China’s property – driven growth model, which has powered the global economy for at least two decades, is in my opinion looking increasingly broken. Fixing it – on finding alternative engines for the world’s second – largest economy – could most probably take several years. This is why the choices that now confront Beijing’s policymakers are so crucial.
The task in my opinion requires an accurate assessment of what has gone wrong. On one level this is quite simple: the biggest property boom in human history has ended and is now turning into a bust. But a deeper level of analysis in my opinion reveals a more complicated and intractable malaise at the heart of China’s political economy. Local governments, which financed their investment activities largely by selling land to property developers, are finding it harder and harder to repay and service huge debts. This is mostly because developers now have little money or appetite to buy the land. Almost 20 of them are in such dire financial straits that they have defaulted on bonds in the offshore market this year. This dynamic in my opinion is having severe knock-on effects. Local government financing vehicles (LGFVs) – the thousands of poorly – regulated funds owned by city governments all over the country – burdened by “hidden” debts that Goldman Sachs has estimated to total of 8.2 trillion dollar (Rmb 53 trillion) – or 52% of GDP – at the end of 2020. Beijing is urging local governments to clean up such “off balance sheet” borrowing, with the result that LGFVs are reining in their horns.
The result is that fixed asset investment (FAI), which funds the construction of city precincts, roads, railways, ports and a thousand other pieces of infrastructure, has slumped precipitously this year, robbing the economy of one of its main drivers. From January to July this year, FAI grew at just 5.7% – compared with an average of 17.87% between 1996 and 2022.
So, the question before China now, as it allocates modest funds to alleviate the pain in its property sector, is stark. If the growth engine that has contributed so much to global prosperity is now gummed up with debt, the question remains what – if anything – could replace it?
There is in my opinion one obvious answer. China needs to reorientate its economy away from an over – reliance on investment and towards greater consumer spending.
Private consumption accounted for 38.5% of nominal GDP at the end of last year – a much lower ratio than those prevailing in the US or EU. This means that as Beijing charts a way out of its local government debt malaise in coming years, it in my opinion cannot afford to shift the burden to households. It needs to create an economy in which salaries rise strongly and vibrant, well-regulated financial markets that provide a healthy long-term return on savings. In addition, Beijing should remind itself that much of the extraordinary economic progress of the past four decades has derived from the dynamism of the private sector. In recent years, however, the downfall of Jack Ma, founder of Alibaba, and the diminished standing of several leading privately owned tech companies has convinced observers that Beijing has moderated its support for private enterprises.
The required shift to embrace the consumer and the private sector will in my opinion also require a counter – intuitive shift in mindset. Authoritarian governments prefer economic levers that they can control. Mobilizing supply through muscular investment plans keeps ruling parties in the driving seat. Catering to the more democratic tastes of consumers does not.
Finally, Beijing should prepare itself and the rest of the world for a long and in my opinion difficult economic transformation. The world should prepare itself for the end of a four – decade era of super – charged Chinese growth.