1) Through a "copy me" structure China built an export led economy focused on providing the world with two values (lower cost, nearly infinite labor). The world was only too happy to engage because this offered a "tool" not available in their native countries.
2) As the Chinese tried to move up the value chain and became more competitive, it became harder and harder to continue the same level of growth. They had to move up the value chain because lower cost geographies existed. Artificial means (currency manipulation) used to maintain cost advantages. With some notable exceptions, the economy built had very little inherent innovation which could be competitive on a world-wide basis.
3) Initial investments in infrastructure had massive productive value (because of the starting base). However, without market discipline and with ideas of full employment, a classic debt/real estate bubble emerged. In these bubbles, structures are built for the sake of building them and not their economic value.
4) Having exhausted domestic construction (many empty buildings), a brilliant idea... Belt/Road initiative! Chinese developers are so competitive that they have to do work for free for people who cannot possibly pay them back, but let's pretend the loans are good. Belt/Road projected as sign of Chinese power, but in reality, it is just feeding the debt beast.
Finally, believing its own media headlines of Chinese power, government takes an aggressive posture. Foreign direct investment plummets. it turns out it is not that hard to move low-value supply chains. Chinese citizens, recognizing the situation far better than their government, shutdown and go into "depression" mode. Demand plummets. Outsourcing of manufacturing accelerates. For their own survival, Chinese companies aid in this process. The whole neighborhood turns hostile.
Underneath, there are lots of green shoots (EV, Solar, etc), but will they survive?
Rahul, I think you have most of this right but I believe you and Noah have missed one key item: lack of development of consumer goods and services demand. It would seem from the outside looking in Chinese economic culture seems to be driven by an obsession with saving and not consumer spending. Given the lack of investment vehicles real estate seemed easy and gave small investors and families an outlet for excess saving. But as we all know, the game cannot go in forever. Finally, I would add that the authoritarian nature of China blocks innovation and creativity which is the lifeblood of a healthy economy. Simply copying and stealing tech ideas cannot go on forever either. That last part may be the reason the choice was made to go with real estate and not allowing ideas and innovation to flourish as it was in the short term least threatening to Xi and CCP.
>>you and Noah have missed one key item: lack of development of consumer goods and services demand.<<
Smith touches upon this in his penultimate paragraph ("better to divert capital toward building a well-balanced economy of high-tech manufacturing and services"), but, I agree, this is a fundamental issue that deserves greater focus. Why does property so dominate the PRC economy? In the main it's because too many Chinese people are (still) too poor to anchor a consumer sector commensurate with the country's middle income status. Also (relatedly), China's paltry safety net renders people too timid with respect to spending their money: they're obsessive savers.
There aren't many places to search for growth when your economy is structured in this manner. To me, this is the real elephant in the room: China needs to rebalance its economy toward sustainable, balanced, growth, because real estate and manufacturing exports can no longer get the job done. This means pushing for a *much* more robust, broad-based, consumer spending sector. But Xi appears to be shackled to the view that trade surpluses and military might are what's important. And that means policies designed to curb consumption (in favor of heavy industry) will continue for the foreseeable future.
It is rather amusing to see the CCP leadership potentially fall back to the Soviet economic model. Turns out deep down they are Marxist-Leninists after all.
My rough impression was that default risk was always a clear part of Belt and Road but that from the statist-authoritarian perspective this was all upside: either relations improve and China gets paid back, or relations take a hit but China basically gets a free port (that it just built) as a result of foreclosing on the collateral of the loan and/or using the debt as negotiating leverage - this being on of the narratives surrounding Hambantota in Sri Lanka.
Only one problem.... you are dealing with significant governance issues in the host countries... so "foreclosure" is not that easy. Also, if the port has limited value, it has limited value for everyone..including the loan holder.
The Atlantic, The Chinese ‘Debt Trap’ Is a Myth, by Deborah Brautigam and Meg Rithmire, February 6, 2021 set the record straight.
Colombo arranged a bailout from the International Monetary Fund and decided to raise much-needed dollars by leasing out the underperforming Hambantota Port to an experienced company—just as the Canadians had recommended. There was not an open tender, and the only two bids came from China Merchants and China Harbor; Sri Lanka chose China Merchants, making it the majority shareholder with a 99-year lease, and used the $1.12 billion cash infusion to bolster its foreign reserves, not to pay off China Eximbank.
Really curious to understand how you reach to the conclusion of "the economy built had very little inherent innovation which could be competitive on a world-wide basis"?
Innovation built capabilities allow for economic pricing power and margin. With some exceptions, there is very little produced in China which demands pricing power. As an example, China assembles a great percentage of the world's cell phones, but the residual profit for the Chinese value added is tiny.. maybe 1-2%. There are exceptions, but they are rare.
I do not understand, You write: "With some notable exceptions, the economy built had very little inherent innovation which could be competitive on a world-wide basis."
The Guardian writes:"Year-long study finds China leads in 37 of 44 areas it tracked, with potential for a monopoly in areas such as nanoscale materials and synthetic biology."
Not sure if you have the correct facts and, therefore, a correct conclusion. Going by history, China has responded well to all challenges, maintaining positive growtth, while Western economies have seen periodic recessions. I'll bet on those who have shown they can make wise decisions before favoring those who predict downfalls for others and never predict or prevent downfalls to themselves.
We will see.... I doubt it. However, the results will be pretty easy to judge... pricing power, gdp growth, margin expansion. Today, I don't see it. Further, like most industrial planning (Russian 5-year plans, Japanese MITI, etc) they track lists of focus points (largely in a follower model). However, exponential gdp growth comes in a pseudo random fashion. Most of these lists are pretty useless in retrospect. We will see...
Excellent quick-and-dirty explainer. Now do a post on how bad you think it's going to get. I'd be interested in your take.
