China's Dangerous Inflection Point
Is China’s growth model exhausted?
This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the
March/April 2024 issue.
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Consider two views of the economy of the People’s Republic of China:
View 1. China leads the countries labeled the “Global South.” China will soon overtake the United States in economic size. China’s renminbi threatens the hegemony of the U.S dollar. China’s “Belt and Road Initiative” may displace the West’s dominance in international lending.
View 2. China faces a major debt crisis. Wealthy Chinese are getting money out of the country, buying apartments in Tokyo, and stowing gold bars abroad. Chinese youth are “lying flat,” rejecting pressures to out-perform their compatriots. China’s growth rate is slowing.
Both pictures painted above capture only a part of China’s complex reality. Understanding these contrasting pictures requires an analysis of China’s growth model, the combination of policy choices and actions, and their intersection with the changing global political economy over the past four decades.
What is going on in China? And what might the future hold for China’s economy?
China’s Growth Model:
Policies, Demographics, and the Neoliberal Global Political Economy
In 1980 China was a poor country. With a population more than 20% of the global total, the country produced only 2.5% of global GDP (a century earlier, in 1870, China produced almost 18% of global GDP). Per capita income in 1980 was under $500, only 25% of the global average. China was marginal to the global political economy.
From 1980 to 2020, China’s GDP doubled every decade, and today, China’s GDP accounts for almost 20% of global GDP. The standard of living for the Chinese population changed dramatically in that period: per capita income increased more than 20-fold to over $11,500. Both the GDP growth in China and the per capita growth over these four decades are historically unique.
How did China accomplish this?
The core elements of China’s growth model are generally known and, in many respects, not unique: high rates of domestic investment, low household consumption as a percent of GDP, a rapid increase of exports, significant inbound foreign direct investment, and, less commented upon, rural-to-urban migration. Lastly, less understood serendipity: China’s “take off” decades coincided with the neoliberal restructuring of the global political economy. Without itself becoming a neoliberal political economy, China benefitted from this restructuring.
High Level of Domestic Investment. As a poor country in 1980, China had a weak transportation network, with poor roads and bridges. Even in 1994, when I spent almost four weeks in China (teaching about financial markets), bicycles were the dominant mode of travel in Shanghai, and our driver in the countryside seemed to view the yellow line in the middle of the two-lane highway as a suggestion rather than a rule. There were few functioning airports, limited educational facilities, often poor housing, an inadequate power-generating system, and few public spaces.
Beginning in the early 1980s, the central government in Beijing directed huge amounts of money into building the basic infrastructure for a modern industrial economy. Much of these funds were directed to state-owned enterprises such as the China Railway Group. Fixed investment represented 40–45% of total GDP during the 1980–2020 period. The central government built airports; created a high-speed rail network; and linked previously isolated villages by road, rail, and air. And beginning in the early 2000s, residential fixed investment (building of owner-occupied and rental housing) soared as millions of new houses were built.
The result was a rapid growth of GDP. From 1980 to 2020, there were only three years in which real GDP growth was less than 5%. Over the 1978–2018 period, the average annual real GDP growth rate was 9.44%.
Low Level of Household Consumption. The data on household consumption in China are not perfect, but the overall picture is clear: the household consumption share of GDP during the four “take-off” decades was only about 30–35% of GDP. Instead, both private and public savings were mobilized for investment. Of course, as GDP multiplied, the total value of household consumption increased, even during the 1980s and into the mid-2000s when the household consumption share of GDP actually declined, becoming a cause for concern for the Chinese Communist Party. As a result, in 2009, Premier Wen Jiabao urged a shift into household consumption. The GDP share of household consumption increased modestly, from 34.5% in 2010 to 38.2% in 2021, still on the low end globally on this measure.
Export-Driven Growth. China’s rapid GDP growth, combined with limited household consumption, required an outlet for the increased output of goods. The answer for China was exports. And here China’s growth model intersects directly with the newly emerging structure and policies of the global political economy: the growth of global trade, capital mobility, and the geographical extension of supply chains.
In 1980, Chinese exports were less than 6% of the country’s GDP in a world where cross-border trade was more than 30% of global GDP. A decade later, China’s export/GDP ratio had doubled, and by 2001, when China joined the World Trade Organization (WTO), the ratio was 20%.
