By Paul Krugman
In 2023, the US economy vastly outperformed expectations. A widely predicted recession never happened. Many economists (though not me) argued that getting inflation down would require years of high unemployment; instead, we’ve experienced immaculate disinflation, rapidly falling inflation at no visible cost.
But the story has been very different in the world’s biggest economy (or second biggest — it depends on the measure). Some analysts expected the Chinese economy to boom after it lifted the draconian “zero COVID” measures it had adopted to contain the pandemic. Instead, China has underperformed by just about every economic indicator other than official GDP, which supposedly grew by 5.2 per cent.
But there’s widespread scepticism about that number. Democratic nations like the United States rarely politicise their economic statistics — although ask me again if Donald Trump returns to office — but authoritarian regimes often do.
And in other ways, the Chinese economy seems to be stumbling. Even the official statistics say that China is experiencing Japan-style deflation and high youth unemployment. It’s not a full-blown crisis, at least not yet, but there’s reason to believe that China is entering an era of stagnation and disappointment.
Why is China’s economy, which only a few years ago seemed headed for world domination, in trouble?
Part of the answer is bad leadership. President Xi Jinping is starting to look like a poor economic manager, whose propensity for arbitrary interventions — which is something autocrats tend to do — has stifled private initiative.
But China would be in trouble even if Xi were a better leader than he is.
It has been clear for a long time that China’s economic model was becoming unsustainable. As Stewart Paterson, author of China, Trade and Power, notes, consumer spending is very low as a percentage of GDP, probably for multiple reasons. These include financial repression — paying low interest on savings and making cheap loans to favoured borrowers — that holds down household income and diverts it to government-controlled investment, a weak social safety net that causes families to accumulate savings to deal with possible emergencies, and more.
With consumers buying so little, at least relative to the Chinese economy’s productive capacity, how can the nation generate enough demand to keep that capacity in use? The main answer, as Michael Pettis, professor of finance at Guanghua School of Management at Peking University in Beijing, says, has been to promote extremely high rates of investment, more than 40 per cent of GDP. The trouble is that it’s hard to invest that much money without running into severely diminishing returns.
True, very high rates of investment may be sustainable if, like China in the early 2000s, you have a rapidly growing workforce and high productivity growth as you catch up with Western economies. But China’s working-age population peaked around 2010 and has been declining ever since. While China has shown impressive technological capacity in some areas, its overall productivity also appears to be stagnating.
This, in short, isn’t a nation that can productively invest 40 per cent of GDP. Something has to give.
Now, these problems have been fairly obvious for at least a decade. Why are they only becoming acute now? Well, international economists are fond of citing Dornbusch’s Law: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.” What happened in China’s case was that the government was able to mask the problem of inadequate consumer spending for a number of years by promoting a gigantic real estate bubble. In fact, China’s real estate sector became insanely large by international standards.
But bubbles eventually burst.
To outside observers, what China must do seems straightforward: end financial repression and allow more of the economy’s income to flow through to households, and strengthen the social safety net so that consumers don’t feel the need to hoard cash. And as it does this it can ramp down its unsustainable investment spending.
It has been clear for a long time that China’s economic model was becoming unsustainable.
But there are powerful players, especially state-owned enterprises, that benefit from financial repression. And when it comes to strengthening the safety net, the leader of this supposedly communist regime sounds a bit like Mississippi governor Tate Reeves, denouncing “welfarism” that creates “lazy people”.
So how worried should we be about China? In some ways, China’s current economy is reminiscent of Japan after its bubble of the 1980s burst. However, Japan ended up managing its downshifting well. It avoided mass unemployment, it never lost social and political cohesion, and real GDP per working-age adult actually rose 50 per cent over the next three decades, not far short of growth in the United States.
My great concern is that China may not respond nearly as well. How cohesive will China be in the face of economic trouble? Will it try to prop up its economy with an export surge that will run headlong into Western efforts to promote green technologies? Scariest of all, will it try to distract from domestic difficulties by engaging in military adventurism?
So let’s not gloat about China’s economic stumble, which may become everyone’s problem.
This article originally appeared in The New York Times.
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