I should probably say, I'm one of those people who has been looking at the Chinese economy, and in particular the real estate/infrastructure-investment bubble (the unused airports, unused high-speed rail lines, etc), with ever-mounting astonishment, for years. I kept thinking it had to pop, but the CCP kept finding ways to inflate it further. If they have finally run out of levers to pull, if the entire property sector is now finally collapsing, I can't see how it won't pull the whole country down the toilet after it. This looks like the mother and father of all property crashes, it is going to hit EVERYONE in China extremely hard (property was the only place a normal person could invest), and there is nobody available to blame except the CCP. How does the CCP survive that, when no young person has ever experienced serious recession before, and the youth employment rate, going INTO this recession, is already so alarmingly high that they have stopped publishing the figures? I fear the mandate of heaven may be withdrawn at some point in the next five years.
Of course, the CCP has made sure there is no remaining organisation, political, social or religious, of any kind in China who could take over any of the CCP's functions – so a massive public collapse of confidence in the CCP, à la East Germany in 1989, is unlikely lead to anything good in the short term.
Anyway, I would value your thoughts! What am I missing? How can the CCP avoid the menacing train of consequences currently steaming down the track towards them?
I actually wrote a post about how bad I think it'll get! Long story short, I think China's rapid growth is over but I don't think they're going to collapse soon. In the late 2030s, demographics will start to be an increasing strain on them. And in the meantime they could make more blunders and hurt themselves more than they have...
Thanks Noah. Still a bit confused though-- you write in today's article that one of the reasons that China tolerated a real-estate bubble (despite warning signs from the bubbles in US and Japan) is that it feared a recession. And you also referred to the current situation as a "crash" and "economic crisis"--which seems really bad. And yet... your July article ("China at the Peak") merely suggests that their growth rate will decline to G7 levels-- so this current crash is not even going to cause a recession? American banks are decreasing their annual growth expectations for China... to 4.7% [1]. Granted, this is much lower than we're accustomed to or had been expecting, and perhaps one could slyly call it a "crash" from previous growth rates or prior expectations. But it's growth nonetheless. I guess I find it a bit hard to square some of our Western media's "crash" language and reporting with the actual numbers... unless those growth expectations are wrong?
You're right. It's a crash or crisis only relative to China's economic performance in recent history. It's likely that the Chinese economy will continue to grow, at least at developed country rates.
The Western media crash language is really more about the political narrative. And they aren't wrong. Developed country growth rates are tolerable for developed countries. China is a very long way from that level of productivity, and if they aren't growing at a meaningfully faster rate, they'll never catch up. Western media is energized by the possibility that the Chinese public will fall out of love with the CCP. Now that would be a story!
Thanks, Noah. Yes, I love that post! (I had read it before, and have just reread it to refresh my memory.) I think you are largely right about the long-term future of China, and the CCP... but only if the current version of China and the CCP survive the collapse of the biggest property bubble in history. So I guess I could rephrase my question as, what do you think the odds are that the property crash and its metastasizing consequences seriously de-legitimises the CCP, brings the unemployed and furious younger generation (plus their parents, who will have lost their retirement savings, which have all gone into property) onto the streets, and pulls down the whole system in the next 5 years? (I agree with you that if the CCP can get through the crash, things will play out as you suggest in your China/Altasia post.)
I think the risk is at least 30%. Every single country I can think of that has had a serious property bubble has experienced furious anger with the government, which has led to massive electoral swings against parties that had often been in power for decades. China doesn't have that electoral safety valve, and this is more than just a property bubble: it is going to wipe out the savings of all the people who believed in the system. It's all in property. So, give me a %, off the top of your head! (Or from your gut.)
(Also, you know; great blog. I agree with you an alarming amount of the time.)
China has the funds to restructure the debts (and impose pain on creditors). The question is - what is the model going forward post-restructuring?
The US did some healthy debt restructuring post 2008 but then relied on nearly a decade of QE and ZIRP afterwards to reinflate asset prices. Or take the Japanese approach - bury the bad debts rather than restructuring and do even more QE with negative rates.
The US has just added reckless fiscal stimulus to the mix, causing inflation and resulting in a reversal of ZIRP and QE.
They will certainly pull every lever they have, in their attempt to pull out of this dive. But will those levers turn out to be attached to the control surfaces, this time? We shall see...
"construction and related industries tend to have lower productivity growth than other industries (for reasons that aren’t 100% clear)."
Tolerances.
Manufacturing based industries are
A. Repetitive. Construction is not
B. Require assemblies in rapid time. Construction is never fast
C.100% of the time there is a difference in between the print/CAD design and the parts made. Always. Every part ever. I know because the most precious made things in the world are precision optics. They require "tolerance analyis" and compensation mechanisms.
D. Automotive evaluates the summation of tolerances, called stack up tolerances. Remember when those 60s and 70s cars had wide gaps between door and fender or fender and hood? They are quite tiny today. But still engineering makes allowances for tolerances
E. Construction is custom, couturier, bespoke. It always has very high tolerances. This comes from the usual variation of components. It comes from the necessary manual assembly. Because of the uniqueness of design.
F. Now manufactured homes, trusses etc are in part "automated". For reptitive cookie cutter homes they work. But they are still hand assembled because of the tolerance variation between even manufactured A-frame roof trusses.
G. BIM - Building Information Modeling. Here, LIDAR beams and collectors are placed in an expensive factory up for some changes. Like a very complex semiconductor fab. The beams create a 3D data cloud that is converted to a true set of "as-built" prints. Why? Because the design prints can be off on piping and structures by inches. Downtime is ultra expensive. So having precision prints avoids dealing with conflicts in location of pipes and structures
What comes to mind is Frank Dikotter's excellent book "The Great Leap Forward(1958-1962)", in which Mao focused the country on a dream of producing more steel than Britain, in pursuit of which Mao got different factions to prove their undying loyalty to him which ultimately wound up reducing millions of Chinese to naked, homeless beings.
This time, the dream will likely be "reunifying China".
China's COVID lockdowns surely merit a mention. The bursting of a real estate bubble can have all sorts of triggers, but I'd guess China's woes are compounded by the urgent effort of global manufacturers to de-couple their supply chain from China, now shown to be an unreliable partner.
