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?
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?
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.
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.
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.
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?
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?
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.
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.
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.
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