Right before the pandemic, China seemed to be an unstoppable force—poised to topple the US from its economic superpower status. Three years later, its economy has slowed to a crawl—and its battling high unemployment and deflation. What happened?
Researched by: Nirmal Bhansali
China: Before & after
Pre-pandemic China: was riding high—and everything it touched came up aces. Just look at the stats:
- Ever since Deng Xiaoping embraced market forces in 1978, the per capita income increased 25X—and 800 million citizens were lifted out of poverty.
- The country had a $18 trillion economy in 2021—and everyone was heralding the start of the Chinese Century.
- That optimism was reflected in household spending—which accounted for almost 40% of the GDP for the past two decades.
- And that GDP continued to grow at an astonishing 9% per year between 2000 and 2019.
- It was a matter of ‘when’ not ‘if’ China outstripped the US as the world’s largest economy. By 2010, China’s GDP was 40% the size of that of America. Most predicted it would be around the early 2020s
Post-pandemic China: presents a far different picture. In 2023, those rosy predictions seem foolish—as the country seems to have hit reverse gear:
- The economy only grew by 3% in 2022—one of the worst performances in nearly half a century.
- Unemployment is at an all-time high of 20.8%.
- Rate of consumption growth has plummeted to 2.8%—a 50% drop from the pre-pandemic number.
- Hence, while the rest of the world battles inflation, China is faced with falling prices. The consumer price index fell 0.3% in July—registering deflation for the first time since the early days of the pandemic
- Total debt held by various levels of government and state-owned companies, climbed to nearly 300% of China’s GDP in 2022.
The future looks no less gloomy:
The International Monetary Fund puts China’s GDP growth at below 4% in the coming years, less than half of its tally for most of the past four decades. Capital Economics, a London-based research firm, figures China’s trend growth has slowed to 3% from 5% in 2019, and will fall to around 2% in 2030.
As one economist sums it up: “We’re witnessing a gearshift in what has been the most dramatic trajectory in economic history.”
China according to Xi
For the past four decades, China’s prosperity and stability was guaranteed by an implicit contract between the government and its people: “no politics, no problem.” Citizens embraced financial well-being as a fair exchange for ceding their personal freedom: “as long as people stayed out of politics, the party would stay out of their economic life.” But underlying this pact was an unsustainable model of growth.
The Chinese model: was built on massive investments in infrastructure—which accounted for about 44% of the GDP. Private companies built factories, skyscrapers, roads and—above all real estate—by taking massive loans from the government. In fact, the booming housing market, in some years, accounted for more than 25% of China’s GDP:
Such heavy spending was made possible in part by a system of “financial repression” in which state banks set deposit rates low, which meant they could raise funds inexpensively and fund building projects. China added tens of thousands of miles of highways, hundreds of airports, and the world’s largest network of high-speed trains.
And these gargantuan projects, in turn, created millions of jobs—which boosted consumer spending. As we noted before, household spending accounted for 40% of the GDP.
But, but, but: There were already signs of trouble in 2018—when around one-fifth of apartments in urban China—or 30 million units—were unoccupied. Here’s one example of how lopsided the model had become:
Guizhou, one of the poorest provinces in the country with GDP per capita of less than $7,200 last year, boasts more than 1,700 bridges and 11 airports, more than the total number of airports in China’s top four cities. The province had an estimated $388 billion in outstanding debt at the end of 2022, and in April had to ask for aid from the central government to shore up its finances.
Enter Xi: When he took power in 2013, the new president was determined to uproot the old ways of doing things. His first target was corruption—which claimed many senior heads within the party. But Xi was equally adamant on dismantling an economy built on debt. He set a fiscal deficit target of 3% of GDP—cracking down on loan-heavy companies.
Xi also pivoted from a model built on consumer spending to one driven by targeted government investments and corporate tax cuts: “The best way to support consumption is through supporting employment, which is believed to be best done by supporting the corporate sector,” via tax cuts. All of which sounded fine until the coronavirus came along.
First came Evergrande: The second largest real estate company grew insanely rich through a loan-supported land-buying spree and selling apartments quickly at low margins. In 2020, it made $110 billion in sales—and had $355 billion in assets. But it also had $300 billion in debt—and many of its properties were never completed or delivered. All of this was fine as long as Evergrande and other real estate companies were backed by government support.
