China’s property-driven growth model, which has powered the global economy for at least two decades, is looking increasingly broken. Fixing it — or finding alternative engines for the world’s second-largest economy — could take several years. This is why the choices that now confront Beijing’s policymakers are so crucial.
The task requires an accurate assessment of what has gone wrong. On one level this is simple: the biggest property boom in human history has ended and is now turning into a bust. But a deeper level of analysis reveals a more complicated and intractable malaise at the heart of China’s political economy.
Local governments, which financed their investment activities largely by selling land to property developers, are finding it harder to repay and service huge debts. This is mostly because developers now have little money or appetite to buy the land. Almost 20 of them are in such dire financial straits that they have defaulted on bonds in the offshore market this year.
This dynamic is having knock-on effects. Local government financing vehicles — the thousands of poorly-regulated funds owned by city governments all over the country — are burdened by “hidden” debts that Goldman Sachs has estimated to total Rmb53tn ($8.2tn) — or 52 per cent of GDP — at the end of 2020. Beijing is urging local governments to clean up such “off balance sheet” borrowing, with the result that LGFVs are reining in their horns.
The result is that fixed asset investment (FAI), which funds the construction of city precincts, roads, railways, ports and a thousand other pieces of infrastructure, has slumped precipitously this year, robbing the economy of one its main drivers. From January to July this year, FAI grew at just 5.7 per cent — compared with an average of 17.87 per cent between 1996 and 2022.
So, the question before China now, as it allocates modest funds to alleviate the pain in its property sector, is stark. If the growth engine that has contributed so much to global prosperity is now gummed up with debt, what — if anything — could replace it?
There is one obvious answer. China needs to fundamentally reorientate its economy away from the current over-reliance on investment and towards greater consumer spending. Private consumption accounted for 38.5 per cent of nominal GDP at the end of last year — a much lower ratio than those prevailing in the US or EU.
This means that as Beijing charts a way out of its local government debt malaise in coming years, it cannot afford to shift the burden to households. It needs to create an economy in which salaries rise strongly and vibrant, well-regulated financial markets provide a healthy long-term return on savings.
In addition, Beijing should remind itself that much of the extraordinary economic progress of the past four decades has derived from the dynamism of the private sector. In recent years, however, the downfall of Jack Ma, founder of Alibaba, and the diminished standing of several leading privately owned tech companies has convinced observers that Beijing has moderated its support for private enterprise.
The required shift to embrace the consumer and the private sector will also require a counter-intuitive shift in mindset. Authoritarian governments prefer economic levers that they can control. Mobilising supply through muscular investment plans keeps ruling parties in the driving seat. Catering to the more democratic tastes of consumers does not.
Beijing should prepare itself for a long and difficult economic transformation that it can no longer avoid. The world should prepare itself for the end of a four-decade era of supercharged Chinese growth.