After joining the WTO, the exports-to-GDP ratio for China jumped, sextupling the 1980 ratio to 35% of GDP by 2008. China was incorporated into the global political economy of trade as an exporter of textiles and a labor-intensive assembly locale. Much of both the export and the GDP growth during the last half of the 1990s and the first decade of the 2000s was facilitated by favorable demographics. The share of the population aged 15–64, prime working ages, reached as high as 74% in the mid-2000s. After the Great Financial Crisis of 2007–2008, China’s “managed trade” policies ran up against the policies of the United States (and other countries) limiting the impact of low-cost imports from China, and then ran into global supply chain problems during Covid-19. Nonetheless, the total value of Chinese exports more than doubled after the Great Financial Crisis and remains in the 20–25% of GPD range.
The industrial distribution of Chinese exports also changed. In the 1990s, China became the global textile production leader, following a well-trod path by which newly industrializing countries are incorporated into the global manufacturing division of labor. Immediately prior to China’s admission into the WTO, textiles remained the second-largest Chinese export.
China challenged the neoliberal global division of labor, moving rapidly up the value-added production chain, shifting the sectoral composition of their labor force into secondary and tertiary industries. Today, textiles are not even in the top 10 Chinese exports, superseded by electrical machinery, computers, and, most recently, by auto exports: sales of electric vehicles produced by Chinese company BYD (“Build Your Dreams”) exceeded Tesla’s sales in the last quarter of 2023.
Foreign Direct Investment. Contrary to dreams of a potential “China Market,” inbound foreign direct investment in the 1980s and 1990s found not new consumers but rather a huge pool of labor power aggregating in the rapidly growing Chinese cities. This labor power could be organized into a labor force with wages below that of established manufacturing centers. Coupled with low-cost ocean freight rates, a product of the containerization revolution, the locales for making everything from clothing to cell phones migrated from the United States and Europe to China (and elsewhere in the Global South).
The best concise description of the neoliberal global economic model came from long-time General Electric CEO Jack Welch when he wished that he could put all his factories on barges.
The barges would “sovereign shop,” moving from one location to another, seeking the most capital-favorable tax and subsidy regimes and the workers with the lowest bargaining power.
China did not create Welch’s floating barge capital, instead establishing geographical spaces where capital could accumulate, benefitting from financial subsidies and favorable employment rules. These “special economic zones” have been important drivers of China’s growth over the past four decades.
Although pioneered in Shannon, Ireland, in 1959, China’s special economic zones, beginning with the 1979 creation of the Shenzhen special economic zone (the first of seven), fueled capital accumulation, both foreign and domestic, in China. By the early 2000s, about two-thirds of the 45 million members of the global workforce that labored in these special capitalist enclaves were found in China. The special economic zones are the source of 60% of Chinese exports, attract almost half of all inbound foreign investment, and generate over one-fifth of China’s GDP while creating at least 30 million jobs.
When the special economic zones were created, Shenzhen was a small fishing village. Today it is larger than New York City.
FoxConn entered the Shenzhen special economic zone in 1988. With 12 factories in China, FoxConn is the country’s largest private-sector employer. In 2001, FoxConn became Apple’s choice for assembling their products.
Together, FoxConn and Apple embody another element of the neoliberal global economic model. Apple does not manufacture anything: In the neoliberal zeitgeist, it is brands, not things, that matter. Workers from Germany to Asia do the work of actually producing product components. These components then meet at FoxConn for final assembly. Under intense pressure from Apple, the less than 5% of total value added by special economic zone workers means mandatory overtime, workplace bullying and harassment, and, sometimes, suicides. Some workers have—literally—died for an iPhone. FoxConn and Apple’s response? Suicide nets. The shiny commodity that Apple presents to you keeps the secret of its creation well hidden.
Rural-to-Urban Migration. In 1980, 80% of Chinese households lived in the countryside, primarily working in agriculture. Today almost 70% of Chinese households are in cities, a result of the largest migration in human history. Rural-to-urban migration, an essential source of the successful Chinese growth model, is now a component of the economic problems confronting China today.
