China’s economic miracle is in transition, not in danger of stagnation

There are concerns China could undergo economic stagnation, like Japan has since the 1990s, because of an asset bubble bursting and its ageing population
But the country’s policy measures, and its vibrant entrepreneurial ecosystem and dynamic capital markets, tell a different story

Fang Zihao

Published: 3:30am, 8 Oct 2021

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When the global financial crisis erupted in 2008, Beijing responded with a 4 trillion yuan (US$559 billion) stimulus package to mitigate its impact on the country and help stabilise the global economy. Since then, China’s economy has followed a growth pattern of rising housing prices, credit expansion and home construction.

The flaws of this credit- and investment-driven growth model have been exposed in recent years. As China’s capital stock accumulates, the depreciation of the existing capital stock increases accordingly, while the marginal return on effective investment diminishes.

In addition, natural resources and environmental protection are growing constraints on the country’s economic growth. China imported 48 per cent of the world’s minerals in 2019 and 26 per cent of its oil in 2020. China also has pledged to reach peak carbon dioxide emissions by 2030.

Therefore, China is pushing to transform its growth pattern. The “three red lines” for developers are the most direct manifestation of the government’s deleveraging policy. China has also been investing heavily in technological innovation. In 2020, China invested twice as much in research and development as in 2013 and its share of global research output tracked by Nature Index was twice as high as it was in 2015.

China is the world’s top international patent filer and accounts for the largest share of hi-tech exports globally. The World Intellectual Property Organisation ranks China as the 12th most innovative country.

Rapid technological advances and large-scale commercial application will fuel higher-quality growth, but this economic transition comes with risks.

The possible default or even collapse of China Evergrande Group is one such risk. While many fear the Evergrande crisis is China’s “Lehman moment”, the company’s predicament does not affect investor confidence in the value of other developers’ land reserves, and Evergrande is not at the heart of the financial network.

As the government pushes deleveraging, defaults by large corporations, including state-owned enterprises, have not been uncommon. Since 2018, some have defaulted on more than US$100 billion of corporate debt.

Chinese investors are now learning to price credit risk and companies, especially SOEs, are learning to honour hard budget constraints.

As a result, more credit is being channelled to firms and industries that can generate sufficient cash flow to cover the interest and principal, improving capital allocation efficiency and market health.

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A more common view of China’s post-deleveraging economic outlook is that the country will face stagnation in the long term due to a possible asset bubble burst and an ageing population, just like Japan has experienced since the early 1990s. However, neither of these factors will necessarily lead to economic stagnation.

South Korea and Taiwan, for example, gained their footing as technology giants after the Asian financial crisis and the dotcom bubble, despite their ageing populations.

Indeed, nourished by the ample economic resources available after a bubble bursts, seeds sown during the asset bubbles may grow new shoots and eventually expand into an economic oasis.

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China may well be able to avoid a sudden plunge in asset prices. Through measures to reduce the number of unsold homes, China’s real estate inventory – measured by pending sales – has fallen sharply from the equivalent of six months of home sales in 2015 to the current equivalent of around three months.

Monthly housing starts are also declining rapidly. Moreover, with a relatively high policy rate and relatively low government debt levels, China still has the ability to deal with asset price volatility.

In the long run, a system that matches internal migration with land use will ensure a more balanced and efficient land supply while retaining 120 million hectares of arable land as part of the government’s “red lines”. More reasonable housing prices will also help stabilise fertility rates.

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Compared to Japan in the 1990s, China today has a larger agricultural workforce and a higher level of industrial automation, making its labour shortage less severe. In 2020, a quarter of China’s workforce was still employed in agriculture, compared with only 7 per cent of Japan’s workforce in 1990.

Moreover, manufacturing jobs are gradually being automated. China has more industrial robots installed per 10,000 employees than Switzerland and France, but it is still a quarter of the number in South Korea and half of Japan’s.

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More crucially, China has a vibrant entrepreneurial ecosystem and dynamic capital markets, which accelerate creative destruction and resource reallocation.

China’s innovation economy is now in a self-motivated cycle – from talent development and technology innovation to revenue growth and wealth explosion.

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Every year, millions of students graduate from Chinese universities and hundreds of thousands of students return home from abroad, a large percentage of whom choose to start their own business or join a start-up.

These start-ups receive tens of billions of dollars of venture capital and private equity, face fierce competition and cruel elimination, and eventually grow into dozens of unicorns and many more small and medium-sized innovative companies each year. These companies then go public, making China’s exchanges among the world’s top-ranked in terms of fundraising.

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China’s capital markets are also very dynamic. In 2005, when the CSI 300 index was first released, the top four constituent industries were steel, thermal power generation, transport facilities, and coal mining.

Today, the top four are financials, electronic components, health care, and electrical equipment. In this way, economic resources are constantly being driven to the firms and sectors at the country’s technology frontier.

Forty years after economic reform and opening up, China’s economic miracle continues to amaze. If successful, this latest transition will open a new chapter.

Fang Zihao is currently studying for a PhD in economics at Koc University in Istanbul