Economics/Class Relations

What’s wrong with China’s economy?

What’s wrong with China’s economy? Victor Shih on the causes, effects, and global reverberations of a big slowdown in the world’s biggest country.
Hiurich Granja
Since the outbreak of Covid, China’s economy has been straining. Recently, Beijing announced stagnant GPD growth for the second quarter of the year—up just 0.8 percent from the first quarter, while exports declined by 12 percent and domestic retail and property sales remained low. Youth unemployment is hovering around 20 percent.

After the country fully reopened in late 2022—following nearly three years of hard pandemic lockdowns—it hasn’t been able to get its economy moving again. China’s main global rival, the United States, saw GDP growth of 2.4 percent in the second quarter, as U.S. inflation continued to fall—defying many economists’ forecasts of recession. The pattern is historically unusual for the People’s Republic. For decades, the Chinese economy has been expanding vigorously, with annual GDP growth regularly hitting government targets of 7 and 8 percent. What’s going on now?

Victor Shih is the Ho Miu Lam Chair in China and Pacific Relations at the University of California, San Diego, and the author of Coalitions of the Weak: Elite Politics in China From Mao’s Stratagem to the Rise of Xi. To Shih, under the lingering effects of Covid, deeper and more intractable problems have been building in the Chinese economy for years, and they’ve come to a point now where they’re preventing Beijing from using its traditional policy repertoire to drive growth.

In the meantime, these economic problems are stoking fears about the future among the Chinese people—and forcing the Chinese Communist Party’s leadership to do what it can to improve ties with the U.S. and other Western countries. But for Shih, it’s still uncertain whether a new, low-growth China will ease other countries’ security concerns about it, as Beijing continues with its financial support for export firms in critical industries and its steadily increased military spending.

Michael Bluhm: What do you see behind the slowdown?

Victor Shih: There are short-term causes and, I think, long-term causes.

In the short term, the country is still suffering in the aftermath of the Covid lockdown, which had a massive impact on the economy. In the U.S., the federal government gave enormous aid to businesses, big and small. But in China, the central government only helped the manufacturing sector; it didn’t help the service sector at all. So a lot of Chinese service firms ended up shuttering during the pandemic—and ultimately couldn’t come back.

Another short-term cause was that Beijing picked a bad time to roll out restrictive policies on lending to the real-estate sector. For many years, the sector had been highly leveraged, with developers beginning to build up dangerous amounts of debt—as you and I discussed back in 2021. Now, the Chinese state did need to regulate lending to real-estate developers, but this was just a really bad time to do it.

Suddenly, these highly leveraged Chinese real-estate companies couldn’t borrow more money, so a lot of them had trouble completing projects. Which really threw a wrench in the works. Even developers who weren’t in any immediate financial trouble hesitated to invest—either because they hoped to buy in-progress projects from other developers who were in trouble, or because they worried that home buyers would be less likely to buy new properties.

As to the long-term causes, there are at least two big ones.

The first is a demographic trend: China’s population is rapidly aging. The average age in China—especially in the workforce—is rising dramatically. The overall population and the working-age population are meanwhile shrinking very fast—which is going to weaken a major pillar of China’s economy that was never that strong to begin with: household consumption.

In the U.S., household consumption makes up more than 60 percent of GDP, but in China, that number is less than 40 percent. The Chinese population is aging, and Chinese households’ ability to spend is falling faster than their incomes are rising. Really, today, it’s debatable whether they’re rising at all.

Even beyond these demographic dynamics, household consumption is a long-term problem. Although China is a communist country, it provides only a minimal amount of social-welfare spending. The state gives health insurance almost only to urbanites working either for the government or for a relatively few state-owned enterprises. As a result, Chinese households tend to save a lot, because they know no one is going to take care of them if anything bad happens. Households with below-median incomes, in particular, usually have very little savings.

There are geographic dynamics that are critical, too: Both the real-estate dynamic and these longer-term factors hit smaller cities particularly hard. So, even though the biggest cities are huge compared to them, these hundreds of smaller cities make up a major part, if not the majority, of China’s economy.

Alvin Leopold
More from Victor Shih at The Signal:

The most visible sign of China’s economic malaise is youth unemployment. The official rate is 20 percent, but some Chinese economists have calculated it at 48 percent in certain provinces, discounting part-time internships. There aren’t any easy solutions here. Very few unemployed young Chinese can find work in another country, as unemployed young people in the EU might be able to. Further education would be costly. And youth unemployment is now affecting college graduates. There are still a lot of jobs in manufacturing, so the government is rolling out programs to encourage college graduates to take blue-collar or farming jobs. But families with a college graduate—even families in the lower middle class—don’t find this appealing. Parents worked very hard to save enough money so their children could have better employment prospects. But the economy isn’t providing that now, and this is a huge problem for parents whose children aren’t finding gainful employment.”

Back in 2020, some in China believed that Covid would enable them to make a great leap over the United States in their economic status. They expected the pandemic would unleash terrible damage on the U.S. economy, whereas China—because it controlled Covid very successfully—would continue to grow, and so would rapidly catch up to the U.S. As we know, reality didn’t bear out those expectations. In the U.S., the Paycheck Protection Program and direct government support for households successfully enabled strong economic growth—not just in late 2020 but continuously through today. China gave some subsidies to export-oriented manufacturing, and that industry is still doing well, but household consumption remained very weak on account of the absence of almost any direct help for households. The Chinese leadership realized in 2022 that their projections didn’t pan out, and that they still needed the U.S., because the U.S. remains the biggest consumer of finished goods.”

China’s very aggressive mercantilist policies—policies that use government finances to support certain domestic industries—led to a political backlash in the U.S. But even some countries that always thought of themselves as having a very complementary relationship with Chinese manufacturers are now realizing that Chinese companies are serious competitors. And so those countries are reassessing their economic relationship with China. This has dovetailed with an aggressive effort by the U.S. to get countries around the world thinking about China as a potential risk. A lot of those countries ignored the U.S., as Germany did under former Chancellor Angela Merkel—partly because of her poor relationship with Trump. But today, the message of China being a risk factor has increasing resonance around the world on account of the rising economic competition China represents. Beijing is trying to fight that, which is why it’s engaging in this diplomatic offensive.”

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