In 2023, the US economy far exceeded expectations. The recession that almost everyone predicted never happened. Many economists (but not me) argued that reducing inflation would require years of high unemployment; Instead, the country has experienced impeccable disinflation, a rapid decline in inflation with no visible costs.
However, in the world's largest economy (or second largest, depending on how you look at it), the story is very different. Some analysts expected China's economy to expand after the country lifted its draconian “zero Covid” measures to contain the pandemic. Instead, China performed worse in almost all economic indicators, except for official GDP, which reportedly grew by 5.2%.
This number causes skepticism among many. Democratic nations like the United States rarely politicize their economic statistics — but ask me again if Donald Trump becomes president again — but authoritarian regimes often do. And on other fronts, the Chinese economy appears to be stalling. Even official statistics claim that China is experiencing Japan-style deflation and high youth unemployment. At least for now, it is not a full-blown crisis, but there is reason to believe that the country is entering an era of stagnation and disappointment.
Why is the Chinese economy struggling, which just a few years ago seemed poised for world domination? Part of the answer is poor leadership. President Xi Jinping increasingly looks like a poor economic manager whose penchant for arbitrary intervention – something autocrats often do – has stifled private initiative.
But China would have problems even if Xi were a better leader than he is. It has long been clear that the Chinese economic model is no longer sustainable. As Stewart Paterson points out, consumer spending relative to GDP is very low, probably for several reasons. These include financial repression – paying low interest rates on savings and providing cheap loans to favored borrowers – that keeps family incomes low and diverts them into government-controlled investments, a weak social safety net that leads families to accumulate savings for possible emergencies to cope, and others.
Since consumers are buying so little, at least relative to the productive capacity of the Chinese economy, how can the country generate enough demand to continue using that capacity? The main response, as Michael Pettis points out, was to encourage extremely high rates of investment, exceeding 40% of GDP. The problem is that it's difficult to invest that much money without seeing a significant drop in returns.
It is true that very high investment rates can be sustainable when a country like China in the early 2000s has a rapidly expanding workforce and high productivity growth as it catches up with Western economies. But China's working-age population peaked around 2010 and has continued to shrink since then. Although China has demonstrated impressive technological capabilities in some areas, its overall productivity also appears to be stagnating. In short, it is not a nation that can productively invest 40% of its GDP. Now these problems have been evident for at least a decade. Why are they getting worse now? Well, international economists like to quote Dornbusch's law: “It takes a lot longer for the crisis to come than you think, and then it happens much faster than you can imagine.” In the case of China, the government managed for several years to obscure the problem of inadequate consumer spending by promoting a gigantic housing bubble. In fact, the Chinese real estate sector has become incredibly large compared to international standards.
But in the end the bubbles burst. To outside observers, what China needs to do seems simple: end financial repression and ensure that more of the economy's income flows to families, and also strengthen the social safety net so that consumers do not feel the need to to accumulate cash. And along the way, you can reduce your unsustainable capital expenditure.
But there are powerful actors, particularly state-owned companies, that benefit from financial repression. And when it comes to strengthening the safety net, the leader of this supposedly communist regime sounds a bit like the governor of Mississippi decrying “welfareism” that creates “lazy people.”
To what extent should we worry about China? In some ways, China's current economy is reminiscent of Japan's after the bubble burst in the 1980s. However, Japan ultimately handled its decline well. This avoided mass unemployment, maintained social and political cohesion, and real GDP per working-age adult increased by 50% over the next three decades, not far from the growth recorded in the United States.
My big concern is that China won't respond either. To what extent will the country hold together in the face of economic difficulties? Will it seek to support its economy by increasing exports, which will be in direct contradiction to the West's efforts to promote green technologies? And most frighteningly, will he try to distract from internal difficulties through military adventures? So we shouldn't be happy about China's economic stumble, which can become a problem for everyone.
Paul Krugman is a Nobel Prize winner in economics. © The New York Times, 2024
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