Aran Woo

Since Deng Xiaoping initiated economic reforms and an open-door policy in 1978, China’s economy has undergone unprecedented and rapid growth. The subsequent restoration of diplomatic relations with the United States, low exchange rates through the single currency system, and accession to the WTO attracted massive foreign capital inflows. China’s cheap labour and rents further solidified its position as the world’s factory.  

Internally, under the collective leadership of the Communist Party, China mirrored the post-World War II development patterns of many European countries by investing over 40% of its GDP in the development of social overhead capital (SOC). This internal growth efforts accelerated after the export slump that followed the 2008 global financial crisis. The real estate market, in particular, has grown to account for nearly 30% of GDP.  

Fuelling an unprecedented construction boom, China’s urbanisation rate, which stood at 19.7% in 1978, soared to 59.6% in 2018. Local governments, property construction companies, banks, and individual property owners all could profit immensely from this high demand. Financial instruments with low interest rates pumped out by local banks further stimulated investment and domestic demand, and the wealth generated from real estate flowed into financial markets to generate further wealth. This rapid economic growth propelled China to become the world’s second-largest economy, and some have predicted that it could surpass the United States in the near future.  

However, the coronavirus lockdown severely impacted China’s exports as the global economy contracted. Real estate, once a growth engine, plunged the country into a crisis. Property prices, which had been built recklessly without regard for demand, fell sharply, and many debt-financed construction projects were halted or abandoned, leaving 130 million homes vacant. 

In the meantime, many real estate companies faced a liquidity crisis as the Chinese government deleveraged the industry by regulating loan-to-value ratios in 2020 to ease the property bubble. Following Evergrande’s default in 2021, Country Garden, the top real estate developer in China, also defaulted on its dollar-denominated bonds last year. The decline in property demand proved fatal for Country Garden, which builds over 60% of its constructions in small and mid-sized cities. This crisis extended to other companies along the supply chain, banks, local governments, and related financial firms. 

Furthermore, China is losing momentum in its conventional growth model, marked by higher wages compared to the past and a diminishing birthrate. The working-age population, aged 16 to 59, peaked at 997 million in 2014 but fell to 876 million in 2022, a decline of more than 100 million. Compounding this issue is China’s declining birth rate, which reached 1.09 in 2022, pointing toward a concerning outlook for the country’s working-age population. Simultaneously, the growth in total factor productivity, a measure of a efficiency of factors in production, has only remained above 1%, while shrinking labour and lack of innovation have contributed to a widespread decline in corporate profits. 

The ongoing trade war with the US has exacerbated the challenges on China’s economy. The average tariff rate of 20% in the Trump administration has been maintained under the Biden administration, and Mexico dethroned China as the largest importer of the US. Intensifying the impact of the decline in global demand during pandemic, the trade war has severely hurt China’s export. Furthermore, China’s efforts to advance its artificial intelligence (AI) sector, crucial for its transition to a technology-intensive economy, face obstacles due to US government pressure on Nvidia to stop supplying $5 billion worth of AI semiconductors to China. 

Moreover, experts argue that President Xi’s strong regulation of domestic companies has increased investment risks. In contrast to Deng’s emphasis on market autonomy during the reform and opening-door era, Xi has prioritized socialist values, advocating for ‘common prosperity’. This approach has resulted in increased control over private enterprises, notably seen in the crackdown on Didi Chuxing and Alibaba for alleged anti-competitive practices. Both companies faced substantial fines, with Didi Chuxing being delisted from the US stock market, causing a sharp decline in Chinese big tech stock prices and prompting a significant withdrawal of foreign investors. 

Furthermore, Xi’s assertive diplomatic stance and territorial disputes with neighbouring countries have also disrupted geopolitical stability. Coupled with the aforementioned negative indicators, this has elevated uncertainty and investment risk in China, leading to capital outflows. Despite the strong performance of global equity market, foreign funds were net sellers of $2.6 billion in Chinese equities in January 2024, redirecting investments to other Asian countries such as Japan, Vietnam, and India. 

China predicted that the reopening in January 2023 would boost its domestic market to overcome its negative economic indicators. However, consumers who have suffered financial hardship for three years have not followed along these predictions. This contrasts with other countries that experienced aggregate demand shock and inflationary pressures. In China, where home prices constitute 59% of households’ total assets as of 2019, the decline in property values has significantly impacted tightened spending, amplifying deflationary fears. The increasing real debt burden on households, without a corresponding rise in prices, has dampened consumption, exacerbating deflationary trends. Specifically, the producer price index and consumer price index have been negative for 14 and 2 consecutive months respectively. The combination of shrinking disposable income and reduced consumer confidence has hindered China’s economic performance, falling short of expectations since the reopening. 

