Understanding the Biggest Challenges in the Chinese Economy Today
Growth in the Chinese economy from 1978 to today
The Chinese economic reforms initiated in 1978 have led to an astonishing 10% y-o-y growth in the Chinese economy. If we measure in dollar value, the Chinese GDP has risen from US$147.3 billion in 1978 to a mind-blowing US$11.2 trillion in 2016!
Take motor vehicle production for example. China has produced over 28 million motor vehicles in 2016, a 14.5% increase over the previous year. In comparison, the US, the world’s second largest producer, manufactured a little over 12 million vehicles, registering a 0.8% growth.
If anything, this growth in the Chinese economy has been a big success story.
The Chinese economic growth has lifted over 800 million Chinese out of poverty in the past decades. However, in the recent years, the expansion of the Chinese economy has tapered off. In fact, GDP growth figures are currently in the 6% to 7% range, instead of the former double digit growth.
So, what are the factors behind the slowdown in the Chinese economy?
Ironically, some of the elements that have contributed to the growth of the Chinese economy are now pulling it down. Previously, easy access to capital from state-controlled financial institutions and the availability of plentiful and cheap labour have helped the country register double-digit growth.
Today, these same factors, the misallocation of capital and the country’s changing demographics, are resulting in slowdown of the Chinese economy.
China’s ballooning debt poses a danger to the Chinese Economy
A recent report in the Financial Times points out that China’s debt to GDP ratio has mushroomed from 140% during the 2007-08 financial crisis to 260% by end of 2016. In absolute terms, China’s debt has increased from US$6 trillion to US$28 trillion.
This massive increase was due to state-run banks injecting easy loans into the system, based on directions from the government.
China debt explosion (Source: Financial Times)
While the rapid increase in credit has fueled the Chinese economy, its level is now assuming alarming proportions. According to a statement issued by the International Monetary Fund, “International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown.”
So, if increasing debt levels have helped the Chinese economy in the past, why shouldn’t the government continue with this policy today?
There are several reasons why this solution will not work now.
The IMF points out that increasing amounts of debt are required to produce the same level of economic output. In fact, data shows that 3 times as much credit was required in 2016 to achieve the same level of growth as in 2008. Additionally, large amounts of credit have gone into financing the country’s state-run “zombie” companies. These firms require constant inflows of capital from external sources to stay afloat.
So, is the increase in debt going to slow down anytime soon? Apparently, the IMF doesn’t think so. It projects a debt to GDP ratio of 300% by 2022.
Increasing debt has led to the formation of asset bubbles
The rising Chinese debt has also contributed to an alarming increase in Chinese property prices in recent years. For example, a 100 square metre apartment in Beijing costs about Rmb5 million today. That’s three-quarters of a million US dollars. An average Beijing resident would take 50 years to earn that amount!
Commenting on rising residential real estate prices, China’s president Xi Jinping remarked that, “houses are for living in, not speculating on.”
The easy availability of money has prompted Chinese investors to venture overseas as well. Early this year, British Land, one of the developers of the “Cheesegrater” building, announced that a sale had been finalised to Chinese investors. The 46-storey building was sold at an all-cash price of £1.15 billion. This was 26% more than the valuation of £915 million arrived at in September last year!
Overcapacity in a range of industries
Another challenge faced by the Chinese economy today is overcapacity in Chinese industries. Over the last few decades, China has improved its infrastructure to a level comparable with its western counterparts. The US$35 billion Beijing Shanghai High Speed Railway project and the US$16 billion Jiaozhou Bay Bridge are two salient examples of China’s massive investment in infrastructure.
But the industries that have provided the raw material for these ventures are now suffering from major overcapacity. The Chinese is now making concerted efforts to cut down on production levels of cement, glass, and aluminium. In the next three to five years, it has been reported that China plans to close around 500 million tonnes of coal capacity, and 100 to 150 million tons of steel capacity.
How will the Chinese economy be affected by the overcapacity of these industries? This remains a serious question that is left to be answered.
An aging population limits growth potential of the Chinese economy
For 36 years, China has followed a one-child policy. This has led to a highly skewed demographic ratio. By 2050, the dependency ratio (the ratio showing the number of dependents, aged zero to 14 and over the age of 65, to the total population, aged 15 to 64) will likely rise to 44% based on estimates.
Share of population aged 60 or older (Source: Statista)
In the immediate future, the rising number of retirees is going to have a significant impact on the economy. In fact, China’s factories, which thrived on the virtually unlimited supply of cheap labour, are already feeling the pinch.
Tackling the challenges facing the Chinese economy
By boosting growth with unsustainable amounts of debt, China’s policy makers may have postponed the Chinese economic problems. The IMF says that in the five years from 2012 to 2016, growth of the Chinese economy would have been maintained at 5.5% per year if debt levels had been increased gradually. Instead, the government chose to use debt to fuel growth and registered a rise in GDP of 7.25% every year.
Will the country manage to overcome the problems that it faces? The Chinese government has said that it will double the size of China’s economy between 2010 and 2020. Considering the mountains of debt, will the growth of Chinese economy be sustainable?
It is important to remember that a large portion of the debt is owed by state-owned enterprises to state-controlled financial institutions. This means that the Chinese government has the means to manage the debt situation more effectively. In fact, in July this year, Chinese banks extended loans totalling Rmb 825.5 billion, which is down from Rmb 1.54 trillion in June. Although part of this drop is seasonal, it is clear that China is well aware of its debt problems and is taking measures to rein in its financial sector.