But in 2018, China's central bank said companies including Evergrande might pose a “systemic risk to China's financial system.” When the government pulled the rug, all those IOUs came home to roost. And soon enough Evergrande went into bankruptcy in 2021. And the collapse of the real estate industry has continued to tailspin.
Where we are now: The largest property dealer Country Garden is now poised on the edge of going broke. The housing market wiped out by the pandemic shows no signs of rebounding:
The construction and sale of new homes has stalled. More than 50 real estate developers have run out of money and defaulted or stopped payment on bonds. The companies have left behind hundreds of thousands of unfinished apartments that many predominantly middle-class families had already purchased, taking out mortgages to do so.
Next target: Alibaba: Having imposed credit limits on real estate companies, Xi turned his attention to tech companies—who had turned into global giants. Spurred by concerns that they would become excessively powerful—like their US counterparts—Xi decided to cut them down to size. The first casualty was Alibaba founder Jack Ma—who was pushed out of his own company. And his IPO plans for the financial services and tech giant Ant Group were squelched in 2020. This soon had a domino effect on the rest of the industry—leading to widespread layoffs.
Where we are now: Over the past two years, China's major tech companies have shed $1.1 trillion in value—that’s equivalent to the entire Dutch economy. And share prices of the biggest five companies—Alibaba Group, Tencent, Chinese food delivery giant Meituan, search engine provider Baidu Inc and e-commerce site JD.com—have plunged between 40.4% and 71% during this time.
Point to note: The record youth unemployment rate of 20.8% is 4X the national rate. The reason: “That’s partly to blame on Beijing’s regulatory crackdown on big technology companies in recent years, which took away a lucrative career path for many young, ambitious graduates.”
Quote to note: As the Economist points out, almost all of China’s economic woes can be laid at the feet of Xi’s “new development” philosophy—a form of economic autocracy that has crippled the economy:
Yet in all cases Mr Xi believes the party must take the lead, and implementation has been punitive and erratic. A blizzard of fines, new regulations and purges has caused the dynamic tech industry, which contributes 8% of GDP, to stagnate. And a savage but incomplete crackdown on the property sector, responsible for over a fifth of GDP, has led to a funding crunch—one reason why housing sales fell by 47% in April compared with a year earlier.
The anxious consumer: The clearest evidence of Xi’s high-handed approach is the precipitous fall in personal spending. It all began with the government’s zero-Covid policies—which left millions of people under house arrest—for months without end. Most importantly, a new generation of Chinese realised that their lives relied entirely on the whims of authorities:
Zero COVID was as unsparing as it was arbitrary in its local application, which appeared to follow only the whims of party officials. The Chinese writer Murong Xuecun likened the experience to a mass imprisonment campaign…. What remains today is widespread fear not seen since the days of Mao—fear of losing one’s property or livelihood, whether temporarily or forever, without warning and without appeal.
Where we are now: The ‘no politics, no problem’ contract has been irretrievably broken. This has created what Adam S Posen calls in Foreign Affairs the ‘long economic Covid’—warning that the Chinese consumer may never recover from this shock to their belief system. And this in turn has dampened spending—leading in turn to deflation. Stimulus packages rolled out have failed to spur demand—and companies are now wary of taking on loans.
When an entrenched autocratic regime violates the “no politics, no problem” deal, the economic ramifications are pervasive. Faced with uncertainty beyond their control, people try to self-insure. They hold on to their cash; they invest and spend less than they used to, especially on illiquid assets such as automobiles, small business equipment and facilities, and real estate. Their heightened risk aversion and greater precautionary savings act as a drag on growth, rather like what happens in the aftermath of a financial crisis.
FYI: Personal bank deposits have reached a record high of 133.1 trillion yuan.
Point to note: Many experts have suggested passing money directly to the consumer—as part of a government stimulus package. However, Xi remains adamantly opposed—and in the past has warned against the trap of “welfarism,” which senior officials say can lead to “laziness.”
The bottomline: Some predict that China will follow the path of Japan—which too was slated to oust the US as the world’s economic superpower. It instead was buried in debt for a ‘lost decade’—that irretrievably damaged its potential. Then again, only fools would underestimate China—or for that matter Xi.
Washington Post and CNN offer a good overview of China’s predicament. Bloomberg News explains why Xi seems to be running the economy into the ground. The Economist takes a scathing look at his economic policy. Wall Street Journal (splainer gift link) has the best deep dive into China’s broken economic model. New York Times is excellent on the housing crisis and the deflation problem.