The China Conundrum. Separating Fact from Propaganda
A “conundrum” is defined by the Collins dictionary as a problem or puzzle which is difficult or impossible to solve.
How do you make authoritarianism, communism, and capitalism work together? Attempting to bring fundamentally opposing economic and cultural value systems together in a comprehensible and effective mix seems a near impossible task. However, this is what the modern Chinese economic and cultural experiment has been about.
The approach is fraught with issues. Where do you start?
Autocracy vs Free (er) Markets
Perhaps the easiest place to start is the top. Autocratic systems which invest great power in one individual to "rule" are subject to the idiosyncrasies and whims of that person. Autocracies are in principle at odds with free market forces. However, when Chinese leaders starting with Deng Xiaoping in the 1980's, and his successors during the four decades after, encouraged private sector development, entrepreneurialism, and greater business autonomy, it fundamentally changed China and transformed it into the worlds second largest economy. As we fast forward to Xi in present time, we are seeing a reversal of this policy as XI clearly feels that China and certain billionaires were becoming “too free”. The state has put its foot down on internet and finance companies such as Alibaba and Ant whose billionaire founders were seen as challenging the CCP’s authority. It has also not intervened in the collapse and demise of Evergrande, China’s largest real estate developer, for reasons that may likewise be construed as seeing Evergrande as being too large and exerting too much influence on the economy.
MIT Sloan professor Yusheng Huang view of the current situation in China puts it succinctly…
“My prediction was based on historical facts and data, not on economic theory. In the past, when the Chinese economy succeeded, it was when the private sector was developing, and the government was more flexible and tolerant of differences of opinions. And in the past, when the Chinese economy was doing badly, it was precisely because of the opposite dynamics. We are basically seeing a repeat of Chinese history, when the Chinese state previously restricted economic and political freedom…and with that comes economic stagnation.”
He goes on to conclude that…“The pandemic added insult to injury, but it was not the only factor. In China in the past few years, the market economy and private-sector development have been undermined, globalization has retreated, and political autocracy has increased. These are not conducive factors for growth.”
Debt, Expansion & Reliance on the Government
When faced with the 2008 financial crisis, Chinese premier Wen Jiabao presided over a huge state spending plan of 4 trillion yuan ($555 billion), almost 13% of China’s GDP at the time, focused on infrastructure. That very same plan has created a significant debt issue today, one of several key items that need to be addressed for China to emerge out of its current economic crisis. China’s debt-to-GDP ratio has doubled to 280% since 2008 with the bulk of the liabilities held by 3,000 local government financial vehicles (LGFVs) which were created by local governments to circumvent a central government ban on direct state borrowing. The LGFV’s have largely been a financial failure with an estimated 60% of them holding approximately 32 trillion yuan of outstanding debt and unable to pay interest with their own EBITDA. The local governments are rightly concerned about letting the LGFV’s default on public markets as they believe this will impair their regions access to funding and possibly trigger a run-on government bonds. There are several creative measures that could be deployed to deal with the debt ranging from slashing interest rates, extending repayment terms to a fire sale of all LGFV’s assets or assigning the debt to the central government. Each approach has its drawbacks. A fire sale of LGFVs’ assets for example could trigger a fall in the value of the collateral for bank loans and cause a deeper crisis of confidence. At this time the government is considering a plan that will allow local governments to raise 1 trillion yuan via bond sales to repay the LGFV debt. Irrespective of what direction(s) they take, it is one of several key areas that need to be resolved to get China back on a more robust financial foundation.
It is important to point out that China’s economy unlike the US relies heavily on infrastructure spending. China’s growth is still driven by investment rather than consumption. Investment as a share of GDP is approximately 40%, according to Oxford Economics, which is double that of the United States which relies far more on consumer spending for its economic growth. Even though Chinese households have accumulated significant savings, the worsening economy, diminishing job prospects, falling real estate prices and trauma from years of extensive and punishing pandemic lockdowns have made them reluctant to spend them.
The bottom line is that for China to dig its way out of its current economic crisis it will need the government and by extension regional governments to play their part in stimulating the economy. That being said, Xi is faced with an additional hurdle as he believes the traditional approach to economic stimulus of boosting real estate is not an option at this time given how over-leveraged developers such as Evergrande became and the extent to which they disrupted the market.
China’s Economy is in Decline Fueled by Multiple Trends
The current knee jerk efforts to stabilize the economy, including a government order for banks to buy stocks to stem the fall of stock prices are questionable short-term measures that avoid the bigger systemic issues. China’s economy was about 77 percent the size of America’s in March 2022. Today, it is closer to 68 percent. Rising youth unemployment, an ageing population and a declining labor supply coupled with a widespread loss of confidence in the governments mishandling of the economy are negatives that need to be overcome. Foreign investors are pulling out and private enterprise is retreating. If Xi will not boost property spending and cannot count on consumers to revive the economy, he will need to focus on addressing the regional debt issue.
China is in a pickle largely of its making. The declining Chinese economy will not be mourned by the USA whose relations remain strained and increasingly restricted. A declining Chinese economy will help offset global inflation and shore up the USA’s leading economic role in the world. China will now need to restore confidence economically both domestically and internationally if it is to rebound. The current policies and approach being implemented by XI are unlikely to do that.
The Propaganda wars are of course intricately tied to the process of restoring confidence. Only a day or so ago Mao Ning, a ministry spokesperson, told a regular news briefing.
"It seems that there will be various theories of China's collapse every once in a while. The fact is that China's economy has not collapsed. It has great potential and the fundamentals of long-term improvement have not changed. We are confident and capable of promoting sustained and healthy economic development."
And while this is clearly a stretch, it must also be said that China’s dynamism, hard work ethic and technological savvy in many areas of technology are strengths that cannot be ignored. Chinese universities produce more engineers annually than any other country in the world. China is far ahead in the development of renewable technologies and infrastructure than the rest of the world combined. Perhaps they will focus on heavy investment into renewabl energy infrastructure and all related industries to pave the way forward. This would make sense as they are already the global leader in this industry.
If Xi does not change his approach, it will continue to erode trust in property rights in China and mark a historic reversal of the pivotal policies implemented by former Chinese leader Deng Xiaoping and his successors.
Given the demographic and economic trends, China’s economic growth rate is likely to slow. And while China or more accurately XI has the means to turn the economy around, it will take a far more pragmatic approach, one that rebuilds trust domestically and internationally, or it is hard to see how China will not inevitably lose ground.