I remembered pretty well at the time of 1998 financial crisis in Indonesia (along with a few other South East Asian nations): wait, we were told for the past 30 years (under one president that keeps getting reelected 6 times in a row, yeah we fixed that after '98) that Indonesia has been growing at a nice clip. So why did we run out of money? Turns out it was a real estate bubble.
I think this is accurate, Noah. It's reflective of a much longer history of China's tendency to expand and contract at periodic intervals. Zheng He opened China up dramatically by exploring the western coast of Africa with the idea of spreading Chinese influence and dominance, and then the empire contracted for a couple hundred years, leading to the opium wars and the modern era. Deng opened it back up around 50 years ago.
I don't know if there will be another Deng in the next decade or so- right now, it looks like a heck no on that one, but things can change quickly. It also seems like the Dengs and Zheng Hes are few and far between.
Noah, is it fair to link the pivot from exports to real estate as enabling the decrease in personal freedom? Real estate is inward facing and doesn’t require doing business with western democracies and their corporations.
Aug 21, 2023·edited Aug 21, 2023Liked by Noah Smith
Good overview of the past few decades, thanks. The over-reliance on investment (and debt) and the diminishing returns of same are clear.
A few other things to consider
1) Many Chinese look at apartments as a type of savings, most Chinese not being able to buy foreign assets in bulk and not trusting the Chinese currency or the stock market.
Right now the PBOC controls a huge pool of foreign assets from accumulated trade surpluses. If the government instead allowed foreign currency to trickle down to individuals and companies , maybe it might have taken some pressure off real estate.
2) not surprising that FDI falls as a pct of GDP in an economy that was growing at 8 pct compounded while its foreign investors were growing at 1-3 pct compounded. There is also the question of why a country with trade surpluses should have positive net FDI at all. Also, exports holding at 7-8 pct of GDP in an economy growing 3-4x the speed of its export customers is an unusual achievement - implies continued market share gains.
3) the Covid and post-Covid era is a little different. China had a huge boom in goods production and exports - the “supply chain” stories really should have been about excessive consumption - there wasn’t a shortage in goods but rather record consumption of them. Manufacturing output rose from a fairly flat 3.8 ish trillion 2018-2020 to 4.9 trillion in 2021 and nearly 5 trillion by 2022. This gain was nearly 1 pct of GDP and (temporarily) reversed a decade-long falloff in manufacturing output as a pct of GDP. The fall off in manufacturing over the past year reflects (in good part) a hangover from front loaded consumption of goods during Covid. US and German manufacturers have also suffered (believe we have had six straight months of negative US manufacturing data).
A difference is that China doesn’t have as much of a services and consumer-led economy to cushion that hangover. I expect 2024-2025 data to look a little better for China as we get beyond the Covid boom/bust. We will see. A question will be how much retrenchment and write offs Xi wants to take in real estate before re-stimulating investment.
However, with the labour force probably shrinking demographically and the easiest productivity gains already harvested, it is not hard to see a future China with l.t. potential GDP growth of only 3-4 pct at best.
Broadly agree with the conclusions, but one aspect that could be covered is why at some point in the last decade China did not try to diversify away from real estate. In 2008-10 funding real estate probably made sense, it's the lowest hanging fruit around for a stimulus and probably at that point in time China did have some amount of developmental catching up to do. However after real estate had played its role, it may have been prudent to incentivise the capital markets (both equity and debt), through lower tax or some other means - so savings would flow there as well, where they have been deployed more productively. They had more than enough time to do so, but as far as I can tell not only was it never attempted but through Xi's takedown of Alibaba, edtech and other new age industries they actually did the opposite.
They definitely have very bright people who should have figured this out. Any views on this? My personal feel is it is a combination of Communist distrust in the financial system combined with the unwillingness to build discipline that would be required in a freer capital market. Plus with Xi's dictatorial turn probably there is nobody left to tell him anything he doesn't want to hear...
Does anyone have any insight into why China doesn't just.....implement a property tax? It seems compatible with both pragmatic capitalism and nominal communism, easy to promulgate (if only by delegating the authority to local governments) in an authoritarian society, and far more sustainable than dependence on land sales.
Well, they're sort of locked in. To implement a property tax now would reduce the value of the real estate that all their wealth depends on, hurting their banking system and local government finances in the process. They ought to just do it and take the hit, but they won't...
I can't speak for China but I live in Vietnam and we are also a communist country with no property tax. Property taxes have been mooted several times and massive popular pushback has (so far) always resulted in the government backing down. Even authoritarian countries hesitate when pushing unpopular issues and weigh the costs and benefits. Kicking the can down the road happens everywhere.
Also, there's probably the reality that the party members are some of the largest land holders around and don't necessarily have the (legal) cash flow to pay a tax on all the land they've somehow acquired and/or put under various family members' names.
The reason that it got to 15-18x income was that they were not apartments to live in, they were investments, which would/could only go up in value. There is also a uniquely Chinese twist to this in that a 'new' apartment for resale/investment reasons must be unoccupied and untouched, so they didn't see any accompanying growth in consumer demand for furniture, appliances, etc. The demand was driven by a desire to own in a quasi "most appreciating value location" not by demand for housing or renting.
Once entrepreneurs saw what happened to Hong Kong the normal escape route of a Guangzhou residence and visa-free travel to HK no longer worked. Most people with reasonable wealth worked very quickly and quietly to get residency in Singapore, Australia, Canada, they literally voted with their feet. While the government's ideas for bolstering private industry is to insist upon each company having a fully operating branch of the CCP in the infrastructure of each private company, it's not going to instill much confidence or risk taking. Locking people up for a couple of months for the crime of being too successful, like with Ma and others, is also not a great signal for entrepreneurs to double down on China.
These are all signs of a declining system not a system going through some growing pains.
I am not sure, as Xi has complete and utter control of the Politburo and the Party at this point. I was just there for the first time since Covid, and it is palpable, the lack of energy, the lack of excitement about the future, a complete turnaround. Some obvious signs of the existing infrastructure starting to creak and fall apart, even in the trendy high-end shopping areas like Xintiandi, the facade is crumbling. They are getting more insular rather than less, lots of pressure on people to vacation in China, obvious propaganda about how dangerous Japan is to visit, "you can't eat the fish due to all the radiation".
