Arthur Kroeber reflects on the downturn of China’s economy
The title of the Fairbank Center’s recent China Economy Lecture asks a direct question: Has China’s Economy Hit the Wall? A number of China analysts have responded to recent negative economic news coming out of China with predictions that Beijing’s current policies—compounded by a challenging global environment—will continue to drag the economy down. But in his lecture, Arthur Kroeber, Founding Partner and Head of Research, Gavekal Dragonomics, suggested that the story is much more complicated. The slowdown, he argued, is part of a plan to put politics back in command, and to transition the economy toward high-tech and new energy sectors. Will the plan—and the tactics—succeed? The jury is still out.
Kroeber points to a growing concern about “the ability of China to continue balancing between an authoritarian political system and a capitalist economic system,” noting that “the political system has become much more authoritarian and much more personalized under Xi Jinping.”
The catalyst for the pessimistic predictions for China’s economy has been a spate of bad economic data: The official youth unemployment rate reached 21.3% in June, so bad that the government shortly thereafter ceased publishing the data; GDP growth has slumped, and is on track this year to be slower than both foreign and Chinese economists expected; and consumption and private-sector investment, respectively, remain at a fraction of their pre-COVID levels. For some, these developments portend catastrophe. Kroeber, however, argues that this is merely “a small number of data points doing an awful lot of work,” and that the thin evidence is not sufficient to prompt a fundamental change in outlook for the Chinese economy.
To understand why such pessimism may be unwarranted, it’s helpful to examine the factors being claimed as the main causes of the slowdown: debt, political incompatibilities, or simply bad management, and bad luck. Notably, Kroeber sees shortcomings in each of these positions:
Unsustainable levels of debt. Investment in infrastructure and property development have been core pillars of China’s growth, and for fifty years, the principal method of financing these projects has been debt at the local level. The claim is that, much like the ‘balance-sheet recession’ of Japan during the 1990s, this debt has reached a point of unsustainability, and China is now facing an inevitable, secular slowdown of the economy. Kroeber, however, does not believe that debt will prove to be an insurmountable problem. Importantly, he points out that the structure of debt in China is largely fragmented. Unlike Japan, where cross-shareholding structures between banks and corporations were ubiquitous, Chinese policymakers have been careful to ensure that the corporate and financial systems remain separate. “I think it’s a little bit of an error to assume that debt in one part of the country necessarily has impact on another part of the system that is in other ways largely unconnected from it,” says Kroeber. In other words, if certain sectors experience debt-related issues, the broader economy is likely to be shielded from a major downturn.
Loss of confidence in economic policy. Another prominent view is that consumer confidence in the government and in the political system has finally burst, leading to a collapse in consumption, as citizens choose instead to save their resources in expectation of future and further downturns. The absence of a post-COVID rebound experienced by other advanced economies seems, at first glance, to support this view. Kroeber points out that this narrative is incomplete, though: It is not that consumers have money and are choosing not to spend it, but rather that the Chinese consumer has fewer resources relative to pre-pandemic levels. In contrast to many Western countries that injected cash into the economy via stimulus packages, for both businesses and consumers, when the pandemic hit in China, the CCP largely did nothing to support its citizens financially. Altogether, this does not necessarily reflect a loss of faith in the government’s ability to steer the economy but can instead be explained by reduced income streams; citizens have chosen to save, in the face of poor economic conditions, and consumption will likely rebound as incomes recover. Indeed, this appears to be happening already in recent months.
Poor management and bad luck. Lastly, some have argued that a combination of bad policies and bad luck have exacerbated an otherwise mild and temporary slowdown. The extreme shutdown of Chinese society, the lack of any stimulus spending, and a hard turn in the geopolitical situation—especially in Sino-U.S. relations—have combined to weaken the appetite for investment and new ventures amongst China’s entrepreneurs. While these factors will likely affect growth for the foreseeable future, there are also clear signs of strength in certain sectors of the economy. For example, Kroeber points to sustained, robust investment in the manufacturing sector, and to the fact that China is ranked first in the world in auto exports as of 2023 (domestic production is now equal to that of the US, EU, and Japan combined). Kroeber also considers China’s genuine leadership in clean energy technologies (the PRC accounts for 70-90% of sales at every stage of EV battery and solar production) to be a clear indication that arguably bad policy choices and challenging geopolitical externalities have not crippled the Chinese economy.
If these examples don’t fully explicate the current slowdown in the Chinese economy, though, what might suffice instead? Kroeber suggests that Xi Jinping is willing to accept slower growth in exchange for greater political control. Economic growth has been the top priority of China’s leadership for decades. But Xi does not view economic growth as an end unto itself. “Security and technology appear more in his speeches at five-year Party congresses than economic growth,” Kroeber points out. It has become increasingly clear in recent years that Chinese leadership is willing to sacrifice economic growth for regime stability and external security. The Party is also reallocating capital away from property and infrastructure, and instead toward high-tech industries. Such sectors see less immediate returns but have the potential to pay much larger dividends in the future. Furthermore, building capacity in these industries, and enhancing indigenous innovation, aligns with the reemphasis on security over fast economic growth.
Ultimately, Kroeber argues that China’s debt problem will not be “fatal.” It will, however, continue to slow the growth of more advanced sectors by diverting resources that could otherwise be spent on aggressive industrial policies. If that assessment is correct, what might we expect for the near future for China’s economy? Kroeber raises a few key points here as well:
China’s economy is not collapsing, and it is not at a major inflection point. There are structural problems that undeniably need to be addressed, such as debt and chronically low consumption. Additionally, the reallocation of capital into high-tech industries will likely yield slower growth in the near term. However, signs of strength are undeniably present.
Private entrepreneurs likely carry a very different outlook on the future of the Chinese economy now. In contrast to the reform era under Deng Xiaoping, politics is back in command in economic policymaking. Though the impact on innovation and dynamism is unknown, private entrepreneurs are likely to be more cautious.
China will likely continue to have technological successes and sustain an external trade surplus in key industries. Emphasis on technologies critical for the green energy transition will help ensure that China does not follow the path of Japan in the 1990s. Demand for China’s manufactures in key sectors will likely persist.
As China gets richer, its growth will keep slowing. China will likely have an economic narrative similar to that of South Korea, Singapore, and Taiwan. Unlike the ‘Asian tiger economies,’ however, China does not maintain a huge percentage of its economy as exports relative to domestic production and consumption. That means that the slowdown in growth will likely be more dramatic, as China will be less able to rely on external demand for its goods.
Xi will pursue technology leadership and push state-led growth in high tech sectors. The reallocation of capital away from traditional sectors and into high-tech industries dovetails with the Party’s renewed emphasis on security. Xi will likely continue centralizing his authority and pursue national self-sufficiency in critical technologies.
So—is China’s economic slowdown here to stay? Maybe. Kroeber’s argument is premised on the belief that this slowdown won’t be as severe as some are predicting. Beyond just the domestic developments, the challenging external geopolitical environment—especially U.S. policies and politicking around the upcoming 2024 presidential election—is going to negatively affect China’s trajectory as well. As Kroeber points out, the Chinese economy has demonstrated “resilience, dynamism, and adaptability,” enough so that we should at least entertain the idea that claims of its impending collapse may be unwarranted.