Why is China’s economy stumbling?

In China, much construction has halted and many commercial buildings remain empty. Photo / Gilles Sabrié, The New York Times

OPINION:

Two years ago China was riding high. Decades of miraculous growth had transformed a desperately poor nation into an economic superpower, with a gross domestic product that by some measures was larger than America’s. China’s aggressive response to Covid was widely praised; its Belt and Road Initiative, a huge programme of infrastructure investments around the world, was clearly a bid for global influence, maybe even supremacy.

But now China is stumbling. Its “zero Covid” policy of locking cities down at the first indication of an outbreak proved untenable, but abandoning the policy hasn’t produced the expected economic surge. In fact, China is now experiencing deflation, inspiring comparisons with Japan’s slowdown in the 1990s (although Japan has actually done much better than legend has it).

What has gone wrong? Can China reverse its slide? And how should the rest of the world, the US in particular, respond?

Some analysts attribute China’s stumble to policies of its current leadership. An influential recent article by Adam Posen, president of the Peterson Institute for International Economics, suggests that China is suffering from “economic long Covid,” a decline in private-sector confidence brought on by arbitrary government intervention, which began before the pandemic but has intensified since.

But while the actions of Xi Jinping, China’s president, have indeed been erratic, I’m in the camp of economists like Michael Pettis of the Carnegie Endowment who see the country’s problems as more systemic.

The basic point is that China, in various ways, suppresses private consumption, leaving the country with huge savings that need to be invested somehow. This wasn’t too hard 15 or 20 years ago, when Chinese GDP could grow as much as 10 per cent a year largely by catching up with Western technology: A rapidly growing economy can make good use of huge amounts of capital. But as China has grown richer, the scope for rapid productivity gains has narrowed, while the working-age population has stopped increasing and has begun to decline.

Inevitably, then, growth has slowed. The International Monetary Fund believes that over the medium term China can expect a growth rate of less than 4 per cent. That’s not bad — it’s something like twice the growth most observers expect for the United States. But China is still trying to invest more than 40 per cent of GDP, which just isn’t possible given falling growth.

This looming issue has been obvious for a decade or more, but China has been able to mask it largely by creating an immensely bloated real estate sector. This strategy, though, was unsustainable. Xi’s fumbles may have advanced the day of reckoning, but absent fundamental reform, China’s current predicament was only a matter of time.

So is China down and out? Is Posen right in asserting that this is “the end of China’s economic miracle”?

I wouldn’t count on it. As Adam Smith once remarked, “There is a great deal of ruin in a nation.” China is already a superpower, and its current stumbles aren’t likely to end that status. Furthermore, while China’s government has been weirdly resistant to reforms that might make its growth sustainable, we can’t assume that this resistance will continue indefinitely.

And what do China’s problems mean for the United States? The Biden administration has taken a very hard line on China — much harder in practice than Donald Trump, who talked tough but mostly flailed around ineffectually. The US government is now promoting semiconductor production to reduce dependence on China, trying to block exports of advanced silicon chips and, most recently, banning some high-tech investments in China.

Have these actions become unnecessary now that China’s path to global dominance seems to be disappearing?

No. You don’t have to be a xenophobe to be worried about the possible future actions of a superpower whose leadership seems to be growing more autocratic and more erratic with each passing year. Trying to reduce that superpower’s ability to do harm makes sense, even if it makes many people nervous. And the possibility that China may not be as much of a superpower as many expected doesn’t change that calculation.

If anything, China’s problems may reinforce the case for precautionary action. China’s rulers have long relied on economic achievement to give them legitimacy. Now they’re facing trouble on the homefront, most immediately in the form of rapidly rising youth unemployment. How will they respond?

Ideally, as I said, they’ll push through long-needed reforms that put more income in the hands of families, so that rising consumption can take the place of unsustainable investment. But you don’t have to study much history to be aware that autocratic regimes sometimes respond to domestic difficulties by trying to distract the population with foreign adventurism.

I’m not saying that will happen. But realistically, China’s domestic problems make it more, not less, of a danger to global security.

This article originally appeared in The New York Times.

Written by: Paul Krugman

Photographs by: Gilles Sabrie

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