Make no mistake, it is a massive economy on its own, and Xi will manage the debt crisis in a way so that he survives. Lecturing graduating kids, who have no job to go to, to be happy and go and toil in the fields like he did at their age will not endear him to them or lead to the posterity he so craves. Especially if you and your parents have worked every hour God gave to pay for the tutors to get you the best grades and into the best school and university.
I meant after Xi's departure. Perhaps Deng 2.0 will follow Xi just as Deng 1.0 followed Mao.
I don't see Xi going anywhere for a considerable length of time. He's a high energy, domineering character who will do whatever it takes to keep a lid on the situation. He also seems quite good at dominating the Chinese political class, AKA CCP.
China's real estate bubble looks like recent similar bubbles in the U.S. and EU. I remember the financial crisis in the U.S. and was impressed with how Obama and Geithner developed a focused plan to stop the damage and to stabilize the financial institutions.
Noah, you give a good, clear overview of how China got into this mess, but China is also uniquely poised to devise a clear, focused plan on rectifying the situation. After all, the CCP owns all the land that is being developed and a real estate crisis is in their best interest to quell. I would be interested in your take on how China will take action to stop this slide.
The land sales mechanism for state government revenue by itself sounds horrible, and they just doubled down. The shenanigans in the US heading into 2008 were also egregious, so I guess I shouldn't judge too much. But it does seem that the increasingly authoritarian government means that no one can say the emperor has no clothes, which makes the problem worse.
I wonder what they'll do next, and whether it will work? I wouldn't be surprised if this ends up being China's long-term plateau, similar to Japan since the 90's (although at a much lower income level).
I see no causal attribution (he uses 'associated with') in your account of China's rapid growth to CCP investment in human capital (sanitation, health, education,) and female labour participation. I wonder what you think of this take Noah, from Mody in Project Syndicate which acknowledges the present financial bust but points to deeper strengths engineered by what I'm thinking to dub a developmental autocracy? 'Rather than tax cuts or economic liberalization, the World Bank report focused on a historical fact recently emphasized by Brown University economist Oded Galor. Since the dawn of the Industrial Revolution, every instance of economic progress – the crux of which is sustained productivity growth – has been associated with investments in human capital and higher female workforce participation.
To be sure, market liberalization greatly helped Chinese and Indian growth. But China built its successful development strategy on the twin pillars of human capital and gender equality, areas where India has lagged far behind.
Even after it became more market-oriented, China invested impressively in its people, outpacing India in raising education and health standards to levels necessary for an internationally competitive workforce. The World Bank’s 2020 Human Capital Index – which measures countries’ education and health outcomes on a scale of 0 to 1 – gave India a score of 0.49, below Nepal and Kenya, both poorer countries. China scored 0.65, similar to the much richer (in per capita terms) Chile and Slovakia. 1
While China’s female labor-force participation rate has decreased to roughly 62% from around 80% in 1990, India’s has fallen over the same period from 32% to around 25%. Especially in urban areas, violence against women has deterred Indian women from entering the workforce.
Together, superior human capital and greater gender equality have enabled much higher Chinese total factor productivity growth, the most comprehensive measure of resource-use efficiency. Assuming that the two economies were equally productive in 1953 (roughly when they embarked on their modernization efforts), China became over 50% more productive by the late 1980s. Today, China’s productivity is nearly double that of India. While 45% of Indian workers are still in the highly unproductive agriculture sector, China has graduated even from simple, labor-intensive manufacturing to emerge, for example, as a dominant force in global car markets, especially in electric vehicles...China is also better prepared for future opportunities. Seven Chinese universities are ranked among the world’s top 100, with Tsinghua and Peking among the top 20. Tsinghua is considered the world’s leading university for computer science, while Peking is ranked ninth. Likewise, nine Chinese universities are among the top 50 globally in mathematics. By contrast, no Indian university, including the celebrated Indian Institutes of Technology, is ranked among the world’s top 100.
Agree with all your points, China is way ahead of India on social indicators, besides the country would never have achieved the super impressive results it has without a great talent pool. However perhaps the problem is the authoritarian system where priorities are driven by the whim of the CCP and neither by market forces nor by individual choice. It's not an open & shut inference, there would be some sort of external determination of priorities in all economies. Besides you have the hardly ideal American experience, where the brightest talent of the last 20 years have been busy devising ways to make you click on a the next advertisement rather than say making clean energy or going to Mars!
It's not an exact comparison because they started earlier but I would say that other locations with ethnic Chinese talent like Singapore, Taiwan, Hong Kong have achieved far more in a relative sense, given that mainland China has expended far greater resources on human capital, hence it is the system which has held the talent back...
India non-withstanding, it seems rather inaccurate to reduce American technological development to simply ad design. The US has continued to be at the forefront of tech development in the 21st century from consumer electronics (Apple) to EVs (Tesla) to space travel (SpaceX) to MRNA vaccines (Pfizer/Moderna). Meanwhile I can't really think of any major tech development that China has pioneered in the last several decades. They are certainly able to come in and play copycat and build their own production of such things but they have yet to actually become a center for cutting edge innovation.
Actually, the real story is simpler ...
1) Through a "copy me" structure China built an export led economy focused on providing the world with two values (lower cost, nearly infinite labor). The world was only too happy to engage because this offered a "tool" not available in their native countries.
2) As the Chinese tried to move up the value chain and became more competitive, it became harder and harder to continue the same level of growth. They had to move up the value chain because lower cost geographies existed. Artificial means (currency manipulation) used to maintain cost advantages. With some notable exceptions, the economy built had very little inherent innovation which could be competitive on a world-wide basis.
3) Initial investments in infrastructure had massive productive value (because of the starting base). However, without market discipline and with ideas of full employment, a classic debt/real estate bubble emerged. In these bubbles, structures are built for the sake of building them and not their economic value.
4) Having exhausted domestic construction (many empty buildings), a brilliant idea... Belt/Road initiative! Chinese developers are so competitive that they have to do work for free for people who cannot possibly pay them back, but let's pretend the loans are good. Belt/Road projected as sign of Chinese power, but in reality, it is just feeding the debt beast.
