For almost two decades economists, analysts, policy-makers, and pundits have advocated for a fundamental rebalancing of China’s economy. These voices were heard both domestically in China and throughout the globe. They argued that Chinese growth had become too reliant on exports and fixed asset investment. It had to rebalance to a much larger focus on domestic consumption for sustainable growth into the future.
But not much changed over the ensuing years. Growth remained focused on exports and investment, especially in real estate. Real estate and related sectors accounted for more than a quarter of China’s economy during the 2010s. The other drivers of growth remained government investment, sometimes linked to real estate via Local Government Financing Vehicles (LGFVs); exports; and high technology, such as the rapid growth of online commerce, entertainment, etc.
For the most part, domestic consumption remained subdued and heavily linked to real estate purchases. This chain started to break in 2020 as the Chinese government clamped down on lending to real estate developers. By now many of the largest private developers are on the brink of bankruptcy, notably Country Garden, the poster child for the excesses of real estate development and financing during the boom years.
The risks to China’s economy of the belated but necessary rebalancing are enormous. The real estate sector is directly linked to the financial stability of many local governments and banks, especially smaller ones. Over the past two years many developers delayed the completion of apartments after failing to obtain financing. Last year this prompted mortgage boycotts by buyers. At present, there are thousands of stalled construction sites throughout China. According to official figures, real estate investment dropped 9.1% in the January-to-September period from a year earlier, a big drag on the economy.
However, for China’s economy to truly rebalance, the real estate sector needs to contract even further, contributing around 10-15% of the economy in the future. This means that more pain is likely to come, and alternate drivers of growth must be rapidly established.
China’s most recent growth figures for the third quarter of 2023 provide some much-needed hope in this respect. The economy continued to recover in the first three quarters of 2023, with third quarter growth coming in at 4.9% over the same quarter a year earlier and 1.3% quarter over quarter. Fixed asset investment continued to disappoint, mainly due to the drag from real estate investment. However, the figures for September 2023 showed 4.5% growth in industrial production and a larger than expected 5.5% spike in retail sales over the prior year.
This indicates that consumption is finally contributing more to growth, while industrial upgrading is accelerating. For Chinese policy-makers this must be music to their ears. They want to create new drivers of high-quality development by speeding up industrial transformation. New Energy Vehicles (NEVs), batteries, and other green technology are often seen as leading the way in this respect.
Somewhat under the radar screen, China has become the world's biggest auto exporter. Even more importantly, more than 60 percent of the world's NEVs are now produced in China. This indicates that the country has been able to successfully build supply chains for many of the key inputs to undertake a green energy transition.
Other industries, such as information technology and online commerce continue to do very well. Finally, investment flows are clearly being focused on new industries and industrial upgrading. This reflects how Chinese policy-makers hope to employ industrial transformation, including large investments in new industries and technologies, such as robotics, to create the new drivers of growth the country badly needs.
Nonetheless, for growth to be of high quality, for it to be sustainable, for it to be inclusive, more will need to done. China’s Statistics Bureau itself admitted that “domestic demand is still insufficient, and the foundation for economic recovery still needs to be consolidated.”
One crucial aspect of a growth model driven by consumption is the further strengthening of China’s social safety net. Households need to be encouraged to spend instead of hoarding away the globe’s largest stack of savings. In fact, massive investments in industry and industrial upgrading, without a commensurate strengthening of domestic consumption, risk all the additional supply feeding into exports.
Some of this is sure to occur anyway, since China is likely to have the most cost-effective solutions for a green energy transition. But it also creates the specter of a large protectionist backlash, especially in advanced industrial economies directly competing with China in the industries of the future. Many signs of this are already apparent, both in North America and Europe.
Against this backdrop, one of the more encouraging figures was how the real growth rate of per capita disposable income reached 5.8% in the first nine months of 2023, significantly faster than in 2022. With low to non-existent inflation, the cutting of some government fees for residents, as well as continued wage growth, this trend could create the conditions for consumption to emerge as the primary driver of growth in coming years.
For now, the picture remains mixed. Hopeful sprouts are emerging in China’s economy. Consumption is starting to play a larger role with household disposable income rising. Industrial upgrading is proceeding apace. But the structural overhang of so much stagnant real estate investment is large. The real estate sector’s festering debt crisis dents consumer sentiment, since, for most Chinese, their largest investment is in housing.
This makes the coming quarters crucial for China’s economic future. Efforts to resolve real estate and local government debts will have to be sped up and become more forceful. While the most recent figures paint a brighter picture, with new drivers of growth emerging, enormous risks remain.
