While the debt saga involving China’s second-largest real estate developer, Evergrande, has caught the attention of the global investment community, there is a risk that a much larger scenario regarding the Empire’s attempts to Medium to overhaul its economic structure be ignored. Xi Jinping’s China is undertaking multiple sweeping reforms that could either set it on a path to better, more sustainable economic growth or prematurely end a four-decade economic miracle that has taken hundreds of millions of people out of poverty.
First, Chinese leaders are trying to reduce the economy’s over-reliance on cheap credit and debt-fueled investments to spur growth. There is a broad consensus both inside and outside China on the need to shift to a growth model driven by domestic consumption.
Following the global financial crisis of 2007-09, Chinese authorities faced a sharp drop in demand for their exports from their main overseas markets, with US and European households focusing on deleveraging and improving their balance sheets. . China has decided to release the credit tap and has entered a period of rapid growth characterized by an extraordinary increase in domestic investment in infrastructure and a massive real estate boom.
The construction boom has enabled China to recover quickly from the global financial crisis. The spillover effects also triggered a global recovery in commodity prices and led to a rapid but brief economic recovery in emerging markets. But it left China burdened with an increasingly unbalanced economy that was starting to show signs of fragility in 2015.
China’s dangerous dependence on its vast real estate sector to support growth and the resulting excesses in the real estate sector have forced the country’s rulers to deal with growing economic and financial distortions. Chinese authorities launched the âthree red linesâ campaign in August 2020 to force deleveraging in the real estate sector.
Evergrande appears to be one of the main victims of the campaign. The Chinese idiom “kill the chicken to scare the monkey” may explain the authorities’ reluctance to bail out Evergrande as they attempt to signal the seriousness of their push to shift to a new growth model.
A second area of ââinterest for the Chinese authorities centers on generating more widespread prosperity in order to improve the real purchasing power of China’s large and growing middle class. Chinese households known for their high savings have so far not increased their consumption enough to make a much-needed transition away from the growth model driven by investment and exports.
A variety of factors – demographic changes and gender imbalances, limited social safety net and the consequent desire for precautionary savings, growing inequalities, high house prices and limited availability of financial instruments and investment opportunities – have taken place. been highlighted as explanations for the high savings. household behavior in China.
Chinese authorities are also aggressively (some say too aggressively) tackling rising income and wealth inequalities. The controversial push to achieve “common prosperity” has created considerable uncertainty among Chinese entrepreneurial elites. Instead of relying solely on market forces to ensure redistribution or mainly on Western-style progressive taxation and redistribution models, Xi Jinping’s China advocates a third alternative. The âcommon prosperityâ approach relies more on societal pressure supported by regulatory squeeze to force the more prosperous and the wealthy to share their good fortune with larger segments of society. There is a real danger that the authorities will go too far and reduce the innate entrepreneurial vigor of Chinese society and limit the country’s future growth prospects.
Finally, Xi Jinping’s China aims to fundamentally change its economic and financial relations with the rest of the world by working to establish a so-called dual circulation economy. As part of this plan, China wants to reduce its dependence on the West, and the United States in particular, for its key technological needs.
In addition, the stated objective of transitioning to a growth model driven by domestic consumption (a model that is reinforced by the establishment of a more open and sophisticated financial system that allows households to access a wide range of of domestic and international investment products) is likely to make China an even more crucial trading partner for the rest of the world. The rising Chinese middle class has the potential to fundamentally change the way we calculate the supply and demand for products and services around the world.
If China also manages to integrate more financially with the rest of the world, the impact on the international financial system will likely be quite significant as well. The establishment of a digital yuan and the desire to internationalize the renminbi could, in the long run, call into question the status of the US dollar as the main global reserve currency.
As Thomas Orlik argues in his excellent book “China: The Bubble That Never Pops”, it is dangerous to assume that China is heading for an inevitable crash and hard landing economically. It may be wise not to automatically assume that China is heading for a fate similar to that of Japan. (After its stock and real estate bubbles burst in the early 1990s, Japan saw its economic power decline rapidly.)
China’s current (US) and future (India) competitors must carefully assess the strength and weakness of China’s unique political and economic structure. It is clear that foreigners increasingly need to be better informed about China as its global importance increases.
Vivekanand Jayakumar is Associate Professor of Economics at the University of Tampa.