Finally, believing its own media headlines of Chinese power, government takes an aggressive posture. Foreign direct investment plummets. it turns out it is not that hard to move low-value supply chains. Chinese citizens, recognizing the situation far better than their government, shutdown and go into "depression" mode. Demand plummets. Outsourcing of manufacturing accelerates. For their own survival, Chinese companies aid in this process. The whole neighborhood turns hostile.
Underneath, there are lots of green shoots (EV, Solar, etc), but will they survive?
Rahul, I think you have most of this right but I believe you and Noah have missed one key item: lack of development of consumer goods and services demand. It would seem from the outside looking in Chinese economic culture seems to be driven by an obsession with saving and not consumer spending. Given the lack of investment vehicles real estate seemed easy and gave small investors and families an outlet for excess saving. But as we all know, the game cannot go in forever. Finally, I would add that the authoritarian nature of China blocks innovation and creativity which is the lifeblood of a healthy economy. Simply copying and stealing tech ideas cannot go on forever either. That last part may be the reason the choice was made to go with real estate and not allowing ideas and innovation to flourish as it was in the short term least threatening to Xi and CCP.
>>you and Noah have missed one key item: lack of development of consumer goods and services demand.<<
Smith touches upon this in his penultimate paragraph ("better to divert capital toward building a well-balanced economy of high-tech manufacturing and services"), but, I agree, this is a fundamental issue that deserves greater focus. Why does property so dominate the PRC economy? In the main it's because too many Chinese people are (still) too poor to anchor a consumer sector commensurate with the country's middle income status. Also (relatedly), China's paltry safety net renders people too timid with respect to spending their money: they're obsessive savers.
There aren't many places to search for growth when your economy is structured in this manner. To me, this is the real elephant in the room: China needs to rebalance its economy toward sustainable, balanced, growth, because real estate and manufacturing exports can no longer get the job done. This means pushing for a *much* more robust, broad-based, consumer spending sector. But Xi appears to be shackled to the view that trade surpluses and military might are what's important. And that means policies designed to curb consumption (in favor of heavy industry) will continue for the foreseeable future.
It is rather amusing to see the CCP leadership potentially fall back to the Soviet economic model. Turns out deep down they are Marxist-Leninists after all.
This is a great TLDR!
My rough impression was that default risk was always a clear part of Belt and Road but that from the statist-authoritarian perspective this was all upside: either relations improve and China gets paid back, or relations take a hit but China basically gets a free port (that it just built) as a result of foreclosing on the collateral of the loan and/or using the debt as negotiating leverage - this being on of the narratives surrounding Hambantota in Sri Lanka.
Only one problem.... you are dealing with significant governance issues in the host countries... so "foreclosure" is not that easy. Also, if the port has limited value, it has limited value for everyone..including the loan holder.
they simply want to extract commodities (minerals, etc) from various client states
yup... some truth to that.
Not sure if your facts are correct:
The Atlantic, The Chinese ‘Debt Trap’ Is a Myth, by Deborah Brautigam and Meg Rithmire, February 6, 2021 set the record straight.
Colombo arranged a bailout from the International Monetary Fund and decided to raise much-needed dollars by leasing out the underperforming Hambantota Port to an experienced company—just as the Canadians had recommended. There was not an open tender, and the only two bids came from China Merchants and China Harbor; Sri Lanka chose China Merchants, making it the majority shareholder with a 99-year lease, and used the $1.12 billion cash infusion to bolster its foreign reserves, not to pay off China Eximbank.
Really curious to understand how you reach to the conclusion of "the economy built had very little inherent innovation which could be competitive on a world-wide basis"?
Innovation built capabilities allow for economic pricing power and margin. With some exceptions, there is very little produced in China which demands pricing power. As an example, China assembles a great percentage of the world's cell phones, but the residual profit for the Chinese value added is tiny.. maybe 1-2%. There are exceptions, but they are rare.
I do not understand, You write: "With some notable exceptions, the economy built had very little inherent innovation which could be competitive on a world-wide basis."
The Guardian writes:"Year-long study finds China leads in 37 of 44 areas it tracked, with potential for a monopoly in areas such as nanoscale materials and synthetic biology."
Not sure if you have the correct facts and, therefore, a correct conclusion. Going by history, China has responded well to all challenges, maintaining positive growtth, while Western economies have seen periodic recessions. I'll bet on those who have shown they can make wise decisions before favoring those who predict downfalls for others and never predict or prevent downfalls to themselves.
We will see.... I doubt it. However, the results will be pretty easy to judge... pricing power, gdp growth, margin expansion. Today, I don't see it. Further, like most industrial planning (Russian 5-year plans, Japanese MITI, etc) they track lists of focus points (largely in a follower model). However, exponential gdp growth comes in a pseudo random fashion. Most of these lists are pretty useless in retrospect. We will see...
Excellent quick-and-dirty explainer. Now do a post on how bad you think it's going to get. I'd be interested in your take.
I should probably say, I'm one of those people who has been looking at the Chinese economy, and in particular the real estate/infrastructure-investment bubble (the unused airports, unused high-speed rail lines, etc), with ever-mounting astonishment, for years. I kept thinking it had to pop, but the CCP kept finding ways to inflate it further. If they have finally run out of levers to pull, if the entire property sector is now finally collapsing, I can't see how it won't pull the whole country down the toilet after it. This looks like the mother and father of all property crashes, it is going to hit EVERYONE in China extremely hard (property was the only place a normal person could invest), and there is nobody available to blame except the CCP. How does the CCP survive that, when no young person has ever experienced serious recession before, and the youth employment rate, going INTO this recession, is already so alarmingly high that they have stopped publishing the figures? I fear the mandate of heaven may be withdrawn at some point in the next five years.
Of course, the CCP has made sure there is no remaining organisation, political, social or religious, of any kind in China who could take over any of the CCP's functions – so a massive public collapse of confidence in the CCP, à la East Germany in 1989, is unlikely lead to anything good in the short term.
