Sustaining The Miracle: China's Paper Tiger of Investment and Crouching Tiger of Consumption
By Solomon Zu ---
China's growth over the past thirty years is aptly called a miracle. At breakneck speed, China went from a largely agrarian economy to one filled with skyscrapers and high-speed rails. China's growth, however, was too good to be true. Amassing unsustainable levels of debt, the national government and local governments bet on never-ending returns on their investments. In recent years, those returns have dwindled, and the miracle of China's growth may turn out to be a curse.
What China pioneered, along with the rest of the 'Asian Tigers' such as Japan and South Korea, was an investment-led approach to economic growth. That is, the main goal was to expand access to credit through government-sponsored investment and the development of a free market open to the world. China's 'magical credit machine', comprised of massive government investments and a boom in the credit market, initially promised a never-ending source of investment for infrastructure (Rhodium Group "The End...").
Investment is only as good as its returns, however. Behind the veil of miraculous progress was a scourge of overinvestment. Just as Mao had overestimated the productivity of workers during the disastrous Great Leap Forward half a century earlier, the new generation of party leadership overestimated how much profit investments could make. Whereas demand and export dominance were expected to keep up with investment, the reality now is far grimmer. Consumer demand is waning (Rhodium Group "No quick fixes..."). Export dominance is increasingly frowned upon by trade partners (Rhodium Group "China's "new" strategic industries..."). And most damagingly, companies suffer from overcapacity; they maintain too much infrastructure and produce too many goods relative to demand, forcing price decreases to the point of unprofitability (Pettis "What's New..."). To escape that trap, the government should prioritize boosting consumer consumption over further investment. Doing so, however, is easier said than done. The lack of a robust social safety net has encouraged high savings rates, and unemployment and declining wages have dealt a blow to purchasing power (Rhodium Group "No quick fixes..."). Politically, supporting the consumer is controversial---party leadership is worried about losing control over its population's spending, and a potential reliance on welfare at the expense of productivity (Lee and Qian).
The Miracle (and Curse) of Investment
It can be said that growth exploded with investment into the real estate industry. As soon as party leadership allowed local governments to sell their land to private developers, banks (often shadow banks) and foreign creditors seized the opportunity to lend money toward perhaps the greatest housing boom in modern history. Returns on investment, it was thought, were high and guaranteed (Rhodium Group "The End...").
Just a few years ago, however, Evergrande, the largest real estate developer in the nation, defaulted. The company, which had taken on a vast amount of debt, found itself in a position where most of its units stood empty (Rhodium Group "The End..."). Many middle-to-upper-class households bought second or even third properties in a bid to profit from rising prices, strangling supply for those who actually needed housing. The bubble was eventually popped by the party, leading to a real estate market crash that tanked millions of rainy-day investments (Rhodium Group "The End..."). The lesson was clear: the government and banks overinvested in an unprofitable market.
Yet the lesson was not learned. In order to quell fears about the slowing economy, the government poured a massive amount of funds into the solar, electric vehicle (EV), and battery market. By the time investment slowed down, manufacturing capacity exceeded that which could be consumed by the world, and stocks massively exceeded demand---in the polysilicon industry, for instance, supply doubled global demand in just four years (Pettis "What's New..."). In an effort to make at least some money, companies dramatically cut prices, leading to unprofitability and likely collapse. Such involution, a term coined by netizens and later adopted by economists, created a 'race to the bottom' wherein companies cut prices even lower to outcompete their overburdened competitors (Pettis "Is China's...").
One would, reasonably, wonder why such overinvestment even happened. After all, it happened before (consider Japan's Lost Decade during the 1990s, for instance). Was the party blind to history? The reason, however, had and still has to do with the party's overwhelming short-termism. Thirty years ago, it was presumably believed that all other considerations (including financial stability and safeguards) were secondary to growth. Every year the government did not put in maximum investment was a year in which the West's economic margin unacceptably widened. Even today, the country is fixated on outdeveloping the West, and is therefore willing to trade off stability and financial viability for the sake of technological superiority (Rhodium Group "China's "new" strategic industries..."). It is a bet to lose money now and monopolize in the future, but it is unclear whether such a strategy will be successful. The current state of involution suggests that collapse will come before scale---exactly what happened with the real estate industry.
A common counterargument is that the country has a wealth of credit. Even credit is stagnating, however (Rhodium Group "The End..."). One reason is that the government itself is less willing to insure risky investments. Indeed, just until a few years ago, companies that invested and were invested in believed themselves so crucial to the economy that their bailout in the event of default was practically insured (Rhodium Group "The End..."). After the government declined (or even forced) the default of Evergrande, that trust collapsed. Banks are now far less willing to lend to high-risk, high-reward ventures, bringing much of the country's credit to a halt (Rhodium Group "The End..."). Another reason has to do with the fact that a lot of credit comes from the shadow banking industry (i.e., informal, quasi-legal financial institutions). Shadow banks, previously, lent riskily en masse; in order to evade regulatory scrutiny, they illegally reclassified much of their risky loans as safe (Rhodium Group "The End..."). It is for that reason that such banks are now extremely hesitant to continue lending. Their shoddy bookkeeping in the past has made it impossible to write off their unviable loans, making them even more unwilling to invest anew (Rhodium Group "The End..."). Further, during and after the Evergrande incident, banks are now required to hold more in savings to act as a buffer against collapsing debt returns, limiting money for investment. For larger banks, these problems are somewhat offset by their ability to access the foreign credit market. Most banks in the country, however, are localized and thereby small (a partial product of localized real estate industries) and often do not have the ability to access international credit nor have the credibility of larger banks (Rhodium Group "The End...").
