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Samarveer Singh

The Dragon loses its fire?

China’s growth puzzle- Can the miracle last?


By: Samarveer Singh; Edited by: Shagun Khetan


Introduction 


China’s economic numbers were like the ones the world had never seen before. The country’s economic boom was applauded by many economists around the world like Barry Naughton ( The Chinese Economy: Transition and Growth) and Paul Krugman (The Return of Depression Economics and the Crisis of 2008), however, that trend seems to be hitting a roadblock. In recent years, the Chinese economy has witnessed a ‘rocky road' and experienced some serious difficulties, threatening its economic position today. This is not only a concern for China, ‘the world’s largest factory’, but can also come to bite the global economy, which is already at a precarious stage. In recent years, China’s economy has witnessed a series of setbacks that threaten its position as a global economic power. What has happened to China in recent years? How bad is it? 


China is facing multiple challenges that are impacting its economy severely. The real estate sector, which contributes to 30% of its GDP, faces a severe crisis with many companies and local governments going bankrupt. This is accompanied by a drop in birth rates, with 2022 witnessing more deaths than births for the first time in decades, threatening future economic growth. The precarious situation is further exacerbated by the growing tensions of a US-China trade war, with many Western countries imposing sanctions and American companies moving production out of China to other regions. China’s integration into the global economy is also being tested by growing tensions in the South China Sea and its strained relationship with its neighbour Taiwan, raising concerns about a potential economic fallout. These factors paint a grim picture of the nation’s future with ripple effects that could also destabilise the global economy.

 

Let’s explore each of these factors in more depth.


Real Estate going down?


For several years, the safest investment option in China for the middle class has been the real estate sector. However, in the past two years, consumer confidence has been shaken as many Chinese real estate companies face difficulties paying back debts and completing projects. Recently, the Chinese Evergrande, the second largest real estate company in the country (by sales) collapsed dramatically with not being able to pay back debts amounting to $300 billion. 



Real Estate Sales and Prices in China


Though in many economies real estate and industrial activity has picked up after the pandemic, it has not been the same case in China. Chinese housing starts have fallen over by 60% (as visible in the graph) which depicts the sluggishness of incoming investments and growth in its real estate market. However, house prices have fallen mildly because some cities have limited the price declines through rules and guidance on listing prices. A key underlying reason for Chinese consumers’ reluctance to buy homes is their belief that property prices will decline as developers struggle with insufficient funds to complete their projects.  This lack of consumer spending could lead to a downward spiral in prices leading to ‘deflation’ in the economy putting the world’s second-largest economy at risk.



Falling birth rates to hamper future growth? 


As we know China is a country that is known for its ‘one-child policy’, the dynamics of this has started to change in the past decades as it is grappling with a population crisis. According to statistics, the birth rate has declined from 1.5 births per woman in the late 1990s to 1.15 in 2021 and is now approaching closer to 1 which is far behind 2.5 births per woman needed for a country to balance its population. Even though China ended its ‘one-child’ policy in 2016 and switched to the ‘three-child’ policy in 2021, its birth rates have not rebounded sparking concerns in the policy circles in China as they predict that the working population in the coming years will be gravely affected by this issue. One of the major reasons why people don't want to have more children is the rise in the cost of education they would have to incur given they have more children. To counter this issue, local governments have tried to crack down on the prices of private tutoring, however no policy has seemed to work. 



China’s declining birth rates


China’s shrinking population


The biggest scare to the Chinese economy came in 2022 when the death rate surpassed the birth rate. After about 20-25 years, the effect of China’s declining birth rates on its shrinking working population will be seen. Falling birth rates will not only impact the world’s factory workforce but will also have an adverse effect on the nation’s healthcare and pensions budget. Handling the rise in the elderly population will put a strain on the Chinese economy with the younger population’s falling contribution to the GDP in the past years. 


To counter this challenge and avoid facing an economic slowdown accompanied by low productivity in the future, the Chinese leadership is trying to “douse the fire" by bringing in several policies and incentives to encourage the Chinese to have more babies. The local governments have introduced a variety of measures like tax deductions, long maternity leaves and housing subsidies to encourage childbirth. However, the majority of these policies have turned out to be ineffective. This is certainly going to drive away investors from the Chinese markets if their projected economic numbers do not look good. 



US-China tensions on the rise


China, historically a key centre of FDI due to its manufacturing capacity, low labour costs and business-friendly environment is now witnessing a dramatic shift. In 2023, FDI in China plummeted by 80%, a sign that global investors are re-evaluating their relationship with the world’s second-largest economy. 


Apple, which long relied on China due to its low production costs, is shifting its supply chain to India due to rising concerns over China's assertive military actions and potential disruptions in case of conflict. India has emerged as a viable alternative, given its economic growth and rising importance in global trade. Apple has always used India for low-cost production, now its growing ability to manufacture high-tech products has opened new avenues for collaboration. However, a significant challenge remains the lack of a highly skilled labour force capable of sustaining large-scale, high-tech production, which limits India’s capacity to fully replace China in the near term. 


Another key area where the nation is feeling the heat is its electric vehicles (EV) industry. China has positioned itself as a leader in EV production, aiming to dominate the global market. However, the US and its Western allies including Canada have imposed 100% tariff on Chinese EV companies. This move is designed to curb Chinese dominance in the sector and protect domestic EV markets. 


To mitigate these tariffs, Chinese EV companies are likely to shift their production to third countries, a strategy similar to what Apple is employing. By moving production outside of China, these EV firms can evade Western tariffs and still export to their markets. However, the effectiveness of this strategy remains to be witnessed as the US and its allies have grown increasingly punitive towards Chinese investments and market presence.  


While companies like Apple are diversifying their supply chains, it is important to note that this does not mean a complete abandonment of China, as it continues to be a key player in high-tech manufacturing and integral to global supply chains. In the longer term, until China faces fierce competition from countries like India, it will likely maintain its position as a dominant force in global manufacturing. However, its ability to do so depends heavily on how it manages its economic challenges. 


Conclusion


China’s once unstoppable economic growth is now facing significant challenges in both domestic and international markets. The Chinese economy faces many internal challenges that it needs to overcome, like the crumbling of local governments and real estate companies under the burden of debt and the loss of consumer confidence in the economy, in order to keep their growth trajectory in a positive direction. In the international arena, China faces a strained relationship with its rival USA, where American companies are pulling out of the country leading to a fall in FDI and the rising tensions in the South China Sea and lack of labour laws are further discouraging companies from investing in the Chinese markets looking at its volatility. 


The future of the Chinese economy thus depends on whether it can overcome these challenges in the right amount of time before it’s too late while also adapting to the new multipolar global order. A failure to deal with these economic challenges could have far-ranging consequences for not only China but also for the global economy, which is getting increasingly intertwined with the Chinese markets. 

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