Anyway, I would value your thoughts! What am I missing? How can the CCP avoid the menacing train of consequences currently steaming down the track towards them?
I actually wrote a post about how bad I think it'll get! Long story short, I think China's rapid growth is over but I don't think they're going to collapse soon. In the late 2030s, demographics will start to be an increasing strain on them. And in the meantime they could make more blunders and hurt themselves more than they have...
https://www.noahpinion.blog/p/china-at-the-peak
Thanks Noah. Still a bit confused though-- you write in today's article that one of the reasons that China tolerated a real-estate bubble (despite warning signs from the bubbles in US and Japan) is that it feared a recession. And you also referred to the current situation as a "crash" and "economic crisis"--which seems really bad. And yet... your July article ("China at the Peak") merely suggests that their growth rate will decline to G7 levels-- so this current crash is not even going to cause a recession? American banks are decreasing their annual growth expectations for China... to 4.7% [1]. Granted, this is much lower than we're accustomed to or had been expecting, and perhaps one could slyly call it a "crash" from previous growth rates or prior expectations. But it's growth nonetheless. I guess I find it a bit hard to square some of our Western media's "crash" language and reporting with the actual numbers... unless those growth expectations are wrong?
[1] https://www.ft.com/content/6d2927c0-bf6f-4b56-87ba-9d8a26fff921
You're right. It's a crash or crisis only relative to China's economic performance in recent history. It's likely that the Chinese economy will continue to grow, at least at developed country rates.
The Western media crash language is really more about the political narrative. And they aren't wrong. Developed country growth rates are tolerable for developed countries. China is a very long way from that level of productivity, and if they aren't growing at a meaningfully faster rate, they'll never catch up. Western media is energized by the possibility that the Chinese public will fall out of love with the CCP. Now that would be a story!
Thanks, Noah. Yes, I love that post! (I had read it before, and have just reread it to refresh my memory.) I think you are largely right about the long-term future of China, and the CCP... but only if the current version of China and the CCP survive the collapse of the biggest property bubble in history. So I guess I could rephrase my question as, what do you think the odds are that the property crash and its metastasizing consequences seriously de-legitimises the CCP, brings the unemployed and furious younger generation (plus their parents, who will have lost their retirement savings, which have all gone into property) onto the streets, and pulls down the whole system in the next 5 years? (I agree with you that if the CCP can get through the crash, things will play out as you suggest in your China/Altasia post.)
I think the risk is at least 30%. Every single country I can think of that has had a serious property bubble has experienced furious anger with the government, which has led to massive electoral swings against parties that had often been in power for decades. China doesn't have that electoral safety valve, and this is more than just a property bubble: it is going to wipe out the savings of all the people who believed in the system. It's all in property. So, give me a %, off the top of your head! (Or from your gut.)
(Also, you know; great blog. I agree with you an alarming amount of the time.)
Maybe they'll do what many autocracies do when the economy crashes - start a war!
China has the funds to restructure the debts (and impose pain on creditors). The question is - what is the model going forward post-restructuring?
The US did some healthy debt restructuring post 2008 but then relied on nearly a decade of QE and ZIRP afterwards to reinflate asset prices. Or take the Japanese approach - bury the bad debts rather than restructuring and do even more QE with negative rates.
The US has just added reckless fiscal stimulus to the mix, causing inflation and resulting in a reversal of ZIRP and QE.
I suspect China will try all of the above.
They will certainly pull every lever they have, in their attempt to pull out of this dive. But will those levers turn out to be attached to the control surfaces, this time? We shall see...
I have a possible answer to this quandry:
"construction and related industries tend to have lower productivity growth than other industries (for reasons that aren’t 100% clear)."
Tolerances.
Manufacturing based industries are
A. Repetitive. Construction is not
B. Require assemblies in rapid time. Construction is never fast
C.100% of the time there is a difference in between the print/CAD design and the parts made. Always. Every part ever. I know because the most precious made things in the world are precision optics. They require "tolerance analyis" and compensation mechanisms.
D. Automotive evaluates the summation of tolerances, called stack up tolerances. Remember when those 60s and 70s cars had wide gaps between door and fender or fender and hood? They are quite tiny today. But still engineering makes allowances for tolerances
E. Construction is custom, couturier, bespoke. It always has very high tolerances. This comes from the usual variation of components. It comes from the necessary manual assembly. Because of the uniqueness of design.
F. Now manufactured homes, trusses etc are in part "automated". For reptitive cookie cutter homes they work. But they are still hand assembled because of the tolerance variation between even manufactured A-frame roof trusses.
G. BIM - Building Information Modeling. Here, LIDAR beams and collectors are placed in an expensive factory up for some changes. Like a very complex semiconductor fab. The beams create a 3D data cloud that is converted to a true set of "as-built" prints. Why? Because the design prints can be off on piping and structures by inches. Downtime is ultra expensive. So having precision prints avoids dealing with conflicts in location of pipes and structures
https://en.m.wikipedia.org/wiki/Building_information_modeling
LIDAR -
That was extremely interesting. I’ll have to ponder and process it, but at first glance… I like it. Thank you.
My pleasure. It comes from direct professional experience in those industries.
What comes to mind is Frank Dikotter's excellent book "The Great Leap Forward(1958-1962)", in which Mao focused the country on a dream of producing more steel than Britain, in pursuit of which Mao got different factions to prove their undying loyalty to him which ultimately wound up reducing millions of Chinese to naked, homeless beings.
This time, the dream will likely be "reunifying China".
China's COVID lockdowns surely merit a mention. The bursting of a real estate bubble can have all sorts of triggers, but I'd guess China's woes are compounded by the urgent effort of global manufacturers to de-couple their supply chain from China, now shown to be an unreliable partner.
I remembered pretty well at the time of 1998 financial crisis in Indonesia (along with a few other South East Asian nations): wait, we were told for the past 30 years (under one president that keeps getting reelected 6 times in a row, yeah we fixed that after '98) that Indonesia has been growing at a nice clip. So why did we run out of money? Turns out it was a real estate bubble.
Awesome! Another China post!