Economic growth can occur either from more workers doing the same set of tasks with the same level of technology or from the increased productivity of the workforce because of new technology and different tasks. Rural-to-urban migration moved labor out of low-productivity agriculture and into higher-productivity sectors. Mechanization in agriculture released surplus rural labor to the urban workforce and allowed employers to expand output without increasing labor’s share. Urbanization meant more workers using higher levels of technology.
This migration was skewed toward the younger end of the working-age years, as the offspring of farmers left to seek their fortunes in the growing cities. In the early 1990s, migrants were only 25% of China’s urban population; by the late 2010s, almost three of every five urban residents were migrants.
Challenges to a Growth Model
The performance of China’s economy over the 1980–2020 period is remarkable, perhaps unprecedented in history. A country that was largely outside the global political economy now occupies a leading—maybe the leading—position in international trade and investment. In achieving this position China was more of a rules-breaker than a rules-follower in the neoliberal global political economy.
Many of the benefits of this rapid growth have accrued to the population as a whole, raising per capita income more than 20-fold and increasing access to food, clothing, and shelter across the country. Although poverty has not been eliminated, it has been significantly reduced. And the life expectancy for ordinary people in China has increased by more than 20%.
Contradictions
But, like all accumulation models that drive rapid economic growth, there are also contradictions. Today these are increasingly visible.
Reliance on markets to generate much of the growth has increased economic inequality. Although China performs better on inequality measures than others of the BRICS quintet (Brazil, Russia, India, China, and South Africa), for income the Gini coefficient (the main measure of inequality) is now at or above that of the United States. Similarly, for wealth, China’s Gini coefficient is above that of the United States.
Inequality is not simply a matter of dry numbers: Premier Deng Xiaoping’s slogan, “To get rich is glorious,” may have been referring to the socialist sharing of riches, but some took this as a call to enrich themselves. China now ranks second only to the United States in number of billionaires. Today a group—a class?—of obscenely wealthy individuals controls large swaths of productive capacity in China.
Beyond the looming issue of inequality, the contradictions of China’s growth model are both financial and nonfinancial. Although the government’s control of the renminbi and banking counteracted the siren song of financialization, the problem of debt, public and private, threatens continued growth. In the nonfinancial economy, overbuilding in the housing sector is becoming a drag on continued growth.
Debt. China’s high investment in growth meant that the country incurred large amounts of debt. In the 1980s and 1990s, the debt-to-growth ratio was positive: the returns on debt-financed investment were greater than the debt incurred. But, since at least the Great Financial Crisis, the ratio began to deteriorate. Today, China’s debt-to-GDP ratio is among the highest for large economies.
Most of the debt is from two sources. First is private debt, for example, from bonds issued by the large developers. Private sector, nonfinancial debt has more than doubled as a ratio to GDP since the Great Financial Crisis.
The second—and largest—source of China’s debt is the bonds issued by local governments’ funding vehicles. These funding vehicles were created in large part to evade the efforts of the central government to rein in local government spending. These entities have restricted access to collected taxes—most go to the central government—while facing demands to deliver on growth targets. The amount of local government funding vehicle debt is opaque; it is difficult to assess just how much there is. However, the International Monetary Fund (IMF) estimates that local government funding vehicles and local governments themselves represent 75% or more of public-sector debt.
Housing. Once all those migrants to Chinese cities got there, where were they going to live?
The answer: the rapid building of many new houses. The new housing stock was primarily the product of the mammoth development companies that were founded in the late 1980s and early 1990s. The largest, Vanke, dates back to 1984. The best known are China Country Garden and China Evergrande, founded in 1992 and 1996, respectively. China Evergrande was forced into liquidation at the end of January 2024.
In 1980, most Chinese households lived in publicly subsidized rental housing. Today over 85% of urban households own their own homes, mostly free and clear. China’s housing market is the largest in the world: about 475 million households, almost three times that of the United States.
The housing market in China was “marketized” in 2003, replacing the in-kind approach to providing housing. Prices became determined by supply and demand. The result was a significant increase in the share of GDP going into residential fixed investment, i.e., housing, from less than 5% in the early 2000s to over 15% in the 2010s. If the industries tied to housing (such as appliances, furniture, cement, and others) are included, the share rises to 20–25%. To grasp the scope of China’s housing market, consider this metric: In three years, more cement was poured into Chinese housing construction than in the entire 20th century in the United States.
