Not trying to scare everyone, but China’s economy is not in good shape. The recent Foreign Affairs issue is chock full of warnings, and many believe the recent instability in China’s stock market is merely the beginning of a much bigger economic decline. If they are correct, it is particularly bad because the structural weaknesses of China’s economy make recovery all but impossible. At this point, it’s just a question of how much damage control the CCP can effectively do.
China’s biggest problem is that it stimulated way to much during the 2008 financial crisis. To quote the Washington Post’s Simon Denyer, “China’s industrial overcapacity is ‘sucking the oxygen out’ of its economy, fueling a dangerous buildup in bad loans and now exacerbating trade tensions with the West.” Basically, the CCP spent vast sums of money to stimulate demand between 2008-2011. Because they needed to compensate for a contraction in global demand, they flooded the Chinese economy with money in order to stimulate domestic demand and maintain their absurd GDP growth levels. Now, however, the central government, and more alarmingly the local governments, are experiencing an enormous debt problem. The scariest part, though, is not the debt itself. Instead, it’s that nobody even knows how much China owes because corrupt officials have been hiding the extent of the problem for years! This is compounded by the fact that many of the factories and industrial zones that China built up during the recession are no longer profitable, yet the government refuses to close them. To quote Denyer again:
China’s state-owned heavy industry expanded too far and too fast during the boom years, in a borrowing and investment splurge. Now, as the economy slows, there is too much industrial capacity chasing too little demand. Many plants have been forced to cut back output and are struggling to pay back loans, but, instead of closing down, these “zombie” factories are being kept alive, at a huge cost to the economy and the banking system.
The government has made numerous attempts to limit industrial expansion and close down inefficient plants, but the effort has made very little headway, and the problem has intensified in recent years.
The second warning sign is that the Chinese are selling vast amounts of their foreign reserves. This can only mean one thing: the Renminbi is at risk of rapid inflation. In fact, it’s hilarious that Trump keeps claiming China is undervaluing its currency because, in reality, China is doing everything in its power to keep the Renminbi’s value from collapsing. Besides the deleterious impacts of rapid inflation, the loss of foreign reserves is also bad for China because it sets China up for a balance-of-payments crisis. If this occurs, China will struggle to pay for imports (which are priced in U.S. dollars) and service its dollar debt payments.
Now, one could argue that all of these problems are surmountable. That would probably be true if China had a meritocratic system with apolitical civil servants and relatively little corruption. This, unfortunately, is not the case. Despite Xi’s Anti-Graft Campaign ostensibly targeting corrupt officials, in reality, it is mostly a political move to weaken or arrest potential rivals. The prioritization of political power over real reforms became worryingly clear recently when Xi visited major Chinese media agencies. Basically, he demanded that the media “restore people’s trust in the Party” because he and his cronies are becoming increasingly concerned that the slowing economy will generate unrest. Instead of expending political influence on actually reforming the economy, Xi is spending all of his political capital on forcing the media to cover up China’s economic woes. That might keep people content in the short term, but it will not fix China’s economy. Absent massive, sustained reforms, China’s economy is in for some severe turbulence in the near future.
Of course, it is possible that continued economic pain will force the CCP to act, and it’s also possible that I’m underestimating the resilience and ingenuity of the Politburo. Nevertheless, to steal a quote from Dan Drezner – one of my favorite political scientists -“if this is China when it’s winning, then I don’t want to see it losing.”