‘The Emperor has no clothes’: Why China’s reputation for economic management is unraveling
As governments in the United States and Europe mishandled one calamity after another — from the 2008 financial crisis to botched efforts to contain COVID-19 — even champions of liberal democracy looked enviously at policymakers. Chinese navigating the same troubled waters with apparent ease.
But the cracks in China’s model of government are starting to show as its real estate sector faces the ramifications of a property market crash and its zero-Covid policy falters in the face of new, fast-spreading variants.
“There was some sort of envy in the West for what seemed like the extraordinary skill of Chinese policymakers, but right now the emperor has no clothes,” said senior researcher Jeremy Mark. at the Atlantic Council and expert. on Asian economies.
With Chinese President Xi Jinping looking set to secure an unprecedented third five-year term when the Communist Party of China holds its 20th Party Congress from October 16, the coming months could be pivotal for the country and its efforts to achieve the status of a world-class power.
The end of China’s growth miracle
The importance of the Chinese economy to global growth became evident in the years following the 2008 financial crisis, when the US and European economies were under the weight of a badly injured financial sector, falling prices housing and rising unemployment which have undermined consumer demand. .
China’s economy has not only been shielded from financial contagion – it has barely lost steam, growing nearly 10% a year from 2008 to 2011 as local governments borrowed heavily to finance a new massive wave of infrastructure development.
Even as Western demand for Chinese manufactured goods evaporated after the financial crisis, its economy propelled forward thanks to a $575 billion fiscal stimulus package – equivalent to 13% of China’s GDP at the time. – which was largely spent on infrastructure projects and encouraged easy lending to the real estate sector.
The stimulus package and subsequent policies built on the success of the previous three decades when the government was able to encourage double-digit economic growth through much-needed infrastructure spending. It also set the stage for another decade in which China’s economy would outperform the West and provide the global economy with the lion’s share of its growth.
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But these policies also concealed a serious problem: China lacked the means to invest productively in roads, bridges and other infrastructure. Michael Pettis, professor of finance at Peking University in Beijing, says this reality has posed a fundamental problem for Chinese policymakers that they have yet to resolve.
After China “closed the gap between the investment it had and the investment the economy could productively absorb…China should have drastically reduced the share of production it was reinvesting,” writes Pettis in a recent essay for the Carnegie Endowment for International Peace.
Rebalancing China’s economy from an economy driven by investment to one dominated by domestic consumer spending has, however, been met with political opposition, as vested interests in maintaining the current model have stalled reforms. required.
“Political priorities are key to understanding the decisions made by the Chinese Communist Party,” said Marks of the Atlantic Council. “Politics has taken precedence over other considerations in economic policy-making.”
A slowly evolving debt crisis
Real estate bubbles are common in economic history, and the bubble that formed in China’s real estate sector is not that different from those that formed in the United States and Europe in the 2000s.
In the United States, homebuyers and builders feasted on the easy credit provided by investor demand for supposedly safe mortgage-backed securities, and rising house prices eventually sparked a flurry of speculation that has drives these prices up until the bubble bursts.
In China, the government has extended easy credit to the real estate sector as it seeks to stimulate economic activity to meet unsustainable GDP growth targets, according to Pettis.
An added wrinkle to the story is the widespread practice by Chinese developers of pre-selling homes that have yet to be built and using those funds not to complete the promised home, but to buy more land.
“Like real estate prices [in China] increased year on year, it changed the behavior of companies in a way that in turn distorted prices,” Pettis wrote, adding that the rapid rise in prices has benefited companies that have taken the most risks by acquiring as much real estate as possible to anticipate future needs.
Just as the real estate market in the United States became dominated by speculators in the 2000s, so has China in recent years.
Burst the bubble
Chinese authorities have long recognized its housing bubble and the growing debt that has fueled its inflation as a problem requiring serious attention.
In 2020, Beijing introduced new regulations that severely restricted access to credit for the property development industry, preventing developers from borrowing to mask cash shortages and preventing some from completing projects that buyers had already paid.
Property developers like China Evergrande Group EGRNF,
have struggled to meet their commitments to buyers and lenders over the past year, and tensions in the real estate sector have hit speculators hard, with property prices in China falling for the 11th consecutive month in August.
Brad Setser, a former senior adviser to the U.S. Trade Representative and member of the Council on Foreign Relations, told MarketWatch in an interview that unrest from China’s housing crisis is unlikely to pose a risk to the financial system because it is already state run and the Chinese government has shown a willingness to recapitalize the banks in the past.
But the bursting of the real estate bubble could be a serious headwind for the Chinese economy, even in the absence of a financial crisis, given the importance of real estate development for the Chinese economy.
“Real estate investment was a much larger part of the Chinese economy than in the US context,” Setser said. “It’s like the whole economy was Nevada and Arizona and some of the booming and building states before our crisis.”
Clean up the mess
The task facing China’s policy makers is to somehow stop the cycle of falling house prices and sales and stabilize real estate development companies so they can finish the houses they promised to build.
Tom Orlik, chief economist at Bloomberg Economics, estimates that the value of mortgages attached to unfinished properties in China is around $230 billion, or 1.4% of the country’s GDP. If homes continue to be completed at their current rate, this amount will increase to $632 billion in 2024, or 4% of GDP.
A growing number of Chinese have begun to boycott mortgage payments on unfinished homes where developers have halted construction, according to Houze Song who leads research on China’s economy for think tank MacroPolo.
Song said in an interview with MarketWatch that it’s hard to know how widespread these protests are because the Chinese government has been working to stop the dissemination of information about the boycotts, in traditional and social media, although that there is evidence that the government takes protests seriously.
Beijing recently announced $29 billion in loans to struggling developers, although Song warned that “the size is probably not enough to solve the problem”.
The regime is in a difficult position as officials want to both stabilize the real estate sector without sending the message that private players will be bailed out by the government if they take too much risk, Song added.
This means the government is likely to slowly roll out its support and will seek to force property companies and local governments to bear as much of the burden as possible.
Current stimulus packages “will only be enough to get by,” but uncertainty and diminishing housing problems will continue to weigh on consumer and business confidence and economic growth, Song said.
Another headwind for China is its so-called zero-COVID policy, involving continued lockdowns of major cities in a bid to rid the country entirely of the virus.
“Without an easing of zero COVID, there will be no stabilization in the housing market,” Carl Weinberg, chief economist at High Frequency Economics and a veteran China watcher, told MarketWatch.
The policy is defensible on moral grounds, especially when compared to the United States, where more than one million COVID deaths have contributed to an almost unprecedented three-year drop in average life expectancy.
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But it lays bare that China’s vaccine production and deployment has been less successful in the West, while betraying the Communist Party’s authoritarian tendencies at a time when its international reputation has been tarnished by events in Hong Kong and Xinxiang. .
See: Chinese think tank says ‘zero COVID’ policy must change to pull economy out of peril
Recent polls from Pew and the Eurasia Group show a growing share of the world’s population has a negative view of China, while countries from India to Nigeria and Brazil say they prefer the United States to China. for the role of leading superpower.
However, China’s biggest decisions are yet to come. The clash between Western powers and China over the fate of Taiwan will define perceptions of China’s economic and political strength for decades to come, Weinberg said.
“A successful repatriation from Taiwan would give it control of the global chip market and a stronger voice on the international stage,” he said. “The stakes are really high.”