All too often the narrative around a series of stylised economic ‘facts’ become detached from the facts themselves.
Nowhere is this more pervasive than in China. While it is broadly accepted that China’s growth is not as rapid as it was back during the breakneck pace of economic progress between 1990 and 2020, the narrative remains that despite a few short-term speed bumps, China is still on course to either catch up with or indeed surpass the US as the world’s pre-eminent economic power.
Debt, deflation and demographics
The facts, detached from the commonly accepted narrative, tell the opposite story. As Ruchir Sharma, the chair of Rockefeller International, has written: “In a historic turn, China’s rise as an economic superpower is reversing.” The story of its growth and transformation is one of the past half-century, not the next half-century. Debt, deflation and demographics are crippling it.
There can be no doubting the phenomenal transformation that has occurred. After opening itself to the world in the 1980s under Deng Xiaoping, China’s share of global GDP rose almost 10 times from an inconsequential 1.8% to 18.4% in 2021. A rounding error became a global powerhouse.
Since then, however, China has simply not been able to keep up. Since 2022 its share of global GDP has shrunk, materially, to barely 17%. According to Sharma, this is the biggest drop since the 1960s.
Interestingly this data comes from Beijing itself, in the form of official nominal GDP data, meaning that Chinese authorities must be all too aware of the malaise. They are, however, not adjusted for inflation, which calls into question the official stance that real GDP has indeed been expanding consistently at more than 5% per annum. Most economic estimates register real long-term potential growth at no more than 2.5%. Has Beijing been doctoring inflation statistics to make the real growth figures look overly robust?
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The reasons behind this structural slowdown are clear. First, the demographic tailwind of the Lewis Theory of an untapped reserve army of labour entering the workforce in the 1980s and 1990s has already turned into a handbrake. The one-child policy resulted in a demographic time bomb of a rapidly ageing population and a shrinking population of workers that will have to carry the cost of this tidal wave of retirees. The ongoing baby bust in China has already lowered its share of the world working-age population from a peak of 24% to 19%, and it is expected to fall further to 10% over the next 35 years. With a shrinking share of the world’s workers, a smaller share of growth is almost certain.
Second is the drop in productivity. Sharply higher debt, an increasingly more interventionist government and bloated state-owned enterprises have all dampened labour productivity growth. This has almost halved from 9.9% in 2010 to 5.5%, according to the IMF. China is simply not the open, agile and innovative economy it once was.
Third, it is now one of the very few countries in the world experiencing deflation. This is tremendously challenging for a country like China which is accumulating debt eye-wateringly fast. During times of deflation, prices and wages fall, but the value of debt does not, raising the burden of repayments. With deflation continuing to eat into profits, companies cut wage growth, creating a vicious “debt deflation doom loop” of ever-weaker aggregate demand and deflationary pressures.
Waning economic superpowers struggling to reinvent themselves are the most dangerous and least predictable.
Finally, the debt-fuelled property crash goes from bad to horrifying. More than half of the country’s massive developers have defaulted and house prices are in freefall. Analysts warn that the housing sector crisis poses a huge risk to the economy, chilling construction activity, cutting household wealth and damping consumer confidence. “The Chinese economy won’t get back on track until the housing market recovers,” says Hang Seng Bank chief economist Dan Wang.
Investors have seen the writing on the wall. About $12-billion of foreign direct investment was cancelled in the third quarter alone, while Chinese investors are making outward investments at a record pace, according to the FT.
Geopolitical consequences
Since 1990 China’s growth in share of global GDP came mostly at the expense of Europe and Japan. In the past two years they have held steady. China, instead, has fallen behind the US and other emerging markets, specifically Mexico, Indonesia, India, Poland and Brazil.
Listening to President Xi Jinping and other China acolytes, one would never believe these realities. But no matter what they might argue is the economic narrative, the fundamentals paint a different picture.
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It is perhaps too soon to argue that the age of Chinese and American bipolarity is giving way to multipolarity. However, as shown by the example of the USSR, waning economic superpowers struggling to reinvent themselves are the most dangerous and least predictable.
While a couple of years of data is perhaps too little to form any secular conclusions, the trendlines are clear. China’s moment has passed. Rather than a Thucydides trap of a grand overtaking of the US, the story of the rest of the 21st century will be how these two hegemons manage their own respective declines. DM