For almost half a century, Chinese officials have overseen one of the greatest economic transformations in human history.
The country has gone from collectivized farms and famine to world-leading tech companies and gleaming megacities connected by superfast trains.
More than 800 million Chinese have been pulled out of poverty as the Communist Party and its leader Xi Jinping string together (according to the party’s numbers) decades of uninterrupted growth.
But the economy is now at another turning point.
In an effort to control what it sees as the excesses of the market, and to limit companies’ power and influence, the party has deliberately swept the legs out from under giants like e-commerce titan Alibaba and ride-hailing upstart Didi, wiping out billions of dollars of market value from China’s most dynamic enterprises.
Evergrande, the massive property developer on the brink of collapse, shows that China’s real-estate boom could be unraveling, with the possibility of sickening the entire economy. (On Oct. 13, after Evegrande missed yet another scheduled coupon payment, borrowing costs for China’s riskier firms soared to record highs.)
If that wasn’t enough, president Xi Jinping also has to manage an electricity crunch—triggered partly by his own aims to cut carbon emissions—that could wear down manufacturing and industry.
These problems come at a sensitive time, for both China and the world. At the party congress next year, Xi may look to secure an unprecedented third term in office, after he abolished the term limits on the presidency in 2018.
The party depends on muscular economic growth to retain its perennial grip on power.
“This was the Faustian bargain, never really explicitly stated but understood, that you get zero political representation but we keep the economy ticking along,” said Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise and a former equity-derivatives trader at Morgan Stanley.
But, Howie said, clearly that bargain is “starting to fray around the edges.” Symptoms of an imbalance in the economy include widening inequality, a dangerous dependence on real-estate, climate-change risks, and high levels of both corporate and consumer debt.
The government’s reforms aim to make life better for rank-and-file workers and their families, and maintain power, but they could also derail the economy as market forces are replaced with even more party control.https://datawrapper.dwcdn.net/IstSl/1/
Elsewhere too, a slowing-down of the Chinese economic engine—at a time when the world is struggling to recover from the pandemic—presents an alarming prospect for investors and policymakers. The question is unavoidable: What would a contracting Chinese economy mean, for both China and the world?
How one building block of China’s economy broke down
It’s hard to overstate how important real estate has become to Chinese growth, and it’s a story that goes back three decades. Soon after the Tiananmen Square protests in 1989, the Chinese government instituted a series of economic reforms.
One of them was to “put all the responsibility for social services on local governments and yet give them none of the financing,” said Anne Stevenson-Yang, the co-founder of J Capital Research, which publishes reports on Chinese listed companies.
The solution that the local governments came up with, Stevenson-Yang said, was to monetize land. They’d borrow money to buy up small adjoining patches of farmland or housing, then sell the aggregate to a real estate developer.
Everyone seemed happy, Stevenson-Yang said: “The government got taxes from all the cement plants and steel mills and construction companies. The local governments could keep borrowing and selling.
The people who lived on these small plots of land could move into the high-rise complexes that were built there. No one had an incentive for this cycle to decline.”
For the government, real estate offered an easy way to fend off worries of flagging growth—perhaps too easy. Housing in large Chinese cities is among the most expensive in the world when measured as a share of income.
Property, including construction and related industries, now accounts for roughly a third of the country’s gross domestic product, according to now widely cited estimates by Kenneth Rogoff of Harvard University and Yuanchen Yang of Tsinghua University.
Some have likened the boom in Chinese real estate to those in the US and Japan in earlier decades; house prices in China’s tier-one cities have soared sixfold since 2002, compared with an 80% increase in US home prices between 2000 and 2005 during the subprime bubble.What Evergrande is telling us now is that the market is cresting.
But as property developers began to incur extraordinary levels of debt, the state recognized the need to deleverage the sector before the bubble burst to catastrophic effect. Last year, new regulations, known as the Three Red Lines, forced developers to tighten up their financing arrangements.
One way to read Evergrande’s struggles is as a giant correction that the government actually wanted: a shake-out of a highly indebted sector, set off by the government’s reforms. “What Evergrande is telling us now is that the market is cresting,” said George Magnus, the former chief economist at Swiss bank UBS.
Another way is to see it as a side-effect of China slamming the brakes, slowing down one of the hottest generators of its growth story. Rogoff and Yang argue that a 20% drop in real-estate activity, even without a banking crisis, could take as much as 10% out of the country’s GDP.
Experts like Howie say there are few signs of a replacement for the property sector, the rocket-fuel that has been powering China over the past two decades. As Evergrande’s missed bond payments pile up, economists says China will have to find a new engine for growth, such as consumption. “This is a tipping point for Chinese real estate,” Magnus said.
The threat of China’s tech crackdown
As China’s government wrestles with its property woes, authorities are also fighting on a second front with entrepreneurs, in an apparent bid to both mitigate the worst effects of market forces and exert greater control over the private sector.