(No irony intended. I really enjoy reading them)
I think this is accurate, Noah. It's reflective of a much longer history of China's tendency to expand and contract at periodic intervals. Zheng He opened China up dramatically by exploring the western coast of Africa with the idea of spreading Chinese influence and dominance, and then the empire contracted for a couple hundred years, leading to the opium wars and the modern era. Deng opened it back up around 50 years ago.
I don't know if there will be another Deng in the next decade or so- right now, it looks like a heck no on that one, but things can change quickly. It also seems like the Dengs and Zheng Hes are few and far between.
Noah, is it fair to link the pivot from exports to real estate as enabling the decrease in personal freedom? Real estate is inward facing and doesn’t require doing business with western democracies and their corporations.
That's an interesting thought...
Good overview of the past few decades, thanks. The over-reliance on investment (and debt) and the diminishing returns of same are clear.
A few other things to consider
1) Many Chinese look at apartments as a type of savings, most Chinese not being able to buy foreign assets in bulk and not trusting the Chinese currency or the stock market.
Right now the PBOC controls a huge pool of foreign assets from accumulated trade surpluses. If the government instead allowed foreign currency to trickle down to individuals and companies , maybe it might have taken some pressure off real estate.
2) not surprising that FDI falls as a pct of GDP in an economy that was growing at 8 pct compounded while its foreign investors were growing at 1-3 pct compounded. There is also the question of why a country with trade surpluses should have positive net FDI at all. Also, exports holding at 7-8 pct of GDP in an economy growing 3-4x the speed of its export customers is an unusual achievement - implies continued market share gains.
3) the Covid and post-Covid era is a little different. China had a huge boom in goods production and exports - the “supply chain” stories really should have been about excessive consumption - there wasn’t a shortage in goods but rather record consumption of them. Manufacturing output rose from a fairly flat 3.8 ish trillion 2018-2020 to 4.9 trillion in 2021 and nearly 5 trillion by 2022. This gain was nearly 1 pct of GDP and (temporarily) reversed a decade-long falloff in manufacturing output as a pct of GDP. The fall off in manufacturing over the past year reflects (in good part) a hangover from front loaded consumption of goods during Covid. US and German manufacturers have also suffered (believe we have had six straight months of negative US manufacturing data).
A difference is that China doesn’t have as much of a services and consumer-led economy to cushion that hangover. I expect 2024-2025 data to look a little better for China as we get beyond the Covid boom/bust. We will see. A question will be how much retrenchment and write offs Xi wants to take in real estate before re-stimulating investment.
However, with the labour force probably shrinking demographically and the easiest productivity gains already harvested, it is not hard to see a future China with l.t. potential GDP growth of only 3-4 pct at best.
Broadly agree with the conclusions, but one aspect that could be covered is why at some point in the last decade China did not try to diversify away from real estate. In 2008-10 funding real estate probably made sense, it's the lowest hanging fruit around for a stimulus and probably at that point in time China did have some amount of developmental catching up to do. However after real estate had played its role, it may have been prudent to incentivise the capital markets (both equity and debt), through lower tax or some other means - so savings would flow there as well, where they have been deployed more productively. They had more than enough time to do so, but as far as I can tell not only was it never attempted but through Xi's takedown of Alibaba, edtech and other new age industries they actually did the opposite.
They definitely have very bright people who should have figured this out. Any views on this? My personal feel is it is a combination of Communist distrust in the financial system combined with the unwillingness to build discipline that would be required in a freer capital market. Plus with Xi's dictatorial turn probably there is nobody left to tell him anything he doesn't want to hear...
I think it was largely institutional momentum related to their banking system, tax system, government system, etc.
Provincial governments are a bit like a man with a hammer- they have one tool (land sales).
Does anyone have any insight into why China doesn't just.....implement a property tax? It seems compatible with both pragmatic capitalism and nominal communism, easy to promulgate (if only by delegating the authority to local governments) in an authoritarian society, and far more sustainable than dependence on land sales.
Well, they're sort of locked in. To implement a property tax now would reduce the value of the real estate that all their wealth depends on, hurting their banking system and local government finances in the process. They ought to just do it and take the hit, but they won't...
I can't speak for China but I live in Vietnam and we are also a communist country with no property tax. Property taxes have been mooted several times and massive popular pushback has (so far) always resulted in the government backing down. Even authoritarian countries hesitate when pushing unpopular issues and weigh the costs and benefits. Kicking the can down the road happens everywhere.
Also, there's probably the reality that the party members are some of the largest land holders around and don't necessarily have the (legal) cash flow to pay a tax on all the land they've somehow acquired and/or put under various family members' names.
The reason that it got to 15-18x income was that they were not apartments to live in, they were investments, which would/could only go up in value. There is also a uniquely Chinese twist to this in that a 'new' apartment for resale/investment reasons must be unoccupied and untouched, so they didn't see any accompanying growth in consumer demand for furniture, appliances, etc. The demand was driven by a desire to own in a quasi "most appreciating value location" not by demand for housing or renting.
Once entrepreneurs saw what happened to Hong Kong the normal escape route of a Guangzhou residence and visa-free travel to HK no longer worked. Most people with reasonable wealth worked very quickly and quietly to get residency in Singapore, Australia, Canada, they literally voted with their feet. While the government's ideas for bolstering private industry is to insist upon each company having a fully operating branch of the CCP in the infrastructure of each private company, it's not going to instill much confidence or risk taking. Locking people up for a couple of months for the crime of being too successful, like with Ma and others, is also not a great signal for entrepreneurs to double down on China.
These are all signs of a declining system not a system going through some growing pains.
Is decline irreversible? It could be that a Deng will follow XI and put the focus back on economic success.
I am not sure, as Xi has complete and utter control of the Politburo and the Party at this point. I was just there for the first time since Covid, and it is palpable, the lack of energy, the lack of excitement about the future, a complete turnaround. Some obvious signs of the existing infrastructure starting to creak and fall apart, even in the trendy high-end shopping areas like Xintiandi, the facade is crumbling. They are getting more insular rather than less, lots of pressure on people to vacation in China, obvious propaganda about how dangerous Japan is to visit, "you can't eat the fish due to all the radiation".
