industries. It controls the big three energy companies: PetroChina, Sinopec, and the China National Offshore Oil Corporation (CNOOC). Government ownership allowed China to direct the companies to high-priority projects.

China requires several things of foreign companies who want to do business in China or work with Chinese companies. One is that they often must share their technology. Chinese companies use this knowledge to make the products themselves.

The People’s Bank of China, the nation’s central bank, tightly controls the yuan to dollar value. It does this to manage the prices of exports to the United States. It wants them to be a little cheaper than those produced in America. It can achieve this because China’s cost of living is lower than the developed world. By managing its exchange rate, China can take advantage of this disparity.

Advantages

China’s growth has reduced poverty. Only 3.3% of the population lives below the poverty line. China contains about 20% of the world’s population. As its people get richer, they will consume more. Companies will try to sell to this market, the largest in the world, and tailor their products to Chinese tastes.

Growth is making China a world economic leader. China is now the world’s biggest producer of aluminum and steel.

Chinese tech companies quickly became market leaders. Huawei is the world’s top telecommunications equipment maker. It is quickly becoming a world leader in developing 5G technology. Lenovo is a world-class maker of personal computers. Xiaomi is one of China’s top smartphone brands.

Disadvantages

Government spending created a total debt-to-GDP ratio of 317% as of the first quarter of 2020, the highest on record. This includes debt held by the government, corporations, and consumers. Since the state owns many corporations, it must be included. The consumer debt may have also created an asset bubble. Urban housing prices have skyrocketed as low-interest rates fueled speculation. High growth levels have come at the cost of consumer safety. The public has protested pollution, food safety, and inflation.

It also created a class of ultra-rich professionals who want more individual liberties. They live in urban areas, since that’s where most of the jobs are. In 2017, almost 60% of the population lived in urban areas. In the 1980s, it was just 20%.

Local governments are charged with providing social services but are constrained in the taxes they can collect to fund them. As a result, families are forced to save. China doesn’t offer benefits to people who’ve moved from the farms to the cities to work. Interest rates have been low, so families don’t receive much return on their savings. As a result, they don’t spend much. That keeps domestic demand low and slows growth.

Future Growth

Chinese leaders have taken steps to boost domestic demand from its 1.4 billion population, the world’s largest. A strong consumer market allows China to rely less on exports and it is diversifying into a more market-based economy. This means relying less on state-owned and more on privately-owned companies to reap the rewards of a competitive environment.

To boost growth, China needs more innovative companies. These only come from entrepreneurship. State-owned companies make up 25% to 30% of total industrial output, down from 78% in 1978. But China must do even better.

China’s leaders realize they must reform the economy. To that end, President Xi Jinping authorized the “Made in China 2025” plan. It recommends advances in technology, specifically big data, aircraft engines, and clean cars. China has become a world leader in solar technology. It is cutting back on exports, including steel and coal production.

The worst risk is the ticking time bomb within the nation’s financial system. Banks are state-funded and owned. This means the government sets interest rates and approves loans. They pay low-interest rates on deposits so they can lend cheaply to state-owned businesses. As a result, banks have channeled government funds into an unknown number of projects that may not be profitable.

China’s leaders now walk a fine line. They must reform to remove asset bubbles. On the other hand, as growth slows, the standard of living may fall. This could cause another revolution. People have only been willing to turn over personal power to the state in return for rapid increases in personal wealth.

One way to boost wealth is by encouraging investment in China’s stock market. That allows companies to rely less on debt, and more on selling stocks, to fund growth. It also helps the tech companies that are listed on the Shenzhen exchanges. China recently installed the Connect program between the mainland exchanges and the Hong Kong stock market.

The Bottom Line

Massive government spending has stoked China’s unprecedented growth over the last 30 years. Government control over major companies and the yuan’s exchange rate have generated large improvements in the Chinese economy. Its regulations on foreign businesses have helped as well.

China’s present debt-to GDP ratio is one of the highest in the world. Its domestic consumer demand is low. So, the nation relies heavily on exports. These factors are now considerably slowing growth.