The large developers have been the beneficiaries of both land sales from local governments and subsidies via low-cost loans. Favorable loan rates are in part the result of keeping interest rates low on bank deposits. And development company founders such as Yang Guoqiang of China Country Garden are reported to be billionaires.
The outcome: a glut of housing. About one in five houses built over the past two decades is now empty. Empty—but not unowned. Most empty houses in China are owned by families; they are not sitting on the books of the developers as an unsold asset. Nor are these houses run-down. They are just empty. Despite this glut—and a homeless population estimated at 2.5 million—house building continues. These efforts include the creation of new “cities,” with a million or more houses planned for fewer than 100,000 households.
Who owns these empty houses? One of every four urban households own a second or even a third house. (For comparison, in the United States, only one in 20 families own more than one house.) The oversupply of houses is also running up against slowing and even falling population numbers.
Why are more houses being built and why are many families buying a second or even third house with little or no plans to live there? The answers will give us important insights into the current economic problems facing China.
There are three drivers for Chinese households to buy a second or even a third house: financial, institutional, and cultural.
Financial: The savings-to-GDP ratio in China is very high, over 45%, about 2.5 times the U.S. rate of 17%, and almost double the rate for Germans, who have a notoriously high propensity to save. What happens to all this savings? Most of it goes into real estate, i.e., second houses.
Over 70% of household wealth in China is in house ownership, compared to 30–35% in the United States. There are few other investment options for most Chinese families. The interest rate on bank deposits has been kept low. And, despite China’s two large equity markets, Shanghai and Shenzhen, fewer than one in 10 Chinese households own stocks. Household savings plowed into housing may also serve as an economic cushion in a country with a weak social safety net. The government controls money movements in and out of the country, so most Chinese residents below the top wealth tier do not have access to offshore investment opportunities. Houses have been the vehicle of choice for savings, but a December 2023 year-over-year sales decline of 17% calls the continued viability of that investment into question.
Institutional: First, under the hukou system, urban-to-urban migrants can purchase multiple houses. It is much harder for rural-to-urban migrants to do so. Secondly, cities in the second tier of the urban hierarchy will offer houses to attract innovative or talented people to live in them. Finally, when housing was marketized in the early 2000s, many first-time owners received houses at below-market prices and then used their savings to acquire a second or third house.
Cultural: The one-child policy, in effect from 1980 to 2015, in combination with sex-selective abortions, generated a “surplus” of males in marriageable cohorts. The male-to-female ratio for people under 35 years old is 110:100. Families of potential brides ask the suitor what he can provide in the way of living space, even if the couple may not plan to move there. Most owners of multiple houses have children under the age of 15. For Chinese families with mobility aspirations for their offspring, there is a strong push to reside—or appear to reside—in the areas served by top schools. These schools are given priority in resource allocation, including teachers, equipment, and funding.
Paths to the Future
China faces several choices. Here is a very brief sketch of some possibilities. The country could choose to continue with the current growth model. Certainly, there are powerful vested interests for continuing on this path. There are, however, at least two risks. First, the current growth model could slow real growth and create economic stagnation. Second, there is the possibility that the country’s continued debt buildup will trigger a financial implosion. Because the bulk of both public and private debt in China is held within the country, the result would likely not replicate the U.S. experience in the Great Financial Crisis, where debt had been distributed globally with a substantial remainder on the books of major financial institutions.
China could seek to shift investment away from fixed infrastructure and into new, high-tech fields. There are some signs of this path. The recently announced “High and New Technology Enterprises” policy offers incentives (reduced profits taxes and subsidized loans) for companies engaged in fields such as semiconductors, high-tech ships, and numerical control tools for advanced robots. And China’s solar energy investment has become a major driver of overall investment. There could be a significant role for state-owned enterprises, which are the largest employers in China, and face only “soft” budget constraints that would allow for research and development without immediate profitability requirements. The question is: Is it possible for this initiative to absorb the 15% or more of GDP now in the housing market?
Another alternative would be to increase the GDP share of household consumption. This would necessarily come at the expense of the current wealth holders and would face their opposition. An avenue for investment on this path would focus on the health needs of an aging population: 14% of Chinese residents are over 65 years old. The future is yet to be written.
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