China's Bubble: Global Investment Risk

There is much debate about whether China's economic growth can be considered sustainable, with some arguing that it is one huge economic bubble. However, others disagree, stating that China's growth rates, while high, are not uncommon when compared to other nations. China's economic slump is being driven by a mountain of debt, with its debt-to-GDP ratio reaching a record 288% in 2023. This has been fuelled by an expansion of credit, with the Chinese housing market growing to around 30% of its overall economy. The property bubble burst in late 2021 when China Evergrande Group, one of the country's biggest property developers, defaulted on its debts. This has had a knock-on effect on the Chinese economy as a whole, with housing prices falling and demand slumping. As a result, there are now an estimated 65-80 million unoccupied homes in China, and several property developers have defaulted on their loans. This has had a significant impact on the Chinese local governments' finances, as their finances are heavily dependent on property tax collections.

China's economic slump

The crisis has been exacerbated by rising youth unemployment, which reached 21% before the government stopped publishing figures. Chinese consumers are now saving rather than spending, and there is a lack of confidence among private businesses and consumers. The crisis has been compared to Japan's crisis in 1989, which saw the end of high growth and rising asset prices.

The seeds of China's economic woes were sown over the last 15 years by pursuing highly unbalanced economic policies. An overemphasis on investment as the primary driver of economic growth has resulted in a large degree of manufacturing overcapacity. This has been compounded by a housing and credit market bubble, with the Chinese housing market fuelled by ample credit, growing to around 30% of the country's overall economy—50% higher than in advanced industrialised countries.

The Chinese government's disastrous zero-COVID policy has also contributed to the economic slump, with housing prices falling in most major cities and demand slumping. Additionally, several Chinese property developers have defaulted on their loans, creating major problems for local governments' finances, which heavily depend on property tax collections.

The Chinese government's recent tendency to rapidly engineer policy U-turns hurts confidence and makes it more difficult for Chinese businesses to attract foreign investment. The worsening relationship between China and the West further threatens the country's growth prospects.

To address the economic slump, China would need to undertake fundamental economic reforms aimed at increasing household consumption by improving the social safety net. However, President Xi Jinping shows no signs of moving in this direction, instead rolling back market-based reforms introduced in the 1980s that were successful in promoting China's economic growth. As a result, China is likely to experience a lost economic decade, and the world can no longer rely on it as the primary engine of economic growth.

The impact of COVID lockdowns

The COVID-19 pandemic and the stringent public health measures taken to control it have had a significant impact on the Chinese economy. The frequent lockdowns, quarantines, and travel restrictions implemented as part of China's "zero-COVID" policy disrupted economic activities, supply chains, and consumer demand, hindering economic growth.

The impact of the COVID lockdowns on China's economy can be observed in several key areas:

Economic Growth and International Trade

The COVID-19 pandemic and the "zero-COVID" policy measures significantly impacted China's economic growth. Before the pandemic, China's economic growth had been slowing, but the pandemic exacerbated this trend. In 2020, China's GDP growth dropped to 2.2%, down from a normal rate of around 6% in previous years. While growth rebounded to 8.4% in 2021, it fell again to around 3% in 2022 due to the recurrence of COVID-19 outbreaks and strict lockdown measures.

International trade was also affected by the COVID lockdowns. China's total imports and exports declined slightly from 2019 to 2020 but recovered and increased in 2021. However, the pandemic and the trade war with the US increased uncertainties in the global economy and led to rising trade protectionism. The pandemic's impact on international trade was further compounded by abnormal price fluctuations in the international market, making it difficult to accurately assess the volume of trade.

Employment and Income

The COVID-19 pandemic and the "zero-COVID" policy had a significant impact on employment in China. The closure of foreign-invested firms and private companies during the pandemic resulted in rising unemployment, particularly among young people. The urban unemployment rate increased, and the youth unemployment rate for those aged 16-24 was three to four times higher than that of older workers. The pandemic and the frequent lockdowns also contributed to a diminishing appetite for entrepreneurship and risk-taking among young people, with more graduates seeking stable jobs in the government and state-owned sectors.

Disposable income and expenditure were also affected by the COVID lockdowns. The growth rate of real wages in urban areas decreased during the pandemic, and disposable income growth declined sharply at the beginning of the pandemic, remaining negative until early 2021.

Business Operations

The COVID lockdowns disrupted business operations across various sectors in China. Many companies, especially small and micro enterprises, faced significant challenges due to the restrictions on economic activities. Foreign-invested companies were also impacted, with some choosing to close or withdraw from China. For example, Canon closed its factory in Zhuhai, laying off 1,300 employees. The pandemic and lockdown measures also disrupted supply chains and manufacturing hubs, affecting industries such as electronics, automobiles, and consumer goods. Companies like Apple, Microsoft, and Estée Lauder experienced significant disruptions to their production and sales, with some warning of potential financial losses.

Education and Human Capital

The "zero-COVID" policy and the resulting school closures impacted education and human capital accumulation in China. Widespread school closures and the shift to online learning affected the quality of education and are expected to have long-term effects on students' human capital accumulation, unemployment, innovation, and economic growth. The pandemic also disrupted the job market for young graduates, with increased competition for jobs in the public sector and a preference for stable jobs over entrepreneurship.

