London
“China’s economy is a ticking time bomb,” said President Joe Biden last week at a political fundraising event in the American state of Utah. It’s certainly in trouble. The consumer price index, the main gauge of inflation, fell 0.3% in July, a clear sign say analysts that the Chinese economy is weakening and in worse long-term shape than is widely understood. On Tuesday, China’s central bank unexpectedly cut key policy rates for the second time in three months, but economists warn that these were too small to make a meaningful difference.
Belief in a Chinese economic juggernaut has been a core assumption in the mainstream understanding of the global economy and diplomatic landscape for a generation. The realisation that the juggernaut is now beginning to resemble a clapped-out banger is causing serious concern among economists around the world. Adam Posen, president of the Peterson Institute for International Economics and a former voting External Member of the Bank of England, describes China’s economic problems as “economic long Covid”, due to a persistent dearth of investment and consumer demand. Others are pointing the finger at Xi Jinping’s mismanagement of the economy in recent years.
It was Deng Xiaoping back in the 1970s who began the reform and opening of China’s economy, resisting the impulse to interfere in the private sector. Deng’s reversal of Chairman Mao Zedong’s stifling centrally-planned command economy resulted in an astonishing growth rate of 9.5% a year between 1978 and 2013, despite the troublesome legacies of socialism, with its erosion of work ethic and anti-market propaganda.
Growth was largely due to the large-scale privatisation of state industries that occurred in the late 1990s. Between 1995 and 2005, close to 100,000 firms with 11.4 trillion yuan ($1.6 trillion) worth of assets were privatised, comprising two-thirds of China’s State-Owned-Enterprises (SOEs) and state assets. China’s privatisation was by far the largest in human history.
It was when President Xi Jinping came into office in 2013 that things began to go wrong. His first act was to embark on an anti-corruption campaign which not only removed some of his potential rivals for leadership but also signalled the move to increased control and regulation over various aspects of China’s economy. Communist Party committees became established within SOEs to ensure adherence to Party directives and enhanced discipline, a move which inevitably stifled their operations.
The Chinese government also began to take steps to exert greater control over the technology sector and data management, including increased oversight of Internet platforms. Control over media and information flows, tighter regulation on online content, social media platforms, and news outlets became the norm. All with the aim of emphasising ideological alignment and increased censorship in order to maintain party narratives and suppress dissenting voices.
Perhaps the most striking recent move by Xi Jinping was to bring to heel those oligarchs who dared to criticise his rule. In November 2020, tech tycoon and outspoken billionaire Jack Ma found himself under fire after criticising state regulators. The following year the regulators retaliated, hitting Ma’s empire with a $2.8 billion antitrust fine. It’s not just Ma who has been in Beijing’s crosshairs. In 2021, food delivery giant Meituan was fined 3.44 billion yuan, and last year the ride-hailing giant Didi was fined 8.02 billion yuan. Only last Friday, Ma’s group was again fined almost $1 billion. The People’s Bank of China, which issued the fine, said the penalty was in response to the “violation of various laws and regulations”.
Unsurprisingly, confidence among private firms and entrepreneurs is low, as Beijing has clearly indicated that the country’s economic future lies less with the private sector than with state-owned enterprises. Analysts report that the share of annual investments going to China’s private sector firms peaked in 2015, after which government pressure led to banks and investment funds favouring state-owned enterprises in their lending, while investment in the private sector was in retreat. Private firms now account for less than 40% of the value of China’s largest 100 firms, compared to over 55% in 2021. They continue to face a tough regulatory and political environment in which they can only make money if they align closely with the Chinese Communist Party’s (CCP) social and political goals.
But it was Xi Jinping’s response to Covid that will likely plague the Chinese economy for years to come. All major economies went through some version of a lockdown early in the pandemic, but none experienced anything nearly as abrupt, severe, and unrelenting as China’s anti-pandemic measures. Many likened the experience to a mass imprisonment campaign. Xi’s calamitous misjudgements led to shortages of groceries, prescription medicines, and critical medical care, even among wealthy communities in Beijing and Shanghai. Disaster struck the country again last December, when Xi suddenly lifted his draconian restrictions to contain the virus, only for it to rampage across China with explosive speed. According to top government scientists, 80% of the populace was infected as a result. Independent experts estimated that the number of deaths resulting from the CCP’s decision to suddenly lift restrictions ranged from about 1 to 1.5 million, far more than the official figures. In absolute terms, China may have suffered more fatalities from Covid in the first two months of 2023 than the United States did in three years of coping with the virus.
