The Chinese Dragon Versus the American Bison

A Snail in the Global Race?

Launched only 45 years ago by Deng Xiaoping, the Chinese economic machine has encountered a hiccup. Moreover, not everyone is convinced it can be rectified. The UK magazine The Economist titled its main article in the August-September issue of this year “Xi’s Misfire: Why He Won’t Fix China’s Economy”. The story was illustrated with a depiction of Xi Jinping, the General Secretary of the Communist Party of China (CPC), riding a snail with a dragon’s head.

What underlies this shift in perception of China’s development? And which predictions now hold greater accuracy?

The immediate cause of the country’s economic slowdown is the crisis in the real estate sector. For years, real estate has been a primary driver of China’s economic growth, constituting 25-30 per cent of GDP–almost twice the percentage in the USA. The real estate sector in the United States triggered the 2008 global financial crisis, impacting developed countries worldwide for years. In pursuit of rapid economic growth, Chinese authorities allowed a speculative bubble to form in the property market. The widespread belief that investing in this segment guaranteed returns led to real estate accounting for as much as 70 per cent of Chinese household assets. The rush for housing encouraged developers to act aggressively, borrowing increasingly to finance large housing projects. Few paid attention to the growing number of ghost estates – built but uninhabited investments. The bursting of the Chinese bubble was inevitable, and due to its scale, the debt of only the largest player in the market, Country Garden, exceeds USD 200 billion. No wonder it is grappling with financial challenges. Faced with insolvency, the developers’ total debts are estimated at a staggering USD 2 trillion.

The State to the Rescue

Will the real estate market crisis sink the Chinese economy? Probably not. In the United States in 2008, government and central bank interventions limited the effects of the property market collapse. However, in China, government intervention in market mechanisms is a daily occurrence. While few believe a deeper crisis will be permitted, decision-makers are acutely aware of the longstanding problem, yet they attempt to address it with minimal involvement. The November-announced stimulus package, involving the issuance of USD 140 billion in bonds and an increase in the fiscal deficit from 3 per cent to 3.8 per cent of the GDP, was met with tepid enthusiasm by financial markets, deeming it insufficient. The Chinese authorities are grappling with a serious dilemma – how to shield society from the consequences of the crisis while avoiding the temptation of moral hazard (concerns that interventions limiting the negative effects of risk encourage taking on that risk). However, it seems unlikely that this key engine of the Chinese economy can be repaired quickly.

The Hydra Has More Heads

The real estate sector crisis is not China’s sole problem. The closure of its economy during the COVID epidemic highlighted China’s crucial role in the global supply chain and the extensive consequences for the global economy. Components or products from China are indispensable for many industries worldwide. Recognisable companies, such as Apple, rely on supplies from China, with over 90 per cent of iPhones, iPads, AirPods, and Macs produced there.

Delays during the pandemic led many European and American businesses to realize the dangers of dependence on a single source. This awareness intensified following Russia’s aggression in Ukraine, where sanctions practically severed the country from the global market. Companies suffered and had to withdraw from Russia. In such a case, losses for the global economy would be many times higher than after limiting ties with Russia. Therefore, attempts to reduce dependence on China are becoming more common. It cannot be done in a year or even five, but the trend is clear and gaining strength.

Unfavourable demographic changes are another factor worsening China’s situation. The country’s society is aging, a normal trend in wealthier countries. However, the predicament lies in the fact that the demographic boom of the previous century, which propelled China’s growth, is now becoming a burden. In the late 1970s and 1980s, over 270 million people entered the labour market, enabling China to become the “world’s factory”. Now, these people are becoming a demographic challenge. According to estimates from the Ministry of Public Security of the People’s Republic of China, by 2025, over 300 million residents will be over 65. With a poorly developed pension system and declining fertility, an aging population poses a challenge for the entire economy.

Just as analysts and economists once competed to enumerate arguments for China’s continued growth during its rapid development period, it has now become fashionable to list factors that could impede this growth. However, this not only signifies a change in perception; it has concrete consequences. The financial markets’ attitude toward China has shifted dramatically. As a result, in the third quarter of this year, foreign direct investment in the Chinese economy turned negative for the first time since 1998.

Running Ahead

Will the Chinese machine take off again and allow it to surpass the US? And if so, when will it happen? An anecdote circulating in the market suggests that the answer to this question is simple: when Xi Jinping wants it to happen. After all, he is the one who controls the Central Bureau of Analysis and Statistics.

