China’s Great Stagnation
China’s economy is stalling. The most likely economic scenario over the course of the next decade is not high growth or an economic collapse, but stagnation. American policymakers need to pay attention.
China’s economy is stalling. The most likely economic scenario over the course of the next decade is not high growth or an economic collapse, but stagnation. If this occurs, the Chinese Communist Party (CCP) will have difficulty sustaining its ambitious national development and strategic plans. In particular, Beijing will not be able to avoid a more serious “guns v. butter” tradeoff.
This has sharp implications for American policy. Most importantly, while the US certainly has its own structural problems, it is far wealthier and more powerful than China, and that gap may actually grow or at least hold, rather than shrink. The dominant Sino-US relations paradigm of a declining power managing a rising power is inaccurate. A truer depiction of the Sino-American relationship is that China is a capable great power seeking to compete with US primacy in Asia, much as Russia has become a US rival in Europe and the Middle East, while Iran challenges American interests in the Persian Gulf. To attribute to China the capability to “overtake” the US or compete with it globally—or to describe the power dynamics as a “power transition” from Washington to Beijing—is at best premature.
Because the bilateral relationship contains cooperative elements, it would be better for American interests for China to return to market-based reforms, both to spur global economic growth and to stabilize Sino-American relations. However, this is unlikely in the medium term. And given the combustible mix in China of less stability at home and foreign policy adventurism abroad, Washington needs to more strongly resist destabilizing Chinese actions. It should reorient US strategy based on the long-term leverage created by likely Chinese stagnation and the enduring power gap.
China’s Economic Future:
There are three views of China’s economic trajectory: (1) it is slowing, but also transforming into a healthier and very large economy; (2) it is stagnating; or (3) a true economic crisis is inevitable in the not-too-distant future. The preponderance of evidence is for stagnation.
Both the China (still) rising and crash scenarios are fundamentally flawed. While their ranks thin and their version of success is watered down every year, there are still “bulls” who see China as a future economic success story. This view is based not on current analysis but on a combination of history—the People’s Republic of China (PRC) in 1978 and 1992 did indeed rise under worse circumstances—and the ensuing faith that pro-market reform will either be chosen by the Communist Party or be forced upon it.
Reform forced on the party by some sort of crisis may indeed be the best hope, since the party voluntarily choosing pro-market reform at this point is highly unlikely. The much-hyped 2013 Third Plenary session did not in fact offer a sound set of reform proposals. For example, it promoted cooperation between the public and private sectors when the exact opposite is needed. Unsurprisingly, no net progress toward the market has been made since. And few bulls would be able to endorse the economy purely on the basis of the present explosion of debt, weakening demographics, depleted natural resources, and other objective indicators.
The economic and financial crash argument has a more specific problem: it mistakenly treats the troubled Chinese financial system as similar to the American system. Commercial financial systems in rich countries may be only as strong as their weakest link, but Chinese finance is dominated by the state. Its primary function is to serve state interests, not to make money. Noncommercial financial systems are only as weak as their strongest link because governments can, without legal or political delay, order the strongest institutions to save the weakest. The cost, of course, is an enormous amount of waste.
Neither Preeminence nor Collapse - The Stagnation Case:
To understand why stagnation is likely, first consider other countries. While the categories are not well-defined, far more economies rise out of poverty than become truly rich. This is sometimes referred to as the middle-income trap.
In the postwar era, the most impressive economic success stories are in East Asia, which bodes well. However, in comparison with the world as a whole, Japan became rich before World War II, and much of its growth during 1946–1990 was a return to the status quo. Hong Kong and Singapore are mere cities, while Taiwan’s population is about the same as Shanghai’s. The structure of these microeconomies is fundamentally different than China’s economy, and they hardly demonstrate that the PRC can become rich.
In contrast, the middle-income trap has not been kind to large nations. Only one country with a population over 30 million has become rich for the first time in the postwar era: South Korea. A long list of countries that have not gone beyond middle-income, from Argentina to Thailand. It would not be surprising if Chinese cities the size of Singapore had income levels similar to France. It would be astonishing for the PRC as a whole to match French income, much more astonishing than what it has accomplished to date.
Second, evaluate Chinese growth. The government continues to report comparatively rapid gains in gross domestic product (GDP) and will do so indefinitely. But official statistics are not a reliable indicator of how the economy is doing. Information control is a vital tool for the party, and economic information is obviously a sensitive component. Purported GDP receives the most attention but is wildly overrated as a measure of success. GDP per person is close to meaningless; it is purely an accounting device that cannot be spent or invested. In terms of what people actually have in their pockets, China reported disposable income per person equivalent to $3,400 at the end of 2015, less than one-tenth of the US.
China “bulls” typically claim that, while the PRC is poorer than the US, it continues to catch up—yet possibly not, according to Credit Suisse, which reports net private wealth figures for all major economies. From the end of 2011 to the middle of 2015, Chinese net private wealth grew 19 percent. American net private wealth grew 43 percent. The two countries’ public sectors are harder to measure, but China’s debt performance over this period is atrocious, approximately 40 percent is attributable to state corporates, and their share is rising.
Nor is all of this a blip. The PRC’s economic weakness did not appear in 2015, as some seem to think. It did even not begin with the 2008 financial crisis. It began in 2003. From 1978 to 2002, several waves of partial pro-market reform created a new economic powerhouse. In 2003, the new government under Hu Jintao decided state-owned banks lending to state-owned enterprises (SOEs) should continue to constitute the core of the economy, employing large numbers of people and otherwise serving the party’s aims. Fresh market-oriented reforms were soon displaced by soaring publicly directed investment.
The National Bureau of Statistics reported investment growth jumped from 12 percent in 2001 to more than 26 percent in 2003, more than four-fifths by state-controlled enterprises. Investment growth then exceeded 25 percent annually for the next nine years, doubling the pace of official GDP—the huge imbalance between investment and consumption is not endemic but rather was created starting in late 2002. After a four-year boom, the economy began to hiccup. It was no longer greater productivity from market reform driving the numbers but increasing dependence on foreign consumption to buy the goods ultimately produced.
The global financial crisis was a double blow. Foreign demand plummeted. And on top of the previous public investment surge, Beijing conducted arguably history’s biggest stimulus through state-run banks. Loans grew 32 percent in 2009 alone, even as profit opportunities vanished. At this point the stagnation path became clearly visible.
Since then, credit expansion has slowed but remains staggering. In a smaller economy, China’s broad money supply is 75 percent larger than America’s. The inevitable outcome of such leveraging is overcapacity and debt. In 2003, the government identified three industries suffering from overcapacity; in 2013, that number had ballooned to 19. Sustained overinvestment and overproduction have badly damaged the environment, exacerbated income inequality, and, most important, created a crippling debt burden.
The PRC’s national debt is in excess of $25 trillion and climbing. Roughly two-thirds has been accumulated in the past nine years. In 2015, total debt rose four times as fast as nominal GDP, mocking the idea that China continues to enjoy comparatively rapid economic growth. When a country has already spent so much, the return on yet more spending is low. This is the main reason growth has slowed. A related point is that, when a country’s debt is so large, a large amount of capital is spent paying it back. This is the main reason growth will slow further.
Demography also portends stagnation. Demography can cause social and political crisis when there are too many young people and not enough jobs. China is instead rapidly aging (by demographic standards), heading toward a situation of hundreds of millions of elderly requiring support and not enough workers to support them and expand economic activity.