China’s slowdown shaped by four major problems
China’s economy has continued to struggle in 2024, laying to rest any remaining hopes of a strong post-pandemic recovery. Instead of a rapid rebound as many analysts predicted, China’s reopening boom never materialised. It also appears that the Chinese government is not inclined to make major changes to its economic management and the high-profile Third Plenum came and went without significant reforms being announced.
The country’s economic trajectory can be traced back to four major issues: first, the real estate market is in a protracted downturn; second, Chinese consumers have held back their spending after the economy reopened; third, deteriorating local government finances threaten a sharp slowdown in investment; and, finally, China’s private sector ‘animal spirits’ remain weak after the policy crackdowns of the past several years.
Real estate correction
The housing market is in disarray, with millions of unsold apartments, bankrupt real estate developers and homebuyers losing confidence that pre-sold units will be delivered and prices will not fall further. Decades of excessive investment and property developers with balance sheets stretched to the point of breaking meant that the real estate market was headed for a painful adjustment irrespective of government policy. However, rather than trying to orchestrate a gradual rebalancing, the Chinese government abruptly pushed the housing market into a sharp correction through Covid-19 lockdowns and poorly designed policies like the ‘Three Red Lines’.
Government rescue plans for the housing market, such as buying up vacant apartments, have been inadequate given the scale of the problem. Housing sales in 2023 were below that of 2017. Sales in 2024 are on an even lower trajectory. The sheer volume of housing built over the past decade and a shrinking population mean that new housing demand in China may never return to its previous highs. As a result, real estate is unlikely to regain its former role as a catalyst for economic growth.
Weak consumption
After China reopened, private consumption recovered much more slowly than economists had anticipated. As shown in Figure 1, China’s retail sales, a high-frequency proxy for household consumption, remain substantially below their pre-pandemic trend.
Chinese homeowners face a negative wealth effect, with their net worth declining as property prices adjust downwards. Coupled with growing concerns about the economy’s direction and high unemployment, particularly among young people, households are being prompted to cut back on spending. Surrounding these challenges is the government’s reluctance to provide significant stimulus directly to households, which has further dampened consumption.
To date, government policies to promote consumption have been piecemeal and small-scale. Instead of sending direct financial supports to households such as stimulus checks or improving the social safety net – two approaches that would likely spur new spending – the government has instead been pushing rebate programmes and nebulous efforts to promote ‘consumption upgrading’.
Fiscal problems
Adding to China’s economic malaise are deep-rooted problems in its fiscal system. Local governments, which play a significant role in driving economic activity, have been overextending themselves by spending tremendous amounts on infrastructure and services for their cities, much more than their official budgets can support. To bridge the gap, they use off-balance sheet entities called local government financing vehicles to issue debt. This method has allowed local governments to invest large amounts in infrastructure they would otherwise be unable to afford. According to the International Monetary Fund, China has funded over $3.8tn in infrastructure spending through off-balance sheet borrowing since 2018.
However, the consequences of this off-balance sheet borrowing are ballooning debt levels and financial instability. Many local governments are cash-strapped, cutting essential services and delaying salary payments to civil servants. Beijing is pressuring local governments to clean up their finances and reduce off-balance sheet debts. Without fiscal reforms to create new and more sustainable revenue sources, local governments will have to reduce infrastructure investments and other spending sharply.
A constrained private sector
The business environment is the final major factor impacting China’s growth. The country’s economic miracle of the past few decades can largely be attributed to private economic activity displacing poorly run state-owned enterprises.
Yet since 2015, Chinese President Xi Jinping has pursued policies that have systematically benefitted state-owned companies at the expense of the private sector. This has been done to reassert the Communist Party’s control over the economy and combat sources of instability associated with free markets. It has significantly impacted growth because more productive private companies no longer displace inefficient state-owned enterprises at nearly the same rate.
The fall in private investment began in 2015 and accelerated sharply during the pandemic (Figure 2). While private companies have slowed their investments, state-owned enterprises have used their privileged access to bank loans and capital markets to entrench themselves further.
Given the severity of the challenges private companies face and their impact on the economy, Beijing has started to recalibrate its approach. The Chinese government is now actively discussing ways to improve the business environment and create a more level playing field for the private sector. However, as long as the CCP refuses to relax its grip over large swathes of the economy, private companies will face challenges growing.
A cloudy outlook
China faces a daunting task in unwinding several decades of overinvestment in real estate – it will likely take years to resolve. At best, policy-makers can try to reduce the negative drag of housing on the economy and prevent financial instability. While China has capacity to address its other economic problems – weak consumption, strained local government finances and a constrained private sector – doing so requires Beijing to correct course and embrace significant reforms. China is not predestined to have a long-term economic slowdown, but poor policy choices make it much likelier.
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