While there is certainly a lot of exaggeration in this joke, the influence of the Chinese leader on what happens in the country is unquestionable. The CCP chairman realises that the previous development model has run out of steam. This is evidenced by his statement two years ago at a seminar for provincial and ministerial-level officials when he said, “We have changed our approach of assuming that GDP growth is the only measure of success. (...) The recommendations for the formulation of the 14th Five-Year Economic and Social Development Plan and long-term goals until 2035 define the creation of a new development dynamic that focuses on domestic flow and is characterized by a positive interdependence between domestic flow and international engagement”.

It is clear from these words that China wants to focus on the domestic market. This is confirmed by another passage in Xi’s speech: “In today’s world, markets are the scarcest resource. The Chinese market is, therefore, a huge advantage for our country. We must take full advantage of this factor and continuously consolidate it so that it becomes a strong pillar creating a new development dynamic”.

Although a population of 1.3 billion creates a huge internal market, in the case of China, there are at least a few factors that make it difficult to exploit this potential. The Chinese are generally not a very affluent society. The GDP per capita in terms of purchasing power parity is approximately USD 21.5 thousand, placing the country 72nd in the ranking of the wealthiest countries (Poland is 40th with USD 43.3 thousand). Moreover, the inhabitants of the Middle Kingdom are not inclined to spend the money they earn due to a weak social security system (pensions, health care), which means that residents have to save “for a rainy day.” However, the potential hidden in these savings is enormous. Data published by the People’s Bank of China shows that in 2022 alone, the value of Chinese household savings increased by as much as USD 2.2 trillion.

Another element that traditionally boosts the domestic market is public spending. However, this is severely inefficient in China due to factors such as lack of transparency, poor project quality, and corruption. Money spent by the government and local authorities does not create as much growth as it could and should. Here too, however, the opportunities are enormous – this year’s central and local government spending, as budgeted at the beginning of the year, was expected to reach USD 4 trillion.

The way to solve the problem of the exhaustion of the current model of development, based on infrastructure investment and exports, is the development of innovative sectors of the economy. After a period of fairly free use of other people’s knowledge, the PRC has been investing in its projects for several years. Quantum computers, communication, or thermonuclear fusion are areas of research in which the country can boast considerable success. However, these are technologies of the future that, although they could revolutionize the world, have so far primarily meant huge expenditure. China’s biggest problem right now is its dependence on semiconductors manufactured abroad. These are one of the most important elements for technological superiority. In this field, however, China lags behind the USA or Taiwan. According to estimates by the Peterson Institute for Economics, in 2020, only 16 per cent of the chips used in China came from China (with the majority of these 16 per cent being products of foreign companies located in the PRC). A major problem for China is the sanctions and restrictions imposed by the US on technology exports to the country. Meanwhile, the lack of modern semiconductors is currently a technological brake on the entire economy. The Chinese authorities are aware of this. In August this year, Reuters reported that China had decided to set up a fund to invest USD 40 billion in the semiconductor sector. The number of universities training specialists in this field has also been growing for years. In technology, however, money is not always a substitute for time.

The Most Interesting Times Are Ahead

In mid-November this year, Xi Jinping met with President Joe Biden in the US. This was the first meeting between the leaders of these countries after a gap of six years. “China is pursuing high-quality development, and the US is revitalising its economy. There is a lot of room for our cooperation, and we are able to help each other succeed and achieve win-win results”, the Chinese leader summarised his visit to the US. This statement was perceived by some observers as a capitulation by the Middle Kingdom in the face of mounting problems. This is an overreaching statement. However, it is apparent that the period of wolf warrior diplomacy adopted under Xi Jinping’s government is over – at least temporarily. China needs to catch its breath. After all, as Sun Tzu teaches in The Art of War, “When it rains, the river stirs. If you want to cross the ford, wait until it calms down”.

Will China overtake the US? The answer to this question should probably be in the conclusion. At this point, however, I would like to quote words attributed to the Danish physicist Niels Bohr: “Forecasting is difficult, especially when it concerns the future”. While there are many indications that the troubles piling up for China may indeed bring the economy that has been surging for years to a halt, this is not a foregone conclusion. China is a country unlike any other. In addition, recent years have taught us that black swans are not all that rare. New technologies, geopolitics, or nature – all of these can radically change the world picture. And if anyone is sorely lacking an answer–in terms of the size of GDP, which takes into account the difference in purchasing power of income, China overtook the USA a few years ago. ©Ⓟ