China’s government is facing the necessity of instituting delicate economic reforms. Such reforms include encouraging investments in China’s stock market, aggressively promoting the Made in China 2025 program, and developing innovative companies, among others. They want to prevent the possibility of another people’s revolution should a pervasive economic downshift occur.

Frequently Asked Questions (FAQs)

How does the U.S. economy depend on China?

China’s economy has become intertwined with the U.S. economy in several ways. For example, China is the top source of U.S. imports, and it’s the second-largest holder of U.S. Treasury debt.

What type of economy does China have?

China has a mixed economy that combines elements of market and command economies. It has more of a command economy than the U.S., but its system does incorporate aspects of a market economy.

Globalization Defined

What is globalization?

Globalization is the process by which ideas, knowledge, information, goods and services spread around the world. In business, the term is used in an economic context to describe integrated economies marked by free trade, the free flow of capital among countries and easy access to foreign resources, including labor markets, to maximize returns and benefit for the common good.

Globalization, or globalisation as it is known in some parts of the world, is driven by the convergence of cultural and economic systems. This convergence promotes — and in some cases necessitates — increased interaction, integration and interdependence among nations. The more countries and regions of the world become intertwined politically, culturally and economically, the more globalized the world becomes.

How globalization works

In a globalized economy, countries specialize in the products and services they have a competitive advantage in. This generally means what they can produce and provide most efficiently, with the least amount of resources, at a lower cost than competing nations. If all countries are specializing in what they do best, production should be more efficient worldwide, prices should be lower, economic growth widespread and all countries should benefit — in theory.

Policies that promote free trade, open borders and international cooperation all drive economic globalization. They enable businesses to access lower priced raw materials and parts, take advantage of lower cost labor markets and access larger and growing markets around the world in which to sell their goods and services.

Money, products, materials, information and people flow more swiftly across national boundaries today than ever. Advances in technology have enabled and accelerated this flow and the resulting international interactions and dependencies. These technological advances have been especially pronounced in transportation and telecommunications.

Among the recent technological changes that have played a role in globalization are the following:

Internet and internet communication. The internet has increased the sharing and flow of information and knowledge, access to ideas and exchange of culture among people of different countries. It has contributed to closing the digital divide between more and less advanced countries.

Communication technology. The introduction of 4G and 5G technologies has dramatically increased the speed and responsiveness of mobile and wireless networks.

globalization

Ben Lutkevich, Technical Writer

What is globalization?

How globalization works

I recommend reading this next:
A deep dive into the differences between 4G and 5G networks
Nick Martin, Senior Director of Content Strategy and Member Engagement

Among the recent technological changes that have played a role in globalization are the following:

Communication technology. The introduction of 4G and 5G technologies has dramatically increased the speed and responsiveness of mobile and wireless networks.

list of benefits of 5G network technology — Increased speed and bandwidth are among the benefits of 5G technology.

IoT and AI. These technologies are enabling the tracking of assets in transit and as they move across borders, making cross-border product management more efficient.

Blockchain. This technology is enabling the development of decentralized databases and storage that support the tracking of materials in the supply chain. Blockchain facilitates the secure access to data required in industries such as healthcare and banking. For example, blockchain provides a transparent ledger that centrally records and vets transactions in a way that prevents corruption and breaches.

Transportation. Advances in air and fast rail technology have facilitated the movement of people and products. And changes in shipping logistics technology moves raw materials, parts and finished products around the globe more efficiently.

Manufacturing. Advances such as automation and 3D printing have reduced geographic constraints in the manufacturing industry. 3D printing enables digital designs to be sent anywhere and physically printed, making distributed, smaller-scale production near the point of consumption easier. Automation speeds up processes and supply chains, giving workforces more flexibility and improving output.

Why is globalization important?

Globalization changes the way nations, businesses and people interact. Specifically, it changes the nature of economic activity among nations, expanding trade, opening global supply chains and providing access to natural resources and labor markets.