Additionally, Chinese youth face significant challenges with high unemployment. In June 2023, the youth unemployment rate was reported by the government at 21.3%, and not released since. However, the experts criticised that this is underestimated and that the figure rises to 46.5% when including millions of individuals who are unwilling to work and are not actively participating in the labour market. This alarming situation, where one in two young people is unemployed, results from a mismatch between supply and demand in the labour market.  

China is grappling with labour shortages in blue-collar and low-paying service jobs, but these are not the positions sought by Chinese college graduates. On the other hand, the tech companies desired by them are downsizing due to regulations, and the focus of companies on reducing debt rather than initiating new projects and job creation, further exacerbate the issue. Additionally, overseas companies are finding limited incentives to return. 

Widespread frustration with this deflation and unemployment is evident across Chinese society. Some homeowners are refusing to pay their mortgages, and data from Freedom House indicates 651 housing-related protests occurred in the six months from June 2023 as construction workers and homebuyers protested unpaid wages and falling prices. In response, the Chinese government has employed measures such as surveillance, detention, and censorship. 

Chinese youth are expressing their discontent through passive resistance, taking on jobs as day labourers, or opting out of the economy by joining Tang Ping(躺平) movement. The government has urged youth to be flexible about jobs and called for patience, but deflation coupled with strict coronavirus lockdowns has built up social discontent. Numerous Western media outlets caution that China’s prolonged economic downturn may lead to widespread social discontent and pose a crisis for the Communist Party’s political system. 

The Chinese government has officially denied deflationary concerns and worked to manage public opinion while implementing measures to stimulate the economy. The loan prime rate (LRP), serving as the interest rate, has remained unchanged for the fifth consecutive month, following a modest decline. This move is considered lukewarm but reflects the government’s apprehension about potential overheating in the real estate market and the depreciation of the yuan. The government also unveiled plans to boost the stock market, including a reduction in stamp duty. In addition, reports from Bloomberg indicate that the Chinese government will inject $27.8 billion into the market to stabilise it. Furthermore, the head of People’s Bank of China announced a 0.5% reduction in the deposit reserve requirement ratio from February 5^th to enhance liquidity. 

To prevent deflation from evolving into a prolonged recession, essential changes are necessary to rebuild market confidence and alleviate reduced consumer sentiment resulting from excessive government control. This means that it may be a difficult task to overcome the crisis without clear steps toward business deregulation and aligning practices with international standards to address internal and external uncertainties. 

China’s rapid economic growth, US restraint, subsequent property bubble burst, and ageing population draws comparisons to the beginning of Japan’s three lost decades. However, China’s situation appears even more challenging. The country finds itself falling into the middle-income trap, with a GDP per capita of $12,850, below the World Bank’s threshold for high-income nations. In contrast, Japan had a per capita GDP of $45,000 just before its economic bubble burst in the late 1980s. If China fails to address its current challenges promptly, it risks experiencing a longer and more severe economic downturn than Japan’s. Indeed, global markets are closely observing China’s next moves. 

Bibliography 

Bloomberg. (2024, January 23). China mulls stock market rescue package backed by $278 billion. Bloomberg. https://www.bloomberg.com/news/articles/2024-01-23/china-mulls-stock-market-rescue-package-backed-by-278-billion?leadSource=uverify%20wall. 

Brands, H., & Beckley, M. (2022). Danger Zone: The Coming Conflict with China. W.W. Norton & Company. 

Freedom House. (n.d.). China Dissent Monitor. Retrieved January 25, 2024, from https://chinadissent.net. 

Krugman, P. (2024, January 18). China’s Economy Is in Serious Trouble. The New York Times. https://www.nytimes.com/2024/01/18/opinion/china-economy-xi.html#:~:text=Some%20analysts%20expected%20the%20Chinese,supposedly%20grew%20by%205.2%20percent. 

Wright, L. (2023). Grasping Shadows: The Politics of China’s Deleveraging Campaign. Center for Strategic and International Studies (CSIS). https://www.csis.org/analysis/grasping-shadows-politics-chinas-deleveraging-campaign. 

Zhao, W., & Ruet, J. (2021). Managing the “Post Miracle” Economy in China: Crisis of Growth Model and Policy Responses. Post-Communist Economies, 33(7), 820-841. doi: 10.1080/14631377.2020.1867427. 

Zhen, S. (2024, February 6). Foreign funds sold net US$2.6 bln of China equities in Jan – Morgan Stanley. Reuters. https://www.reuters.com/markets/asia/foreign-funds-sold-net-us26-bln-china-equities-jan-morgan-stanley-2024-02-06/.