Introduction
Imagine the stark contrast between the famines of Mao’s command economy and the boom of Deng Xiaoping’s reforms – that’s China’s economic journey in a nutshell. Now, after decades of dazzling growth, the dragon faces new challenges: slowing progress, debt worries, and internal strains. This analysis delves deep, exploring trade tensions, social shifts, and the ambitious Belt and Road Initiative. Join us as we undergo a deep analysis of China’s complex economic landscape, past and present.
The History of China’s Economic Development
China’s Economy in the Realm of Chairman Mao
Prior to 1979, China, under the leadership of Chairman Mao Zedong, maintained a centrally planned, or command, economy. A large share of the country’s economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of China’s individual household farms were collectivized into large communes. To support rapid industrialization, the central government undertook large-scale investments in physical and human capital during the 1960s and 1970s. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled, state-owned enterprises (SOEs), according to centrally planned output targets. Private enterprises and foreign-invested firms were generally barred. A central goal of the Chinese government was to make China’s economy relatively self-sufficient. Foreign trade was generally limited to obtaining those goods that could not be made or obtained in China. Such policies created distortions in the economy. Since most aspects of the economy were managed and run by the central government, there were no market mechanisms to efficiently allocate resources, and thus there were few incentives for firms, workers, and farmers to become more productive or be concerned with the quality of what they produced.
In addition, China’s economy suffered significant economic downturns during the leadership of Chairman Mao Zedong, including during the Great Leap Forward from 1958 to 1962 which led to a massive famine and reportedly the deaths of up to 45 million people and the Cultural Revolution from 1966 to 1976 which caused widespread political unrest and greatly disrupted the economy. From 1950 to 1978, China’s per capita GDP on a purchasing power parity (PPP) basis doubled from $119 in 1950 to $230 in 1978, representing an increase of roughly 93%. However, from 1958 to 1962, Chinese living standards fell by 20.3%, and from 1966 to 1968, it dropped by 9.6%.
Shortly after the death of Chairman Mao in 1976, the Chinese government decided to break with its Soviet-styled economic policies by gradually reforming the economy according to free market principles and opening up trade and investment with the West, in the hope that this would significantly increase economic growth and raise living standards. As Chinese leader Deng Xiaoping, the architect of China’s economic reforms, put it: “Black cat, white cat, what does it matter what color the cat is as long as it catches mice?”
China’s Economic Growth and Reforms: 1979-the Present
Since the introduction of economic reforms, China’s economy has grown faster than during the pre-reform period, and, for the most part, it has avoided major economic disruptions. From 1979 to 2018, China’s annual real GDP averaged 9.5%. This has meant that on average China has been able to double the size of its economy in real terms every eight years. The global economic slowdown, which began in 2008, had a significant impact on the Chinese economy. China’s media reported in early 2009 that 20 million migrant workers had returned home after losing their jobs because of the financial crisis and that real GDP growth in the fourth quarter of 2008 had fallen to 6.8% year-on-year. The Chinese government responded by implementing a $586 billion economic stimulus package, aimed largely at funding infrastructure and loosening monetary policies to increase bank lending. Such policies enabled China to counter the effects of the sharp global fall in demand for Chinese products. From 2008 to 2010, China’s real GDP growth averaged 9.7%. However, the rate of GDP growth declined slowed for the next six consecutive years, falling from 10.6% in 2010 to 6.7% in 2016. Real GDP ticked up to 6.8% in 2017 but slowed to 6.6% in 2018, (although it rose to 6.8% in 2017). The IMF’s April 2019 World Economic Outlook projected that China’s real GDP growth will slow each year over the next six years, falling to 5.5% in 2024. The question arises what is causing this slowdown? Many economists relate it to the growing suspicion in the Western World about the mammoth size of China’s Rise and its associated impact on the global political chessboard, other associated reasons include the trade war between China and the United States. There are a number of other reasons, one pertinent issue is the advent of the COVID-19 pandemic and its economic fallouts.
Economic Slowdown
China’s post-pandemic economic recovery is experiencing a notable slowdown, largely attributed to the declining demand for exports and sluggish domestic consumption. The country’s real estate market challenges exacerbate concerns about the stability of China’s financial system, posing risks of a deeper economic downturn.
In 2023, despite a dynamic start to the year, China’s economic growth momentum began waning in the second quarter of 2023. The once-reliable growth driver of exports now faces considerable hurdles, with a staggering 14.5% contraction recorded in July 2023—the sharpest decline since the onset of the COVID-19 pandemic. Weaker global demand and escalating geopolitical tensions are inflicting harm on Chinese exporters.