Changing the way trade and financial exchange and interaction occurs among nations also promotes the cultural exchange of ideas. It removes the barriers set by geographic constraints, political boundaries and political economies.

For example, globalization enables businesses in one nation to access another nation’s resources. More open access changes the way products are developed, supply chains are managed and organizations communicate. Businesses find cheaper raw materials and parts, less expensive or more skilled labor and more efficient ways to develop products.

With fewer restrictions on trade, globalization creates opportunities to expand. Increased trade promotes international competition. This, in turn, spurs innovation and, in some cases, the exchange of ideas and knowhow. In addition, people coming from other nations to do business and work bring with them their own cultures, which influence and mix with other cultures.

The many types of exchange that globalization facilitates can have positive and negative effects. For instance, the exchange of people and goods across borders can bring fresh ideas and help business. However, this movement can also heighten the spread of disease and promote ideas that might destabilize political economies.

History of globalization

Although many people consider globalization a twentieth century phenomenon, the process has been happening for millennia. Examples include the following:

The Roman Empire. Going back to 600 B.C., the Roman Empire spread its economic and governing systems through significant portions of the ancient world for centuries.
Silk Road trade. These trade routes, which date from 130 B.C. to 1453 A.D., represented another wave of globalization. They brought merchants, goods and travelers from China through Central Asia and the Middle East to Europe.
Pre-World War I. European countries made significant investments overseas in the decades before World War I. The period from 1870 to 1914 is called the golden age of globalization.
Post-World War II. The United States led the effort to create a global economic system with a set of broadly accepted international rules. Multinational institutions were established such as the United Nations (UN), International Monetary Fund, World Bank and World Trade Organization to promote international cooperation and free trade.

The term globalization as it’s used today came to prominence in the 1980s, reflecting several technological advancements that increased international interactions. IBM’s introduction of the personal computer in 1981 and the subsequent evolution of the modern internet are two examples of technology that helped drive international communication, commerce and globalization.

Globalization has ebbed and flowed throughout history, with periods of expansion and retrenchment. The 21st century has witnessed both. Global stock markets plummeted after the Sept. 11, 2001, terrorist attacks in the United States, but rebounded in subsequent years.

More recently, nationalist political movements have slowed immigration, closed borders and increased trade protectionism. The pandemic has had similar effects on borders and immigration and also disrupted supply chains. However, overall, the early 21st century has seen a dramatic increase in the pace of global integration. Rapid advances in technology and telecommunications are responsible for much of this change.

What is the G20?

The G20, or Group of Twenty, is an international forum that aims to foster international cooperation by addressing global economic issues, such as financial stability and climate change. The G20 is made up of 19 countries and the European Union, including most of the world’s largest economies.

The nations involved account for 60% of the planet’s population, 75% of global trade and 80% of world GDP. It was founded in 1999, following the 1997 financial crisis, and has met every year since then.

Since 2008, the G20 has held an annual summit that brings together heads of state to discuss important economic issues. The G20’s president is selected annually on a rotating basis, and that person’s home country hosts the summit.

In 2019, the summit was held in Osaka, Japan, and it addressed issues such as women’s empowerment, climate change and artificial intelligence. The 2020 summit was to be in Riyadh, Saudi Arabia, but was held virtually because of the pandemic. Three of the main themes addressed were empowering people, especially women and youth; safeguarding the planet; and long-term strategies to share the benefits of innovation and technological advancement. The 2021 summit will be held in Rome, Italy, and will focus on recovery from the pandemic and climate change.

The members of G20 are Argentina, Australia, Brazil, Canada, China, France, Germany, Japan, India, Indonesia, Italy, Mexico, Russia, South Africa, Saudi Arabia, South Korea, Turkey, the United Kingdom, the United States and the European Union. Spain is a permanent guest of the organization.

Types of globalization: Economic, political, cultural

There are three types of globalization.

