Experts React: China’s Economic Slowdown: Causes and Implications
This commentary is previewing a recorded roundtable discussion from Freeman Chair Jude Blanchette and Trustee Chair Scott Kennedy on August 31, 2023, on how best to analyze the Chinese economy with an eye to the future.
Sentiment on China’s economy has grown increasingly negative in the past few weeks, with public discourse variously emphasizing “structural” issues such as debt, demographics, and China's deteriorating relationship with the West. This commentary reflects on the various perspectives and the data on which they are based, discusses metrics for how to judge the Chinese economy’s performance going forward, and considers the implications for the United States and the rest of the world.
It is premature to declare a permanent slowdown.
Senior Adviser and Trustee Chair
Gauging by media coverage, one would be certain that China’s economy is on the edge of a crisis. Reports seem to be universally negative, so much so that my skeptic’s radar is blinking bright red telling me to not accept conventional wisdom so quickly.
Among analysts, most agree with the Council on Foreign Relation’s Zongyuan Zoe Liu and the Rhodium Group’s Logan Wright, also with CSIS, that long-term structural issues, such as debt and demography, are finally biting. The Peterson Institute’s Adam Posen emphasizes Xi’s pro-state interventionism and the negative reaction it is engendering as the main sources of weakness. One contrarian is Posen’s colleague Nicholas Lardy, whose careful reading of the data suggests it is premature to declare a permanent slowdown and shows there are already some signs of a modest rebound.
Although direct observation can yield unrepresentative anecdotes and hence be biased, in an era of limited travel and field research, some sense of what things feel and look like on the ground can be particularly useful. In my case, that involves three trips to China in the past year (September–October 2022, March 2023, and July 2023). In all three, the overwhelming sense I came away with on the economy is a massive crisis of confidence among private businesses and consumers. The lone bright spot—the booming electric vehicle sector—was so discordant that it actually sat clearly in juxtaposition to the dominant foul mood.
Company executives, investors, and consumers I privately spoke with in Beijing, Shanghai, and Hangzhou raised three common concerns. The first is the mishandling of the Covid-19 pandemic, particularly from March 2022, when Shanghai began its lockdown. Lockdowns elsewhere were more partial but still highly disruptive and stressful. The sudden abandonment of zero Covid with no preparation only reinforced these worries. The second is the withering attack on the private sector, particularly internet-based companies, and the emphasis on “common prosperity,” which leads businesspeople to fear that their success cannot be long-lived. The third is the growing rivalry with the United States and other advanced economies. These tensions raise the possibility of war; increase doubts about future access to technology, markets, and capital; and reduce the feasibility of regular travel and engagement with the West.
So many people I spoke with were deeply uncertain about their country’s future and their own prospects. These anxieties appear to have translated into increased savings and less investment and consumption. My sense is that although the real estate sector’s malaise is squeezing pocketbooks, the broader drop in confidence is less tied to the popping of the property bubble and more to do with a sense that the country is broadly going in the wrong direction.
If this is the case, then although authorities need to tackle debt and demography, the real challenge is to re-instill a sense of a common positive purpose about China which the public accepts, reduce tensions with the West, and demonstrate basic competence in governance. Such changes will not necessarily result in an economic boom, but they would rebuild a sense of optimism that would generate greater popular acceptance—and possibly happiness—with whatever economic outcome would emerge.
Nothing has replaced the property sector as a driver of growth.
Senior Associate (Non-resident), Trustee Chair
The slowdown in China’s economy is structural, dating from the end of China’s unprecedented credit and investment expansion. Simply put, the factors that sustained China’s growth at high rates after the global financial crisis cannot be repeated in the next decade, particularly in terms of property construction and local government investment.
The property sector was surprisingly resilient for a few years after Beijing’s deleveraging campaign, in part because developers replaced one form of borrowing from shadow banks with revenues from sales of homes before construction had even started. But when sales started declining—a trend exacerbated by lockdowns and Covid-19 restrictions in 2022—developers suddenly needed to cut back on new land purchases and new construction, while leaving homebuyers waiting for their homes to be delivered. The property sector’s decline has been the primary channel through which China’s economic slowdown has manifested, given that the industry represented 20 to 25 percent of GDP at its peak. New annual housing starts are down 57 percent, and the sector will likely remain below half of its previous size over the next decade.
