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Has China’s Era of Rapid Economic Growth Come to an End?
In last week’s column, we focused on whether China’s period of rapid economic growth had reached its limit. While China still has the potential to catch up with the living standards of the world’s richest countries due to its relative poverty, it faces significant obstacles to sustaining its success. One of the most important hurdles is “underconsumption.”
The past two decades have debunked the notion that economies naturally gravitate towards full employment. Instead, excessive saving tendencies can lead to chronically deficient demand, which must be countered with expansionary monetary and fiscal policies. However, these solutions may create their own set of problems. I extensively explored this point in my book, “The Shifts and the Shocks,” when analyzing the global financial crisis of 2007-09. Excess savings also played a significant role in Japan’s economic decline and the eurozone crisis caused by Germany’s surplus savings.
China’s situation is similar, albeit on a larger scale. In 2008, its gross national savings peaked at 52% of GDP, and even in 2019, before the impact of Covid, it stood at 44%. Before 2008, almost one-fifth of these savings were channeled into China’s current account surplus. However, after the crisis, such surpluses became politically and economically unacceptable. The alternative was increased investment, particularly in property. From 2007 to 2012, gross investment rose from 40% to 46% of GDP.
Interestingly, this surge in investment coincided with a significant decline in the growth rate. The “incremental capital output ratio” (the ratio of investment to growth) increased from three in 2007 to a pre-Covid peak of seven in 2019. This indicates a decline in the return on investments. Additionally, as mentioned in last week’s column, the debt ratio soared, adding financial fragility to the equation.
As early as 2007, Wen Jiabao, then premier, warned that China’s economy was “unstable, unbalanced, uncoordinated, and unsustainable.” Michael Pettis of Peking University’s Guanghua School of Management has echoed this argument at length.
It is impossible to predict when unsustainable processes will come to a halt. However, they inevitably will, as the late Herb Stein astutely stated, “If something cannot go on forever, it will stop.” It appears that China’s unbalanced economy is now being halted by a significant property crash. According to UBS, new property starts in July were 65% lower than their level in the second half of 2020. UBS also expects property sales and construction to stabilize at 50-60% of the peak reached in 2020-21. Since the property sector accounts for around a quarter of China’s economy, this suggests enduring weakness in demand, resembling a Japanese future.
The danger lies not in a major financial crisis, as China is a creditor country, and most of its debts are denominated in its own currency, with its government owning crucial banks. A policy of financial repression would be effective. However, the risk lies in chronically weak demand. It is challenging to generate a significant export boom or consistent current account surpluses in today’s global environment. The investment rate is already remarkably high, while growth is slowing. Further increased non-property investment cannot be justified.
The obvious alternatives are higher public and private consumption. However, higher public spending would require the central government to overcome the financial difficulties faced by local governments. On the other hand, higher private consumption would necessitate a shift in income distribution towards households. Neither seems likely at this point, as the central government appears reluctant to take such drastic measures.
The fundamental reality of the Chinese economy is that household consumption only accounts for about 40% of GDP. This is partly because the household savings rate averaged around 35% of disposable income before Covid. However, the main reason is that household disposable incomes only represent approximately 60% of GDP, with the remaining 40% going to governmental entities, state-owned enterprises, and private corporations. The savings rate of these entities appears to have been around 60% of total incomes, overshadowing the household savings rate.
In reality, China is hyper-capitalist, with a significant portion of national income going to capital controllers who save it. This arrangement worked well during the earlier period of hypergrowth but now leads to savings that surpass productive utilization. Income needs to shift towards those who will spend it. This shift would fuel medium-term consumption growth and long-term consumption levels, creating a solid foundation of domestic demand for future expansion. However, achieving this requires redistributing income and assets to ordinary people and refocusing public spending. Additionally, it demands an early restructuring of existing debts.
This seems to be a critical moment in China’s modern economic history. If the government recognizes that the old high-saving, high-investment model is no longer viable, it can foster reasonable growth through a more balanced consumer-driven economy. A savings rate of around 30-35% of GDP would be sufficient. However, achieving this would require revolutionary changes in income distribution and the government’s priorities. It would be beneficial for China to avoid falling into the same trap as Japan. The question remains: will it take the necessary steps?
Reach out to Martin Wolf at [email protected] and follow him on myFT and on X.
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