Economic globalization. Here, the focus is on the integration of international financial markets and the coordination of financial exchange. Free trade agreements, such the North American Free Trade Agreement and the Trans-Pacific Partnership are examples of economic globalization. Multinational corporations, which operate in two or more countries, play a large role in economic globalization.
Political globalization. This type covers the national policies that bring countries together politically, economically and culturally. Organizations such as NATO and the UN are part of the political globalization effort.
Cultural globalization. This aspect of globalization focuses in a large part on the technological and societal factors that are causing cultures to converge. These include increased ease of communication, the pervasiveness of social media and access to faster and better transportation.

These three types influence one another. For example, liberalized national trade policies drive economic globalization. Political policies also affect cultural globalization, enabling people to communicate and move around the globe more freely. Economic globalization also affects cultural globalization through the import of goods and services that expose people to other cultures.

Effects of globalization

The effects of globalization can be felt locally and globally, touching the lives of individuals as well as the broader society in the following ways:

Individuals. Here, a variety of international influences affect ordinary people. Globalization affects their access to goods, the prices they pay and their ability to travel to or even move to other countries.
Communities. This level encompasses the impact of globalization on local or regional organizations, businesses and economies. It affects who lives in communities, where they work, who they work for, their ability to move out of their community and into one in another country, among other things. Globalization also changes the way local cultures develop within communities.
Institutions. Multinational corporations, national governments and other organizations such as colleges and universities are all affected by their country’s approach to and acceptance of globalization. Globalization affects the ability of companies to grow and expand, a university’s ability to diversify and grow its student body and a government’s ability to pursue specific economic policies.

While the effects of globalization can be observed, analyzing the net impact is more complex. Proponents often see specific results as positive and critics of globalization view the same results as negative. A relationship that benefits one entity may damage another, and whether globalization benefits the world at large remains a point of contention.

Comparison of internationalization and localization product strategies — Internationalization and localization are both product strategies used in globalizing industries.

Examples of globalization

Multinational corporations are a tangible example of globalization. Some examples include the following:

McDonald’s had 39,198 fast-food restaurants in 119 countries and territories, according to its Securities and Exchange Commission filing at the end of 2020. It employed more than 2.2 million people at that time, the filing said.
Ford Motor Company reported in 2021 that it works with about 1,200 tier 1 suppliers around the globe.
Amazon’s recent expansion has it using tens of thousands of suppliers and employing more than nearly 1.3 million full- and part-time employees.

Through their influence on social and economic development in the countries that host them, multinational corporations embody the contradictions of globalization. They bring jobs, skills and wealth to the region they are investing or doing business in. But they also can destroy local businesses, exploit cheap labor and threaten indigenous cultures. The benefits they offer are often unsustainable because the loyalty of multinationals is to their investors and bottom lines and not to the local people, economies and cultures where they are doing business.

Another example of globalization is the response to the COVID-19 pandemic. Because the world was able to communicate across boundaries, nations were able to work together to quickly produce vaccines for the virus. In addition, doctors traveled where they were needed. For example, Cuba sent doctors to Italy at the beginning of the pandemic to assist with the crisis as it developed there.

However, countries also enacted strict travel restrictions and many closed their borders to cut down on the free movement of people and spread of the virus.

Benefits of globalization

Globalization enables countries to access less expensive natural resources and lower cost labor. As a result, they can produce lower cost goods that can be sold globally. Proponents of globalization argue that it improves the state of the world in many ways, such as the following:

Solves economic problems. Globalization moves jobs and capital to places that need these resources. It gives rich countries access to lower cost resources and labor and poorer countries access to jobs and the investment funds they need for development.
Promotes free trade. Globalization puts pressure on nations to reduce tariffs, subsidies and other barriers to free trade. This consequently promotes economic growth, creates jobs, makes companies more competitive and lowers prices for consumers.
Spurs economic development. Theoretically, globalization gives poorer countries access to foreign capital and technology they would not otherwise have. Foreign investment can result in an improved standard of living for the citizens of those nations.
Encourages positive trends in human rights and the environment. Advocates of globalization point to improved attention to human rights on a global scale and a shared understanding of the impact of people and production on the environment.
Promotes shared cultural understanding. Advocates view the increased ability to travel and experience new cultures as a positive part of globalization that can contribute to international cooperation and peace.