The role of the Chinese government

The Chinese government has played a significant role in the country's economic bubble, and its actions have had both positive and negative impacts.

Firstly, the government's implicit guarantees have helped drive economic investment and expansion. Over the past three decades, China has achieved astonishing growth, and the government's policies have contributed to this success. However, as argued by Ning Zhu in "China's Guaranteed Bubble," these same guarantees have also contributed to the challenges the country now faces. As lending tightens and corporate earnings decline, the leverage ratios of the Chinese government, corporations, and households have increased, leading to a debt crisis.

The government's efforts to address the overheating economy through credit restrictions, known as the "Three Red Lines" policy, have had a significant impact. While these restrictions aimed to assist in cooling down the economy, they had a more negative effect on the real estate market, causing a slump in the housing sector. The restrictions made it difficult for property developers and investors to access credit, leading to a decrease in new construction and a fall in housing prices. This, in turn, resulted in a wave of loan defaults and financial problems for local governments that relied heavily on property tax collections.

Additionally, the Chinese government's response to the COVID-19 pandemic with a zero-COVID policy further exacerbated the economic situation. The policy's economic impact was disastrous, contributing to the bursting of the housing and credit bubble.

Despite the challenges, the Chinese government has taken some actions to mitigate the negative consequences. For instance, they have intervened to prevent the Chinese currency, the renminbi, from falling too far too fast by selling foreign reserves and buying renminbi.

However, the government's current approach, as of 2024, seems to be rolling back the market-based reforms introduced by Deng Xiaoping in the 1980s, which had previously contributed to China's economic miracle. This shift in policy has led to concerns about a potential lost economic decade for China and its impact on the global economic recovery.

The property bubble

China's economic growth over the past few decades has been fuelled by real estate. However, this engine now seems to have stalled, and the property bubble has burst.

The property sector was the backbone of the Chinese economy, with real estate being seen as a can't-lose investment. However, this has changed in the last two years, with firms collapsing under massive debts and sales of new homes plummeting. This has resulted in a sharp loss of faith in property as an investment, which is a significant problem for Chinese policymakers as property is the main store of wealth for many Chinese families.

The crisis in the property market was epitomised by the forced liquidation of China Evergrande, which defaulted on payments it owed to investors and struggled to pay creditors. Evergrande tried to maintain confidence that its apartments were still a sound investment, but the market did not bounce back. Instead, the downturn accelerated, with China's housing sales falling 6.5% in 2023.

The Chinese government has tried to revive the ailing industry, but with little effect. Analysts predict that it will take at least four to six years to resolve the problem, with efforts to boost funding to developers failing to address the issue of uncompleted homes.

China's growth sustainability

China's Economic Growth:

Since initiating economic reforms in 1978, China has experienced remarkable economic growth, with an average GDP growth rate of over 9% annually. This growth has lifted millions of people out of poverty and improved access to health, education, and other services. China's strong growth has been driven by investment and export-oriented manufacturing, contributing to its current status as an upper-middle-income country.

Sustainability Challenges:

However, China's growth model has also led to economic, social, and environmental imbalances. The country's heavy emphasis on investment has resulted in an overreliance on manufacturing, creating overcapacity and imbalanced development. Additionally, the pursuit of rapid growth has resulted in environmental degradation and pollution, particularly in the form of air, water, and soil pollution. China's growth model has also contributed to global climate change, with the country accounting for a significant share of global carbon dioxide and greenhouse gas emissions.

Addressing Sustainability Challenges:

Recognizing these challenges, China has taken several steps to promote more sustainable growth:

• Transition to Green Development: China has made notable efforts to transition towards green and low-carbon development. It has implemented measures to reduce air, water, and soil pollution and has actively participated in global climate governance, including the Paris Agreement. China has also invested in renewable energy sources, such as wind and solar power, and is working towards peaking carbon dioxide emissions before 2030 and achieving carbon neutrality before 2060.
• Agricultural and Rural Development: China has prioritized the development of agriculture and rural areas, implementing strategies such as the rural revitalization strategy. These efforts have improved food security and contributed to bumper harvests in grain production.
• Social Development: China has made strides in improving social security and social services, ensuring equal access to basic public services, and promoting human development. The country has also successfully controlled the COVID-19 pandemic, investing in public health infrastructure and social safety nets.
• Economic Reforms: China has recognized the need for economic reforms to address imbalances and promote sustainable growth. This includes shifting from manufacturing to high-value services, reducing investment-driven growth, and transitioning to a more consumption-based model.
• International Cooperation: China has actively engaged in international development cooperation and promoted the Belt and Road Initiative to facilitate sustainable development in other countries.

Future Prospects:

While China faces challenges in sustaining its rapid economic growth, the country has demonstrated a commitment to addressing these issues. By prioritizing environmental protection, social development, and economic reforms, China aims to achieve more balanced and sustainable growth. However, the success of these efforts will depend on effective implementation and the ability to adapt to changing global conditions.

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