Make no mistake, it is a massive economy on its own, and Xi will manage the debt crisis in a way so that he survives. Lecturing graduating kids, who have no job to go to, to be happy and go and toil in the fields like he did at their age will not endear him to them or lead to the posterity he so craves. Especially if you and your parents have worked every hour God gave to pay for the tutors to get you the best grades and into the best school and university.
I meant after Xi's departure. Perhaps Deng 2.0 will follow Xi just as Deng 1.0 followed Mao.
I don't see Xi going anywhere for a considerable length of time. He's a high energy, domineering character who will do whatever it takes to keep a lid on the situation. He also seems quite good at dominating the Chinese political class, AKA CCP.
>It could be that a Deng will follow XI and put the focus back on economic success.<
He's only 70, and gets the best (Western) medicine money can buy. He could easily be on the throne another 25 years.
Really insightful article Noah! Great read
China's real estate bubble looks like recent similar bubbles in the U.S. and EU. I remember the financial crisis in the U.S. and was impressed with how Obama and Geithner developed a focused plan to stop the damage and to stabilize the financial institutions.
Noah, you give a good, clear overview of how China got into this mess, but China is also uniquely poised to devise a clear, focused plan on rectifying the situation. After all, the CCP owns all the land that is being developed and a real estate crisis is in their best interest to quell. I would be interested in your take on how China will take action to stop this slide.
Another adverse factor is China's strict "zero-COVID" policy in 2020-2022.
The land sales mechanism for state government revenue by itself sounds horrible, and they just doubled down. The shenanigans in the US heading into 2008 were also egregious, so I guess I shouldn't judge too much. But it does seem that the increasingly authoritarian government means that no one can say the emperor has no clothes, which makes the problem worse.
I wonder what they'll do next, and whether it will work? I wouldn't be surprised if this ends up being China's long-term plateau, similar to Japan since the 90's (although at a much lower income level).
I see no causal attribution (he uses 'associated with') in your account of China's rapid growth to CCP investment in human capital (sanitation, health, education,) and female labour participation. I wonder what you think of this take Noah, from Mody in Project Syndicate which acknowledges the present financial bust but points to deeper strengths engineered by what I'm thinking to dub a developmental autocracy? 'Rather than tax cuts or economic liberalization, the World Bank report focused on a historical fact recently emphasized by Brown University economist Oded Galor. Since the dawn of the Industrial Revolution, every instance of economic progress – the crux of which is sustained productivity growth – has been associated with investments in human capital and higher female workforce participation.
To be sure, market liberalization greatly helped Chinese and Indian growth. But China built its successful development strategy on the twin pillars of human capital and gender equality, areas where India has lagged far behind.
Even after it became more market-oriented, China invested impressively in its people, outpacing India in raising education and health standards to levels necessary for an internationally competitive workforce. The World Bank’s 2020 Human Capital Index – which measures countries’ education and health outcomes on a scale of 0 to 1 – gave India a score of 0.49, below Nepal and Kenya, both poorer countries. China scored 0.65, similar to the much richer (in per capita terms) Chile and Slovakia. 1
While China’s female labor-force participation rate has decreased to roughly 62% from around 80% in 1990, India’s has fallen over the same period from 32% to around 25%. Especially in urban areas, violence against women has deterred Indian women from entering the workforce.
Together, superior human capital and greater gender equality have enabled much higher Chinese total factor productivity growth, the most comprehensive measure of resource-use efficiency. Assuming that the two economies were equally productive in 1953 (roughly when they embarked on their modernization efforts), China became over 50% more productive by the late 1980s. Today, China’s productivity is nearly double that of India. While 45% of Indian workers are still in the highly unproductive agriculture sector, China has graduated even from simple, labor-intensive manufacturing to emerge, for example, as a dominant force in global car markets, especially in electric vehicles...China is also better prepared for future opportunities. Seven Chinese universities are ranked among the world’s top 100, with Tsinghua and Peking among the top 20. Tsinghua is considered the world’s leading university for computer science, while Peking is ranked ninth. Likewise, nine Chinese universities are among the top 50 globally in mathematics. By contrast, no Indian university, including the celebrated Indian Institutes of Technology, is ranked among the world’s top 100.
Chinese scientists have made significant strides in boosting the quantity and quality of their research, particularly in fields such as chemistry, engineering, and materials science, and could soon take the lead in artificial intelligence. As the figure shows, Chinese researchers, both in academia and industry, are rapidly generating high-quality patents'. https://www.project-syndicate.org/commentary/india-economic-boom-is-overhyped-by-ashoka-mody-2023-07 or for an open access shorter version without the graph showing US registered Chinese patents https://asialink.unimelb.edu.au/insights/unlike-china,-india-cannot-be-an-economic-superpower
Agree with all your points, China is way ahead of India on social indicators, besides the country would never have achieved the super impressive results it has without a great talent pool. However perhaps the problem is the authoritarian system where priorities are driven by the whim of the CCP and neither by market forces nor by individual choice. It's not an open & shut inference, there would be some sort of external determination of priorities in all economies. Besides you have the hardly ideal American experience, where the brightest talent of the last 20 years have been busy devising ways to make you click on a the next advertisement rather than say making clean energy or going to Mars!
It's not an exact comparison because they started earlier but I would say that other locations with ethnic Chinese talent like Singapore, Taiwan, Hong Kong have achieved far more in a relative sense, given that mainland China has expended far greater resources on human capital, hence it is the system which has held the talent back...
India non-withstanding, it seems rather inaccurate to reduce American technological development to simply ad design. The US has continued to be at the forefront of tech development in the 21st century from consumer electronics (Apple) to EVs (Tesla) to space travel (SpaceX) to MRNA vaccines (Pfizer/Moderna). Meanwhile I can't really think of any major tech development that China has pioneered in the last several decades. They are certainly able to come in and play copycat and build their own production of such things but they have yet to actually become a center for cutting edge innovation.
S Korea has also achieved more- starting at a level below China’s in the 1950s