Nothing else in China’s economy has replaced the property sector as a driver of growth, which explains why economic growth has slowed so dramatically over the past two years. Compounding these problems has been the Chinese leadership’s crackdowns on dynamic private sector firms and industries, such as the internet platform companies and education and tutoring firms. The campaigns have ended, but the damage to private sector confidence will take much longer to repair. Employment among small businesses and service sector enterprises suffered considerably under Covid-19 restrictions and has not yet healed, impacting household incomes and consumer spending.
Against the scale of these challenges, policy support for the economy has been piecemeal, reactive, and limited in scope. Fiscal policy cannot respond to these challenges given that local government debt burdens are limiting infrastructure investment growth. In addition, the centralization of China’s political system has weakened the credibility of anyone not named Xi Jinping in delivering confidence-building messages that the leadership intends to change course.
Implementing solutions will be especially difficult.
John L. Holden
Senior Associate (Non-resident), Trustee Chair
There is good reason to believe that in the period leading up to its 18th Party Congress in 2012, a consensus was formed among top leaders in the Chinese Communist Party that China’s future looked bleak because the party had lost its way and its leadership had become ineffective. Over the subsequent decade, Beijing has been on a path to recentralize power and to control behavior through anticorruption and ideological campaigns. Whether or not these approaches have achieved their political goals, they have weakened innovation and sapped entrepreneurial energy, and also blinded leaders to the fact that in many cases the core problem is not corruption but the state-sponsored incentive systems to which it is parasitically attached.
Without fundamental reforms, corruption will always be a feature of policy transmission mechanisms in China. Implementing solutions to the many structural and cyclical problems China faces would be daunting for any polity. However, in a system that has become conditioned to the current set of rewards and punishments, it will be especially difficult.
Looking ahead, observers of China will be alert for evidence that the calculus of risk/reward is changing. Will the country’s central economic planners and managers be given more leeway to craft innovative policies? Will entrepreneurs risk their capital in new ventures that are not tied to the state’s apron strings? And will local officials experiment with solutions to local problems?
The answers to these questions may hinge on discussions in the secret conclaves of Zhongnanhai about whether China’s future is now assured and whether it is no longer necessary to view everything through the lens of national security. Stay tuned.
We should not underestimate China’s capacity to muddle through.
Senior Associate (Non-resident), Trustee Chair
Many commentators have viewed recent data out of China as presaging a major slowdown in China’s economy with attendant new risks for China and the world. One question is what all this means for China’s interactions with trading partners like the United States. Will China be defensive and distracted or receptive to certain economic reforms? Or will it be more willing to make trade compromises to keep the external environment calm as it focuses on the domestic front?
For starters, it is important to recall that China has faced significant economic challenges in the past and somehow has muddled through. We should not underestimate China’s capacity to muddle through again, even if its glory days of super high economic growth are a thing of the past.
China’s economic difficulties will not make things much easier for Washington and its other trading partners. No one should assume China’s current worries will make it any more ready to make concessions. In fact, it may be less ready in many instances.
China does not negotiate outcomes that are against its perceived self-interest. That self-interest includes both the impact of substantive policy and the critical dimension of “face”—how the outcome comports with China’s sense of importance and image. President Xi has inveighed against U.S. export controls, sanctions, and investment policies that he says are intended to keep China down and that are leading other countries in the wrong direction. Baseline, then, from a “face” perspective, China will resist any economic outcome that helps the United States.
Xi also has made clear that China needs to reduce dependence on the West, so if China agreed to any market reform measures, it would have to facilitate only the “quality investment” Xi is seeking. That means only encouraging foreign participation in sectors where China feels it is behind and wants to bring in foreign expertise—for the time being. This would be a fraught area for any U.S. negotiator.
On top of these existing constraints on reaching major trade or commercial outcomes, if Chinese officials are feeling stressed by the economic challenges China faces, they are likely to be more cautious in negotiations with market economies, not less. Proposed changes to China’s policies would need to have no Chinese political downsides and promise significant upsides, both in terms of substance and China’s image to ensure Chinese negotiators would not be punished for agreeing to them.