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Tuesday, December 5, 2023

China’s Economic Future: The Intersection of Reform, Crisis, and Stagnation

BusinessMacroChina's Economic Future: The Intersection of Reform, Crisis, and Stagnation

A Decade of Aspiration:

Chinese President Xi Jinping’s inaugural reform plans, outlined about a decade ago, were among his most audacious, setting the path for China to adopt a Western-influenced free market economy. The services and consumption sectors were poised to be the driving force behind this change, with a target completion year of 2020.

Outlined in a comprehensive 60-point agenda, these reforms aimed to recalibrate a growth model that seemed more fitting for lesser-developed nations. Yet, a decade on, a significant number of these proposed changes remain unimplemented. Instead, the Chinese economy leans heavily on legacy policies that have significantly augmented both China’s debt and its industrial overcapacity.

China’s Economic Growth – A Double-Edged Sword:

The stagnant reforms prompt a pressing inquiry – what lies ahead for the world’s second-largest economy?

For some observers, such as William Hurst, Chong Hua Professor of Chinese Development at the University of Cambridge, there’s a looming risk. “Things always fail slowly until they suddenly break,” he commented, highlighting the imminent danger of an economic or financial crisis that could pose severe sociopolitical challenges.

China, emerging from its Maoist planned economy phase in the 1980s, had a predominantly rural demographic, urgently necessitating infrastructure and manufacturing capabilities. Come the global financial crisis of 2008-09, China had sufficiently addressed most of its investment needs, given its developmental stage.

However, the subsequent decade saw China’s economy multiply fourfold in nominal terms. In a bid to sustain this high growth trajectory, investments in infrastructure and property were aggressively doubled, inadvertently sidelining household consumption.

Such a strategy meant that compared to many nations, consumer demand relative to GDP in China remained subdued. Furthermore, this led to a concentration of job opportunities in construction and industry, sectors becoming less attractive to the emerging educated youth demographic. Simultaneously, an oversized property sector emerged, responsible for nearly 25% of economic activities.

Challenges Intensify:

The implications of this growth strategy have been further amplified by unexpected challenges: the COVID-19 pandemic, demographic shifts, and geopolitical strains. Despite reopening, the Chinese economy has struggled to bounce back robustly.

Max Zenglein, chief economist at MERICS, a China studies institute, remarks on this, “We’re just beginning to be confronted with the reality. We’re in untested territory.”

This economic deceleration has potential global ramifications, especially for commodity exporters. Domestically, it endangers the economic wellbeing of millions, particularly university graduates and those whose assets are tied up in real estate.

Possible Paths Forward:

Given the current scenario, economists broadly envision three potential outcomes for China:

  1. Swift and Painful Crisis: A rapid financial meltdown that writes off outstanding debts, scales back excess industrial capabilities, and deflates the property bubble.
  2. Gradual Economic Stagnation: A prolonged period of winding down economic excesses, which will come at the expense of growth.
  3. Structural Reform: Transition to a consumer-driven model through deep-seated reforms. While these reforms will introduce immediate challenges, they offer the prospect of a resilient rebound.

The property sector, which is vast in scale, poses one of the most significant risks. If it implodes without control, it might drag the entire financial sector along. Additionally, there’s the ticking time bomb of local government debt, estimated at a whopping $9 trillion by the IMF.

However, many experts, like Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, believe a full-blown crisis is unlikely due to the tight grip Beijing holds on developers, banks, and capital outflows. Instead, she predicts a phase of slow growth, emphasizing that as more capital is locked into unproductive ventures, economic growth becomes increasingly elusive.

Reform – The Road Not Taken?

Another path, albeit seen as improbable, is a reform-driven switch to a new model. One can’t help but reflect on President Xi’s 60-point program, which lost momentum around 2015 amidst a capital outflow panic that saw stocks and the yuan plummet.

Promised major financial liberalizations have been dialed back, while bold plans for state enterprise reformation and comprehensive social welfare are yet to see the light of day.

Prof. Hurst opines that there’s potential and appetite for a significant shift. However, he also underscores the palpable fear of the consequences, particularly the risk of inadvertently triggering an economic crisis.

In conclusion, China finds itself at a crucial juncture. Its past successes with building a robust middle class might become its vulnerability, especially if the newer generations face economic stagnation. The road ahead demands crucial decisions that will shape not only China’s future but also have ramifications for the global economy.

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