The Chinese economy is suffering through a difficult year. After the COVID-19 lockdowns in 2022, analysts widely expected a buoyant 2023 with pent-up consumer demand and real estate to boost China’s economic prospects.
Then, the harsh reality of 2023—from falling trade levels to bankrupt developers—confronted the second-largest economy in the world. The question being asked by economists and analysts is whether this is a short-term cyclical bump or a long-term structural problem in the Chinese economic model.
Economic data is noisy. Day-to-day, month-to-month, and year-to-year data bounce around and surprise us. However, on average, over longer time horizons, a lot of economic data is actually pretty steady. Real U.S. economic growth has averaged about 3 percent since World War II. Some years have been lower and some higher, but growth in incomes and other variables have very consistent long-term growth. In China, we see similar patterns where even if we don’t accept the official growth, we can clearly see with our eyes the Chinese economy has grown very rapidly for many years to improve living standards.
So are the current 2023 problems China faces that noise factor where it is just a bad year, or are there structural factors that seem likely to change the long-run rate of growth in the Chinese economy for years to come?
Realistically, China faces a structural downward shift in its growth rate that is not simply due to noise. First, although China’s population recently started declining, the working-age population began falling in 2014, which will only accelerate in the coming years. Mathematically, it is nearly impossible for countries to grow total GDP while the number of people working to produce that GDP shrinks. This is not statistical noise or variation but a permanent change in China’s growth rate.
Second, Chinese debt is a structural factor that will inhibit growth in the future. A large percentage of China’s rapid GDP growth post-global financial crisis in 2008 was driven by rapid debt accumulation funding fixed asset investment in everything from high-speed rail to real estate. China is now more indebted than most developed countries across all sectors and is more indebted than countries at similar income levels, like Russia, Malaysia, and Mexico. It will be increasingly hard to increase debt levels at historical rates while keeping banks solvent and borrowers servicing their loans. Most countries increased their debt levels after becoming relatively well off. China no longer has that luxury.
Third, the entire Chinese model will need to change to generate growth. After the 2008 global financial crisis, the majority of Chinese growth came from construction. Government officials tasked with hitting growth targets built enormous amounts of infrastructure with borrowed money. Developers built vast amounts of real estate with borrowed money. The move made sense at the time because China suffered from a lack of infrastructure.
Now, the opposite is true. China has vast amounts of empty real estate with an estimated five years of unsold inventory and excessive infrastructure projects like roads and airports. China cannot continue to boost growth by building more things that no one will use when the current projects are not being used. China has already used up its investment boost dividend and will not repeat itself.
What ultimately determines an economy’s health is something called productivity. In simple terms, how do workers do more with less? Chinese growth benefited from adding lots of investment, such as roads and lots of people to make more things. With the investment model coming under pressure from mounting debts and oversupply and the number of workers falling, the only way to sustain growth in the future is to increase productivity.
Unfortunately, Chinese productivity growth after the 2008 global financial crisis has been very low. Economists argue over how best to measure productivity and measure it over time. Still, there is little disagreement that China has had very low productivity growth, and by some metrics, it has declined since 2008. According to a recent report by the International Monetary Fund, physical and innovative productivity was actually negative on average for firms over two years old in China from 2011 to 2018. Given the subsequent crackdowns on tech and other firms, this productivity decline likely only worsened since 2018.
With state-owned enterprises and state-linked firms faring the worst in productivity studies and new investment overwhelmingly flowing to these firms, China faces a dilemma: a dynamic, innovative, productive economy depends on promoting competition, creativity, private enterprise, and entrenched incumbents to be challenged or even fail. But in 2023, China is not marked by competition, creativity, private enterprise, or challenging of state interests.
China’s structural problems will not be entirely offset by increased productivity; those numbers are simply too large. However, boosting productivity would ease the problems of excessive debt, supply overhangs, and a declining population. However, I would not hold out hope that Beijing suddenly becomes an adherent of private enterprise and market competition. The CCP seems likely to compound the problems of its own making.