On the domestic front, issues in the real estate market are dampening investments, while consumer spending is dwindling as Chinese citizens adopt a more cautious approach toward job security, income stability, and overall economic prospects. In June 2023, the youth unemployment rate reached a record high, 20.0% among urban populations aged 16 to 24. Additionally, retail sales in July 2023 saw a mere 2.3% year-on-year expansion.
Although projected growth rates for China in 2023-2024 exceeded 3.0% recorded in 2022, the anticipated growth rate of approximately 5.0% still falls below the pre-pandemic level, which averaged 7.7% annually from 2010 to 2019. To revitalize the economy, the People’s Bank of China implemented interest rate cuts in June and July 2023, yet further fiscal stimulus—such as tax breaks or incentives for manufacturers—may be necessary to stimulate economic growth.
Despite persistent challenges, the manufacturing sector in China has managed to sustain growth, although at a slow pace. Industrial production expanded by 3.7% in July 2023 year-on-year, down from 4.4% growth recorded in June. Similarly, fixed asset investments grew by 3.4% in the first half of 2023, compared to a 3.8% rate a year earlier. However, Chinese factories grapple with weakened demand in export markets, domestic construction industry issues, excess capacity, and declining profit margins. Moreover, geopolitical tensions have further deterred foreign direct investment (FDI), with FDI in China in the second quarter of 2023 hitting a low of 4.9 billion dollars—its lowest level since 1998. These challenges are reflected in subdued business confidence and the continuous contraction of factory activities, underscoring the uncertain path ahead for China’s manufacturing and broader business-to-business sectors in 2023.
Overreliance on Export-Led Growth:
China’s export-led growth has been a key driver of its economic success. However, the global economic landscape has changed, with a diminishing role of global trade and an increase in protectionist measures. In 2020, China’s exports grew by 3.6%, a significant decrease compared to the 5.4% growth in 2019. Trade tensions with the United States have impacted China’s exports. The U.S.-China trade war, marked by tariffs and trade restrictions, has affected various sectors.
Debt Overhang:
China’s high levels of corporate and government debt are a concern. As of 2020, China’s total debt-to-GDP ratio was around 282%, with corporate debt accounting for a significant portion. The debt level has raised fears of financial instability. The International Monetary Fund (IMF) has highlighted the risks associated with China’s corporate debt, stating that the country’s debt levels are higher than those of other emerging market economies.
Aging Population:
China’s workforce is aging, leading to a decline in labor supply and productivity growth. In 2020, the working-age population (15-64 years) accounted for 63.5% of the total population, a decrease from 70% in 2000. The aging population has implications for pension systems, healthcare, and social services. The ratio of elderly dependents (65 and older) to the working-age population is rising, putting pressure on support systems.
Population Decline:
China’s population, which had surged to 1.4 billion, is now experiencing a historic decline. The removal of the one-child policy in 2016 has not led to a significant increase in birth rates. In 2020, China’s population stood at approximately 1.41 billion, reflecting a decrease from 1.44 billion in 2019. The declining population has economic ramifications, affecting consumer markets, labor force dynamics, and social welfare programs.
Fertility Rate:
Despite efforts to encourage childbirth, China’s fertility rate remains low. In 2020, the total fertility rate was 1.3 births per woman, well below the replacement level of 2.1. The United Nations projects a further decline in fertility rates, even under optimistic scenarios. The challenges in boosting fertility rates include changing societal norms, high living costs, and the impact of past population control policies.
Structural Imbalances
Overcapacity in Real Estate and Industry:
China has experienced overcapacity issues in various industries, including steel, coal, and manufacturing. In 2016, estimates suggested that China’s steel production capacity was about 1.2 billion metric tons, exceeding domestic demand. While capacity has decreased since 2016, estimates suggest it still sits around 1.1 billion metric tons, exceeding domestic demand by over 200 million tons. This continues to fuel concerns about China’s role in global steel trade and potential dumping.
China’s coal production capacity continues to exceed demand, leading to stockpiles and pressure on coal prices. In November 2023, China’s coal production reached 861 million tons, while consumption was 722 million tons. Likewise, cement production capacity is estimated to be around 2.5 billion tons, while domestic demand sits closer to 1.4 billion tons. Overinvestment in real estate has contributed to excess housing inventory. According to China’s National Bureau of Statistics, the total floor space of unsold homes in China reached 700 million square meters in 2020, highlighting the overcapacity issue.
Property Bubble:
China’s real estate market has been a significant driver of economic growth, but concerns about a property bubble and overvaluation have emerged. In 2020, the average new home prices in China’s 70 major cities rose by 3.8%, contributing to fears of a property bubble. While the rapid price increase of 2020 has subsided, prices remain high. In October 2023, average new home prices in 70 major cities saw a modest year-on-year increase of 0.7%, showing stabilization rather than a decline.
