Anyone doubting that China is well on its way to a Japanese-style lost economic decade has apparently missed the bursting of its massive housing and credit market bubble and the souring of U.S. and European trade relations with that country.
And if China, the world’s second largest economy, were to fall, it would constitute a major headwind for world economic recovery.
The seeds of China’s current economic malaise were sown over the last 15 years by the pursuit of highly unbalanced economic policies. Overemphasis on investment as the means of driving economic growth has resulted in a situation where Chinese investment accounts for more than 40 percent of that country’s overall economy — around twice the ratio in the U.S. That has, in turn, resulted in a large degree of Chinese manufacturing overcapacity, as Treasury Secretary Janet Yellen recently pointed out when warning China not to try exporting that overcapacity to the U.S.
Another indication of economic imbalance has been China’s housing and credit market bubble. According to Harvard’s Kenneth Rogoff, fueled by ample credit, the Chinese housing market grew to around 30 percent of its overall economy. That is about 50 percent higher than in advanced industrialized countries. Meanwhile, the Bank for International Settlements estimates that Chinese credit increased by 100 percent of GDP since 2008. That rate of credit growth was larger than that experienced before Japan’s lost economic decade in the 1980s. It is also larger than that experienced before the bursting of the U.S. housing and credit market bubble in 2008.
In the wake of China’s economically disastrous zero-COVID policy, there is now the clearest of evidence that the Chinese housing and credit bubble has burst. Over the last year, housing prices have fallen in most major Chinese cities and housing demand has slumped. There are now an estimated 65 million to 80 million unoccupied home dwellings that are weighing heavily on new demand. Meanwhile, a number of Chinese property developers, including most notably Evergrande and Countrywide, have defaulted on their loans. This spells major problems for the Chinese local governments’ finances, given how dependent their finances are on property tax collections.
In the past, China might have resorted to budget, monetary and exchange rate policy to boost its flagging economy. By increasing public spending and by lowering interest rates, it might have stimulated domestic demand. By cheapening its currency, it might have boosted export demand. In the past, such a policy approach has been successful, most notably in response to the 2008 global economic recession. However, things have changed since then that limit China’s room for economic policy maneuvering.
With local governments and the banking system likely to need large-scale government support, China now has limited room for added budget stimulus. Meanwhile, with China having become a major exporter, it cannot resort to monetary and exchange rate policy to export its way out of an insufficient domestic demand problem without provoking a backlash in its main trade partners. Underlining this point, in her recent visit to Beijing, Yellen has put China on notice not to try to export its way out of its domestic excess capacity problems. At the same time, European countries are threatening China with increased trade restrictions, especially on Chinese electric cars and other strategic products.
As the IMF has suggested, the optimal way out of China’s current economic predicament would be to undertake fundamental economic reforms. Those reforms might be primarily aimed at increasing household consumption by improving the country’s social safety net. Unfortunately, President Xi Jinping shows no signs of moving in that direction. Instead, he seems to be rolling back the 1980s market-based reforms introduced by Deng Xiaoping that were successful in promoting China’s economic miracle.
This makes it all too likely that China will now experience a lost economic decade. No longer will the world be able to count on China as the world’s primary engine of economic growth.
American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.