With the downbeat economic news and real estate developers staring at bankruptcy, questions about the path of the Chinese economy raise more concerns. Due to the concentration of real estate and banking concerns, the most obvious question is this: Will China have a financial crisis?
Since the 2008 global financial crisis, pundits and analysts have been obsessed with the latest crisis du jour. A type of post-traumatic stress disorder seems to be besetting every self-appointed financial guru with predicting the next collapse.
In defense of the China chicken littles, similarities do exist between 2008 America and 2023 China. Consumers borrowed extensively on the back of rapidly appreciating home values as banks lent excessively to households and developers, failing to account for a variety of risks. China defenders have made a different comparison to the Japanification of the Chinese economy. High real estate prices, coupled with a rapidly aging population and a state-influenced economy, lead to long-term stagnation. Each picture has enough similarities and differences to warrant consideration.
Before attempting to answer this, let us take a step back and ask what exactly constitutes an economic crisis and continued economic growth. To many observers, these questions seem obvious but become more difficult in practice. Would the failure of a major Chinese bank constitute a crisis? What if China unilaterally devalued the yuan by 50 percent? Conversely, what if Chinese growth continues to expand by building more unused infrastructure and homes? We must resist the temptation of requiring history to repeat but allow it to rhyme to make sense of a unique economy with novel pressures and objectives.
The economic event comparisons fail to consider key variables. For example, unlike the United States, Japan, or other countries, we might point to China not being a democracy. In 2008, U.S. voters chose Barack Obama and moved forward, and other countries from Japan to Spain, facing deep economic issues, voted for new representation at various points. China does not have that option. In fact, more than simple discontent with a leader, the Chinese Communist Party (CCP) has staked its ruling legitimacy on delivering results to its people.
We should be very cautious, however, in jumping to the conclusion that any slowdown or event will result in a crisis. The CCP, knowing any financial crisis could result in a once-a-century global event, has a vested interest in ensuring there is no crisis. The very real threat of death or imprisonment has an uncanny ability to focus the minds of regulators and cadres to prevent a crisis.
China has immense resources that will help it to prevent a crisis. From extremely tight control of the population, businesses, and institutions such as media and regulators to opaque data that will help it hide or cover up problems, Beijing has more tools at its disposal to turn back the tide of a financial crisis than any other government probably in history. By no means does this guarantee its ability to prevent a crisis of some kind, but it dramatically improves its ability to prevent it.
However, we should be just as cautious in assuming this implies Beijing possesses the knowledge or objectives to facilitate a healthy functioning economy promoting welfare-improving growth. The CCP continues to prioritize state enterprise and state objectives above a healthy private enterprise and consumer welfare. This has important implications for future growth and crisis avoidance.
Though many conceptualize the low level of household consumption as a policy error, it is, in point of fact, the very heart of Chinese economic policy. By keeping social benefits such as health insurance and unemployment benefits very low, households engage in pre-emptory savings. Those savings are recycled through purchases of real estate with large implicit taxes that flow to government coffers or are deposited at large state banks that fund government priorities in infrastructure and national development. State-directed investment failing to earn a return then requires ongoing subsidies in a variety of forms that come from financially repressed households.
The reality is that China can keep growth going and avoid addressing its financial cancer for many years into the future. GDP growth is, at its core, a measure of activity and does not mean it needs to be productive or beneficial for the workers or investors. To borrow an economic textbook example, an economy can count the labor payment to both dig a hole and then have the laborer who dug the hole pay someone else to fill the hole up. Theoretically, these two workers can pay each other to dig and fill holes up, rapidly expanding GDP even if neither grows richer or more productive.
Since around 2005–2008, Chinese productivity—the primary metric of long-term economic health and rising wages—has been weak at best or even negative, according to some studies. China is effectively digging and filling up holes at a massive level by building so many homes and infrastructure that it will never earn the necessary rate of return.
By continuing to close its economy to imports while maintaining a large U.S. dollar trade surplus, which is expected to account for an amount equal to 10–12 percent of household income in 2023, China can delay confronting the problems but keep infrastructure-led growth and employment high enough to avoid a collapse for some time. This does not mean it will see healthy growth, addressing the underlying financial weaknesses or policies to improve competitive productivity. It means the CCP will keep the economy strong enough to avoid significant events and stay in power.
It is rumored that on a trip to China, the Nobel Prize-winning economist Milton Friedman was shown a valley of Chinese workers building a dam with shovels. His government host proudly commented on all the jobs that Beijing created, to which Mr. Friedman commented, “If it is jobs you want, give them spoons instead of shovels.” China has shovels, excavators, and artificial intelligence in 2023. Unfortunately, those excavators are busy building infrastructure or homes that will go unused, and artificial intelligence monitors worker time spent reading “Xi Jinping Thought” on an app rather than on productivity-enhancing activity.
Do not expect a crisis in China any time soon, but neither should we expect welfare-enhancing growth. The CCP can prevent a crisis and maintain good enough growth by tightening further. Expect more of the same but only worse.