Property speculation and excessive borrowings are contributors to instability. Despite government efforts to stabilize the market, home sales continue to experience significant declines. In November 2023, sales volume of floor space in key cities dropped by 36.2% year-on-year, reflecting decreased buyer confidence.
Inefficient State-Owned Enterprises (SOEs):
State-owned enterprises dominate key sectors such as energy, telecommunications, and finance. However, many of these SOEs operate inefficiently, leading to resource misallocation and hindering competition. In 2019, the efficiency of Chinese SOEs was a topic of concern. The World Bank reported that the return on assets for Chinese SOEs was significantly lower than that of private firms, indicating operational inefficiencies. A McKinsey Global Institute report in September 2023 revealed that SOEs lag behind private firms in productivity by 20-40%. This gap persists despite reforms aimed at improving competitiveness. A McKinsey Global Institute report in September 2023 revealed that SOEs lag behind private firms in productivity by 20-40%. This gap persists despite reforms aimed at improving competitiveness.
Weak Consumption and Low Innovation:
China’s economic model has been criticized for being too reliant on investment and export-driven growth, with insufficient emphasis on domestic consumption. Although there’s been modest growth, household consumption as a share of GDP reached 55.4% in 2023, still lagging behind desired levels. Despite significant progress in innovation, China faces challenges in transitioning towards a more innovation-driven economy. China’s ranking in the Global Innovation Index improved to 12th in 2023, showcasing progress in areas like research and development spending and venture capital investment. However, concerns remain about the translation of research into commercially viable products and the need for a more open and collaborative ecosystem.
Financial Vulnerabilities
Shadow Banking
China’s real estate problems have again drawn attention to the world of shadow banking and the risks it poses to the economy. Shadow banking — a term coined in the U.S. in 2007 — refers to financial services offered outside the formal banking system, which is highly regulated. In contrast, shadow bank institutions can lend money to more entities with greater ease, but those loans aren’t backstopped in the same way as traditional banks can. That means sudden and widespread demand for payment can have a domino effect. On top of that, limited regulatory oversight of shadow banking makes it hard to know the actual scale of debt – and risk to the economy. In February 2024, Zhongrong International Trust failed to make payments on multiple investment vehicles, raising fresh concerns about systemic risk. Similarly, despite government intervention, the ongoing struggles of property giant Evergrande continue to cast a shadow over the real estate sector, indirectly impacting shadow lenders.
In China, the government has tried to limit the rapid growth of such non-bank debts. Developers were able to borrow liberally from shadow banks, bypassing limits on borrowing for land purchases. What makes the country’s situation different is the dominance of the state. The largest banks are state-owned, making it harder for non-state-owned businesses to tap traditional banks for financing. The state-dominated financial system also meant that until recently, participants borrowed and lent money under the assumption the state would always be there to provide support with a guarantee. Estimates of the size of shadow banking in China vary widely but range in trillions of U.S. dollars. China’s secretive shadow banking industry includes gigantic financial institutions and is worth more than $3 trillion – that’s roughly the size of Britain’s economy. But, after years of exponential growth, several firms have defaulted on billions of dollars of payments to investors.
Uncertainty in the Property Market
The property market is a significant driver of China’s economic growth, but concerns about affordability, overvaluation, and speculative activities have increased risks. The average new home prices in China’s 70 major cities rose by 3.8% in 2020, contributing to fears of a property bubble. The property market accounts for a significant portion of household wealth, making it susceptible to fluctuations. In 2021, China Evergrande Group, one of the country’s largest property developers, faced a debt crisis, heightening concerns about the stability of the property market and its potential spillover effects.
Mounting Non-Performing Loans
The accumulation of non-performing loans (NPLs) in China’s banking sector is a notable financial vulnerability. As of 2021, the official NPL ratio in Chinese banks was reported to be around 1.74%, representing a slight increase from previous years. The true extent of the NPL issue may be higher, as there are concerns about the accuracy of official data.
External Pressures
US-China Trade Tensions
US-China trade tensions have negatively affected consumers as well as many producers in both countries. The tariffs have reduced trade between the US and China, but the bilateral trade deficit remains broadly unchanged. As of 2022, US-China total trade reached an estimated $758.4 billion, a slight increase from 2021’s $757.8 billion, and the US-China trade deficit stood at $367.4 billion.
In 2018, the US imposed tariffs sequentially on three “lists” of goods from China, targeting first $34 billion of annual imports, then $16 billion more, and finally an additional $200 billion. As a result, US imports from China have declined quite sharply in all three groups of the goods on which tariffs were imposed.