Even worse, the party's bet on exports---buffering overcapacity with international demand----is proving dangerous. Protectionism is on the rise; the United States, long China's key trading partner, is veering toward tariffs and sanctions. Even other countries, cautious about what they perceive to be an attempt to develop global supply chain dominance and thereby leverage, are more wary of overconsuming Chinese exports (Stevenson-Yang). (In reality, the problem is even worse because, in some industries, overcapacity already exceeds global demand) (Pettis "What's New..."). It is therefore unwise for the party to continue pumping investment in the hopes that export demand will catch up. Just as the country must become self-reliant in terms of its supply, it must become self-reliant in terms of its demand. If that shift does not happen, the country risks economic disaster. Further investment would be funded by debt, which in turn is funded by older debt. That 'Jenga Tower' makes the economy vulnerable to decreasing returns, as default on older debt begets default on newer debt. It is therefore imperative to boost consumer spending to prevent the first domino of default from falling.
Consumer Spending (and Why it is so Hard to Elevate)
The root causes of the malaise are lower incomes and rising unemployment. In particular, low-income households---the group most likely to save less and consume more---are strapped for cash. As China's population booms, the surplus of unskilled labor rockets, leaving many low-income individuals starved for employment. The result is either flat-out unemployment or, arguably worse, employment in the gig economy, where employees overwork and overcompete for little gain (Rhodium Group "No quick fixes..."). Adding to the pressure is the government's new focus on high-value industries that generally require less labor than blue-collar industries like construction (Rhodium Group "China's "new" strategic industries..."). Involution, therefore, describes not only excess competition amongst companies, but the low-reward rat race of employment.
A more nefarious problem is that weak or non-existent social safety nets have spooked spending. The government has chronically underinvested in social services and medicine, for instance. (Rhodium Group "No quick fixes..."). Worse yet, migrant workers---who comprise much of the working population---are barred from accessing welfare. The reason stems from policies in the Hukou system, wherein individuals are discouraged from migrating to begin with through government services discrimination. And another historical source for high savings was the One Child Policy. Parents traditionally relied on their children for support. Yet by limiting the permitted number of children, the party forced adults to save more of their own money to fill the gap (Zhang).
Such demographic shifts are not all bad, however. One reason for optimism is that the decline in the working-age population increases the number of retirees, who, by definition, spend their savings. However, savings are proportional to incomes, which have been declining. And so it seems, after all, that it is impossible to run away from the real solution---expanding welfare and redistribution.
No Viable Fixes
Such policies, however, face logistical and political inertia. Taxes, the primary tool for redistribution, for instance, are far and few between. Less than a fifth of the population pays income tax at all, and there are few tax levers in the first place. Unlike much of the world, there is no capital income tax, personal income tax, property tax, or inheritance tax. (Rhodium Group "No quick fixes..."). Moreover, the state is limited in its capacity to redistribute. Household incomes, consumption patterns, and access to financial infrastructure are incredibly uneven---many households do not have access to formal banking or online payment, and economic data regarding these distributions is far from perfect (Lee and Qian). To boot, the state itself is strapped for the cash used to handle these issues---fiscal resources are running thin in poorer cities and provinces, very often because much of it goes to Beijing (Rhodium Group "The Myth of China's Fiscal Space).
However, even if the logistical problems were to be overcome, there is immense political opposition to expanding welfare and redistribution. Leadership, in almost-Confucian fashion, has touted against a potential overreliance on welfare and resulting laziness---a term Xi coined 'welfarism.' (Rhodium Group "No quick fixes..."). Worse, boosting consumer spending would mean less money in CCP-controlled savings funds, which would economically empower households. Given the CCP's obsession with the centralization of planning and resources, such empowerment may be a hard bullet to bite (Lee and Qian).
Takeaways
Ultimately, it is clear that more investment and exports will not do anything to cure the real sickness of low consumption. If anything, they will exacerbate overcapacity, credit squeezes, and overreliance on foreign consumer markets. In reality, the path forward is to boost spending through expanding welfare and redistribution. Sadly, however, logistical and political barriers make such a task a hard one. There are no quick fixes, but sustaining the miracle of growth and avoiding the catastrophe of recession requires a painful shift in policy. Hopefully Xi and his cadres are willing to make this hard transition.
Works Cited
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