Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday
It is commonly accepted that China has come to the rescue of the world economy twice in the past 15 years. In 2008-09, its stimulus complemented that of other big economies to arrest the collapse in activity from the global financial crisis. A few years later, it offset fiscal retrenchment across the west and a new financial crisis in the eurozone. Germany, in particular, outperformed the rest of western Europe on the back of strong Chinese demand. Now, a decade on, the Chinese economy seems to have run out of steam. Below I share my take on a recent debate about why — but I would love to hear your thoughts too. Write to us at email@example.com.
“Who killed the Chinese economy” is the title of a recent colloquium in Foreign Affairs — in article form, followed up with a webinar hosted with the Peterson Institute for International Economics.
That headline is a little hyperbolic: the Chinese economy isn’t dead yet. While it has become popular to go bearish on China, some remain relatively optimistic. Short term, the IMF has raised its 2023 growth forecast to 5.4 per cent. Longer term, the FT’s own Martin Wolf has warned against calling “peak China” just yet.
But to run with the metaphor, I want to share the one thing I have recently read that makes me think China’s economy is, if not murdered, then in lethal danger. Two years ago I wrote about the world-historic size of real estate’s economic footprint there. It was clear then that a fall in real estate activity would have huge effects. In a paper in May, Sheng Zhongming shows just how huge.
The paper calculates the effect on China’s public finances of permanently lower activity levels in real estate (defined as sustaining the current sales level of Rmb13tn/year [$1.8tn]). The result is that public sector revenues will be Rmb3.6tn lower than before the real estate crash, and available government financing lower by the same amount. This is enormous. It corresponds to 3 to 4 per cent of gross domestic product each. Most of this will hit local government budgets, which in 2021 made up about two-thirds of overall fiscal revenue of Rmb30tn. In other words, we could be looking at a permanent revenue loss of 15 per cent, and as much again in curtailed financing, for that government level. There is no way such a big change would not be extremely disruptive.
So we should be worried, very worried. More importantly, so should Chinese policymakers, as the ones able to actually do something about it. But what? Here is where the Foreign Affairs/Peterson Institute colloquium comes in handy. Designed as a response to Peterson Institute president Adam Posen’s analysis of China’s “economic long Covid” (which I mentioned in the summer), it sets up a debate between Posen and China experts Zongyuan Zoe Liu and Michael Pettis about how best to understand China’s economic problems.
Read the whole exchange and watch the webinar (which unfortunately seems to be missing the start) for a good sense of the perspectives. But to simplify, they divide into the political and the structural. Everyone agrees that private domestic demand, especially consumer demand, needs to make up a greater share of the Chinese economy. That’s because export-driven growth will no longer be accommodated by the rest of the world (Pettis explained why in a recent FT column) and because state-led investment is no longer finding productive outlets. But the obstacles to this rebalancing depend on one’s view of the causes.
Posen sees arbitrary government interference, especially during and after the pandemic (which is why he calls it economic long Covid), as the chief cause of declining Chinese growth. Liu and especially Pettis both offer more “structuralist” analyses that place the root causes in an economic and institutional structure that outgrew its usefulness one or two decades ago and failed to renew itself.
In the webinar, Posen usefully sets out a view of how the two perspectives have different policy implications, which the other experts did not contest. He said that if the structuralist interpretation was correct, then, if “you restructure the debt . . . stimulus will work [and] fiscal stimulus should be effective even if monetary stimulus is not. Whereas in my point of view, because the households are beaten down, it’s not going to work that way.” Put in different words, if it’s the debt burden that keeps people from spending, removing it and giving them money will make them spend; if it’s their lack of confidence in their (and their investments’) safety from the government, then any extra money that gets into private hands will only be squirrelled away (and out of the country).
I lean towards the structuralists, inasmuch as I think the debt overhang is a big constraint on growth. It was left unsaid — but I think because they all take it for granted — that debt restructuring is a necessary condition for restoring healthy growth. The question is what other policies are also needed. And here I struggle to share Posen’s fatalism about policies to stimulate domestic demand growth.
There are still many poor people in China: according to the world inequality database, the bottom 50 per cent of earners make only about €5,000 a year on average.
If the government pursued significant transfers to the poorest, they should have a high propensity to spend out of any additional income. Of course, even poor people may save rather than consume (because of the lack of a social safety net) or invest (because of government arbitrariness). Even so, it beggars belief to think that no large groups of income- or liquidity-constrained households exist in China.
Not just income but wealth is extremely unequally distributed in China. So if income redistribution given current wealth inequalities fails to boost domestic spending (because poor people want to save up), then it can be complemented by wealth redistribution. At an individual level, a previously poor person with a sudden cushion of wealth may feel more comfortable spending a sudden increase in income, or invest it in long-term projects. One straightforward type of wealth redistribution is to rejig the troubled real estate industry by using government subsidies to build better housing for poor people to own.
This suggests another solution to the supposed conundrum of getting domestic spending up: the government can spend on poor people’s behalf. This is no contradiction to the need to restructure public debt. Direct fiscal spending could be funded through taxes. If it really is true that private actors have a low propensity to spend out of new income, then taxing and spending by the government should expand demand by much more than it represses private spending. This, too, would be a strategy of redistribution through significantly raising spending on public services for the poor.
The same, of course, holds true for direct public investment (or at least directly state-funded investment). While most observers think China’s investment rate is far too high, surely the core of the problem is one of misallocation of capital, that is to say investment on unproductive things. But again, there are a lot of poor people in China: is there really nothing that can be invested in to significantly increase their economic wellbeing?
If these strategies are unachievable, the question must be why. And the answer must be that the Chinese government is unable or unwilling to shift more of its national resources to directly benefit its poorest citizens. Why that should be could have institutional reasons — the Chinese state may be set up to silence the interest and voices of the poor and entrench those of the rich. Or they could be political — China’s leaders just don’t care about the poor. Either would, therefore, have to change.
The upshot, then, is that a recovery of China’s economic mojo relies on building a welfare state: a Chinese economy with European characteristics.
US inflation keeps falling — at 3.2 per cent in October, year on year consumer price inflation was below expectations. This is not just about “base effects” (flattering comparisons with price changes a year ago). The chart below shows three- and six-month averages of month on month inflation (expressed in annual rates): it is heading steadily downwards.
Uncapped? Almost all of Russia’s oil exports are now circumventing the west’s price cap.
Brussels has downgraded its growth forecasts for the EU — but independent economists still find it too optimistic.
Recommended newsletters for you
Chris Giles on Central Banks — Your essential guide to money, interest rates, inflation and what central banks are thinking. Sign up here
Unhedged — Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here