For many Chinese, the party’s Covid response was a clear indication that the CCP was the ultimate decision-maker about their ability to earn a living or access their assets. Beijing’s sudden U-turn last December only reinforced the people’s sense that their jobs, businesses and everyday routines remain at the mercy of the party and its whims, something unlikely to engender the spirit of enterprise necessary in a flourishing economy. Once a regime has lost the confidence of the average household and business, it is difficult to win back.
This month has seen a plethora of economic statistics that revealed the true extent of China’s ailing economy, which has now fallen into deflation. Foreign trade showed a sharp fall in exports last month, with an even sharper decline in imports, signifying weakness in demand at home. Youth unemployment has topped at 21%, three times the rate in the US, with many of the country’s 11-12 million graduates experiencing difficulty in finding work. (Beijing announced on Tuesday that it would stop announcing the figures for youth unemployment).
Household consumption as a share of GDP, normally a sign of a balanced and sustainable economy, is currently 38%, no higher than it was in 2000 and lower than in Mexico or Turkey (in the UK it is 61% and 67% in the US). This is all down to sluggish growth in personal income, a weak social safety net, high inequality, and a ubiquitous shift in the structure of work towards low-pay and low-skill occupations instead of higher-paid skilled work in manufacturing and construction.
Over-supply and indebtedness are proving to be a disaster in China’s construction sector, which last year was 60% lower overall than in 2021 and sales were 40% lower. Many Chinese households who use property as a form of savings, have been choosing to repay their mortgages early, a sign that they are disillusioned about the future of house prices. The real-estate sector, a core pillar of China’s economy, contributing as much as 30% of the country’s GDP, has not only suffered tumbling sales but tight liquidity and a series of developer defaults since late 2021. The once-mighty China Evergrande Group is at the centre of the debt crisis, revealing losses of $81 billion for 2021 and 2022 last month. On Friday, the company filed for bankruptcy in the US. With total estimated debts of more than $300 billion, it was the world’s most heavily indebted property developer.
Alarmingly, the Country Garden Group, a developer with more than four times as many housing projects as Evergrande and until recently considered to be financially sound, saw its shares dive 18.4% last Friday, down 50% in a month, prompting fears of a default due to its severe liquidity crisis. This could spill over into its peers, as values of their collaterals decline and buyers become more cautious about purchases. Following a disastrous 2022, China’s total property sales are again down more than 20% so far this year and new construction starts down 25%. These figures could have a chilling effect on homebuyers and financial institutions, pushing many private companies close to tipping point.
Many recall that the global financial crash of 2008 was triggered by the slump in the US housing market and fear that history could be repeating itself, this time in China. Although unlikely, the contagion is beginning to spread. Last month APG, one of the world’s largest asset managers said its pension fund clients were shying away from China, in a growing pullback by investors alarmed at rising geopolitical risks. It was reported in the Financial Times last week that a Canadian $400 billion investment group, Caisse de depot et placement du Quebec, had stopped making private deals in China and was closing its Shanghai office. Singapore’s sovereign wealth fund GIC had slowed the pace of its direct investments in China, while Ontario’s Teachers’ Pension Plan had paused future investments in the country. “On the one hand, it seems inconceivable to me that we would withdraw from such a large part of the world economy”, Thijs Knaap, chief economist of APG told the Financial Times last week, “but at the same time we’ve certainly seen some dark clouds around China”. Jens Eskelund, president of the European Chamber of Commerce in China, told reporters in June that business confidence in China is “pretty much the lowest we have on record”, adding that “we do not expect the regulatory environment to improve over the next five years”.
None of this augurs well for China’s economy. To return to the growth of the past, Xi Jinping must urgently introduce substantive measures to boost household consumption, although he seems clueless about how to do this. He should also consider returning China’s economic and institutional structures to those introduced by Deng Xiaoping fifty years ago. The former may be possible, but the latter would be anathema to Xi and the CCP and therefore unlikely to happen. So, Joe Biden is right. China’s economy has all the appearances of a ticking time bomb.
John Dobson is a former British diplomat, who also worked in UK Prime Minister John Major’s office between 1995 and 1998. He is currently Visiting Fellow at the University of Plymouth.