Beijing has dismayed its private-education sector by enacting strict new rules, trying to limit both the expenses incurred by students and the intense pressures felt by them in a hyper-competitive academic environment.
Shares of New Oriental, the leading tutoring company, plunged by 70% in Hong Kong, leading the slump of fortunes for several other education firms.
The country’s tech companies, meanwhile, have scrambled to pledge their profits to charity after the government cracked down on gaming time for teenagers, launched some of the world’s strictest data laws, gave record fines to Alibaba and its peers on antitrust grounds, and promised to review companies seeking overseas listings much more strictly. Shares of Didi have shed more than half their value since going public in the US in July.
In a viral opinion piece widely republished by state media this year, the columnist Li Guangman read into these crackdowns a profound revolution. “The capital market will no longer be a paradise for capitalists to grow rich overnight,” Li wrote. But more broadly still, it’s easy to wonder if Beijing is turning hostile towards private companies and China’s so-called capitalists altogether.
That concern is making some of the world’s top investors think twice about Chinese tech firms. Soros Fund Management said this month that the hedge fund isn’t putting money into China. Cathie Wood, the celebrated stock-picker, told the Financial Times last month that her firm ARK Invest had slashed its China holdings. Wood, ordinarily bullish on China, said that she was focusing only on firms that are clearly “currying favor” with Beijing.
“This is a real risk, that they could impinge on many of the forces that have been so dynamic in driving the economy in recent years—the private sector, the internet platform companies, and the entrepreneurial spirit required to drive these innovative companies,” said Stephen Roach, senior lecturer at Yale’s School of Management and the former chairman of Morgan Stanley Asia. “I say that as someone who has been optimistic on China for 25 years. I think it’s a big issue.”
Not everyone is giving up on China
Some others, though, are more optimistic.
Ray Dalio, for one. China’s leaders “believe that capitalism is a way of increasing the wealth and power of the country—that’s been key—at the same time that it’s important to redistribute [wealth],” Dalio, the founder of the world’s biggest hedge fund Bridgewater, said in a recent interview with CNBC.
According to Dalio’s research and metrics, the US and China are still the most capitalist countries. China is “not going back to what you would call the old communism,” he said.Many of the crackdowns are driven by social goals.
Even a slowing economy is unlikely to significantly dent China’s efforts to expand its industries, which are essential for the economy’s long-term success, according to Jacob Gunter, a senior analyst at the German think tank MERICS. Core sectors, such as the manufacturing of chemicals or industrial machinery, will likely be insulated even if growth slows, Gunter said.
And Roach says a key underpinning of the expansion of Chinese real-estate—the migration of people from farms to cities—is still in place. He estimates that about 60% of China’s population is urban, and that the number will swell to 75% or 80% in the coming decade. “I don’t subscribe to the idea that this is a US- or Japanese-style bubble,” he said.
What happens if China’s economic growth slows?
What happens, though, if China can’t make the math work—if the country can’t crank out world-leading growth while handicapping its innovative tech businesses, coping with electricity deficits, and powering down debt and real-estate as the engines of growth? At what point does discontent turn into social unrest?
Much will depend on just how much the economy slows, said Gunter, and also how citizens view the benefits of these crackdowns in comparison to the costs. “Many of the crackdowns are driven by social goals—destroying private tutoring means less pressure on families, pushing better working conditions for delivery workers means better and safer jobs, real estate restrictions could make home ownership more feasible for middle-class folks, and cracking down on data abuse means more choices for consumers regarding their data.”
Should growth slow to worrying levels, to the point that citizens are hit with steep losses on generational wealth tied up in real estate, China may well witness civil unrest. But given the government’s control over information and protest, a more likely outcome of an economic downshift is upheaval within the party, said George Magnus, the former UBS chief economist.
Until now, Magnus said, there has been “little factional rivalry because challengers to Xi Jinping tend to end up punished or in prison.” But that could change quickly if Xi is seen to be losing control of the economy. “I’m not really optimistic that this leadership in China, the incumbent leadership, is going to be able to resolve this kind of contradiction with big business,” he said.
China is so tightly wrapped into the world economy now that a slowdown will cause jitters everywhere. Foreign investors held around 3.5% of China’s equity and bond markets as of last year—a small percentage that nonetheless runs into hundreds of billions of dollars.
In turn, China is one of the world’s largest customer for US Treasury securities; if it slows its purchases of these instruments, the US might have to draw other customers by raising interest rates, in turn affecting rates across the US economy. One study showed that a Chinese growth shock would hit emerging economies in Asia and the rest of the BRICS economies harder than it would Western countries.
China cannot hit the brakes abruptly without causing a pile-up behind it.
Gunter also speculated that an economic deceleration might turn China further into itself. “Any slowdown or economic challenge can always be painted as the result of foreign powers, especially the US, ‘containing’ China,” he said. “Stirring up nationalism as a pressure valve to domestic troubles is hardly new, nor is it something that only the Chinese Communist Party has done.”