China’s Economy Is in Serious

Trouble

In 2023, the U.S. economy vastly outperformed expectations. A widely predicted

recession never happened. Many economists (though not me) argued that getting
inflation down would require years of high unemployment; instead, we’ve
experienced immaculate disinflation, rapidly falling inflation at no visible cost.
But the story has been very different in the world’s biggest economy (or second
biggest — it depends on the measure). Some analysts expected the Chinese economy
to boom after it lifted the draconian “zero Covid” measures it had adopted to contain the
pandemic. Instead, China has underperformed by just about every economic indicator
other than official G.D.P., which supposedly grew by 5.2 percent.

But there’s widespread skepticism about that number. Democratic nations like the
United States rarely politicize their economic statistics — although ask me again if
Donald Trump returns to office — but authoritarian regimes often do.

And in other ways, the Chinese economy seems to be stumbling. Even the official
statistics say that China is experiencing Japan-style deflation and high youth
unemployment. It’s not a full-blown crisis, at least not yet, but there’s reason to believe
that China is entering an era of stagnation and disappointment.
Why is China’s economy, which only a few years ago seemed headed for world
domination, in trouble?

Part of the answer is bad leadership. President Xi Jinping is starting to look like a poor
economic manager, whose propensity for arbitrary interventions — which is something
autocrats tend to do — has stifled private initiative.

But China would be in trouble even if Xi were a better leader than he is.

It has been clear for a long time that China’s economic model was becoming
unsustainable. As Stewart Paterson notes, consumer spending is very low as a
percentage of G.D.P., probably for multiple reasons. These include financial repression
— paying low interest on savings and making cheap loans to favored borrowers — that
holds down household income and diverts it to government-controlled investment, a
weak social safety net that causes families to accumulate savings to deal with possible
emergencies, and more.
With consumers buying so little, at least relative to the Chinese economy’s productive
capacity, how can the nation generate enough demand to keep that capacity in use?
The main answer, as Michael Pettis points out, has been to promote extremely high
rates of investment, more than 40 percent of G.D.P. The trouble is that it’s hard to invest
that much money without running into severely diminishing returns.
True, very high rates of investment may be sustainable if, like China in the early 2000s,
you have a rapidly growing work force and high productivity growth as you catch up with
Western economies. But China’s working-age population peaked around 2010 and has
been declining ever since. While China has shown impressive technological capacity in
some areas, its overall productivity also appears to be stagnating.
This, in short, isn’t a nation that can productively invest 40 percent of G.D.P. Something
has to give.

Now, these problems have been fairly obvious for at least a decade. Why are they only
becoming acute now? Well, international economists are fond of citing Dornbusch’s
Law: “The crisis takes a much longer time coming than you think, and then it happens
much faster than you would have thought.” What happened in China’s case was that the
government was able to mask the problem of inadequate consumer spending for a
number of years by promoting a gigantic real estate bubble. In fact, China’s real estate
sector became insanely large by international standards.

But bubbles eventually burst.

To outside observers, what China must do seems straightforward: end financial

repression and allow more of the economy’s income to flow through to households, and
strengthen the social safety net so that consumers don’t feel the need to hoard cash.
And as it does this it can ramp down its unsustainable investment spending.
But there are powerful players, especially state-owned enterprises, that benefit from
financial repression. And when it comes to strengthening the safety net, the leader of
this supposedly communist regime sounds a bit like the governor of Mississippi,
denouncing “welfarism” that creates “lazy people.”
So how worried should we be about China? In some ways, China’s current economy is
reminiscent of Japan after its bubble of the 1980s burst. However, Japan ended up
managing its downshifting well. It avoided mass unemployment, it never lost social and
political cohesion, and real G.D.P. per working-age adult actually rose 50 percent over
the next three decades, not far short of growth in the United States.
My great concern is that China may not respond nearly as well. How cohesive will China
be in the face of economic trouble? Will it try to prop up its economy with an export
surge that will run headlong into Western efforts to promote green technologies?
Scariest of all, will it try to distract from domestic difficulties by engaging in military
adventurism?
So let’s not gloat about China’s economic stumble, which may become everyone’s
problem.