Negative consequences of globalization

Many proponents view globalization as way to solve systemic economic problems. But critics see it as increasing global inequality. Among the critiques of globalization are the following issues:

Destabilizes markets. Critics of globalization blame the elimination of trade barriers and the freer movement of people for undermining national policies and local cultures. Labor markets in particular are affected when people move across borders in search of higher paying jobs or companies outsource work and jobs to lower cost labor markets.
Damages the environment. The transport of goods and people among nations generates greenhouse gas and all the negative effects it has on the environment. Global travel and trade also can introduce, sometimes inadvertently, invasive species to foreign ecosystems. Industries such as fishing and logging tend to go where business is most lucrative or regulations are less strict, which has resulted in overfishing and deforestation in some parts of the world.
Lowers living standards. When companies move operations overseas to minimize costs, such moves can eliminate jobs and increase unemployment in sectors of the home country.
Facilitates global recessions. Tightly integrated global markets carry a greater risk of global recessions. The 2007-2009 financial crisis and Great Recession is a good example of how intertwined global markets are and how financial problems in one country or region can quickly affect other parts of the world. Globalization reduces the ability of individual nations to effectively use monetary and fiscal policy to control the national economy.
Damages cultural identities. Critics of globalization decry the decimation of unique cultural identities and languages that comes with the international movement of businesses and people. At the same time, the internet and social media are driving this trend even without the movement of people and commerce.
Increases the likelihood of pandemics. Increased travel, critics say, has the potential to increase the risk of pandemics. The H1N1 (swine flu) outbreak of 2009 and coronavirus in 2020 and 2021 are two examples of serious diseases that spread to multiple nations quickly.

Future of globalization

Technological advances, particularly blockchain, mobile communication and banking, are fueling economic globalization.

Nonetheless, rising levels of protectionism and anti-globalization sentiment in several countries could slow or even reverse the rapid pace of globalization. Nationalism and increasing trends toward conservative economic policies are driving these anti-globalization efforts.

Global trade is also made more difficult and facing rising threats from other factors, such as these:

climate change
decaying infrastructure
cyber attacks
human rights abuses

The takeaway

Globalization is a longstanding trend that is in the process of changing and possibly slowing. There are advantages to the more open border and free trade that globalization promotes, as well as negative consequences.

In a modern, post-pandemic world, individuals, businesses and countries must consider both sides of the globalization issue. Learn how companies are rethinking global supply chains to avoid disruption and reap the benefits of globalization.

Has China’s Economic Growth Been Greatly Overstated?

Low Error Rate

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PATH 1: CAN CHINA KEEP DOING WHAT IT HAS BEEN DOING?

PATH 2: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH PRODUCTIVE INVESTMENT?

PATH 3: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH RISING CONSUMPTION?

PATH 4: CAN CHINA REPLACE NONPRODUCTIVE INVESTMENT WITH A RISING TRADE SURPLUS?

PATH 5: WHAT HAPPENS IF CHINA DOES NOTHING TO REPLACE NONPRODUCTIVE INVESTMENT?

THE OUTLOOK FOR THE REST OF 2022

The Direction of Travel is Clear

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The Stakes: Implications of Downgrading China’s Economic Future

China’s Economic Growth, Its Causes, Pros, Cons, and Future

It’s Good That China’s Growth Is Slowing. Really.

Causes

Advantages

Disadvantages

Future Growth

The Bottom Line

Frequently Asked Questions (FAQs)

How does the U.S. economy depend on China?

What type of economy does China have?

What is globalization?

How globalization works

globalization

What is globalization?

How globalization works

Why is globalization important?

History of globalization

What is the G20?

Types of globalization: Economic, political, cultural

Effects of globalization

Examples of globalization

Benefits of globalization

Negative consequences of globalization

Future of globalization

The takeaway

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