Global Economic Uncertainty:
The global economic landscape has faced uncertainty, exacerbated by factors like the COVID-19 pandemic and rising geopolitical tensions. China, as a major player in the global economy, is not immune to these challenges. In 2020, the International Monetary Fund (IMF) projected a contraction of 4.9% in the global economy. China, heavily reliant on exports, faced a decline in external demand, impacting its economic performance.
Shifting Global Supply Chains:
The trend of diversifying global supply chains away from China has been accelerated by factors such as trade tensions, rising production costs, and the desire for risk mitigation. Some companies have been relocating manufacturing operations to other countries, impacting China’s export competitiveness. A report by the United Nations Conference on Trade and Development (UNCTAD) in 2022 highlighted a decline in foreign direct investment (FDI) inflows to China, signaling a potential shift in global investment patterns. A 2022 McKinsey Global Institute report estimated that US companies alone could shift 20-30% of their sourcing away from China by 2030.
China’s Massive Belt and Road Initiative
The Belt and Road Initiative (BRI), often called the New Silk Road, is a massive project launched by China’s President Xi Jinping in 2013. It aims to connect East Asia to Europe through infrastructure like railways, highways, and energy pipelines. Over time, it has expanded to include Africa, Oceania, and Latin America, boosting China’s influence worldwide. Xi Jinping envisioned a network of transportation and economic zones spanning Asia to enhance connectivity and promote the use of China’s currency, the renminbi. China also promoted its technology, such as Huawei’s 5G network, and invested in port development for maritime trade along the Indian Ocean. The BRI is ambitious, with 147 countries participating so far, covering a large portion of the world’s population and economy.
However, some see it as a way for China to extend its power, and there’s growing opposition due to rising project costs. In 2022, Sri Lanka faced economic difficulties and defaulted on loans for a BRI-funded port project. The project costs reportedly ballooned from an initial estimate of $1 billion to over $8 billion, raising concerns about unsustainable debt burdens. A 2021 report by AidData, a research lab, found that the average cost of BRI projects rose by 35% between 2013 and 2020. Another report by the World Bank in 2022 highlighted the risk of “debt distress” for some BRI recipient countries.
In Malaysia, the new government in 2018 reviewed and renegotiated several BRI projects due to concerns about transparency and feasibility. Some projects were cancelled or scaled back. Likewise, a 2022 survey by the Pew Research Center found that public opinion towards China’s economic influence is increasingly negative in many countries along the BRI route, with concerns about debt and lack of transparency.
The United States is also concerned that the BRI could serve as a cover for China’s military expansion. To counter BRI, the US has struggled to offer alternative economic opportunities. President Biden has continued to be cautious about China’s actions.
Social and Cultural Shifts in China
China has experienced remarkable social and cultural shifts in recent years, notably in urbanization, social expectations, and the emphasis on education and innovation.
Urbanization has been a defining trend, marked by millions relocating from rural to urban areas. The urbanization rate surged from 17.9% in 1978 to approximately 63.9% in 2020, driven by industrialization and improved living standards. To ensure sustainable growth, China endeavors to balance rural and urban development. Policies like the “New-type Urbanization Plan” aim to integrate rural migrants into urban centers and upgrade infrastructure in rural regions.
As China’s economy burgeoned, its citizens began demanding a higher quality of life, environmental conservation, and enhanced social welfare services. China unveiled the “dual circulation” strategy in 2020, prioritizing domestic consumption and innovation to improve overall well-being, reflecting a shift in focus beyond mere economic growth.
In education and innovation, China has made substantial investments. The gross enrollment rate in tertiary education soared from 8.9% in 1978 to 51.6% in 2019. Innovation has also emerged as a core agenda, with China becoming the world’s second-highest spender on research and development (R&D) in 2020.
However, these advancements are not without challenges and implications. Urbanization, while offering economic prospects, presents hurdles such as inadequate infrastructure, social disparities, and environmental degradation. The government faces the dual challenge of sustaining economic growth while addressing environmental concerns, enhancing social welfare, and narrowing income disparities.
End Note
China faces challenges that could impact its growth. Economic growth has slowed, with concerns about overcapacity, particularly in real estate and industries. Structural imbalances, such as inefficient state-owned enterprises and reliance on exports, pose risks. Financial vulnerabilities include high corporate and government debt, banking sector challenges, and risks in the shadow banking system. Trade tensions with the U.S., global economic uncertainty, and evolving global supply chain dynamics add external pressures. Social and cultural shifts, like rapid urbanization and rising expectations, further complicate matters. Successfully navigating these challenges is vital not only for China’s economic well-being but also for global economic dynamics.
