China’s economy: Powerful, yes, but vulnerable

Walden Bello

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China’s economy: Powerful, yes, but vulnerable
China's rapid growth has produced prosperity and reduced poverty. It has also generated less wholesome economic, social, and ecological consequences which are now catching up with it.

Part 1: China: An imperial power in the image of the West?
Part 2: Capitalism with Chinese characteristics

China’s economy is often presented as a powerful engine. This is, however, only one face of it. It has also been marked by vulnerabilities, and these have become more obvious over time, as the costs of high-speed growth have rebounded on the country, giving rise to social tensions that are straining the capacity of the reigning Communist Party to contain them.   

Uneven development among regions has been one of the legacies of the Chinese road to capitalism, with most of the benefits of growth being cornered by the eastern and southeastern coastal region that led the integration of China into the global economy.

While the growth of income disparities has slowed overtime, it continues, with the inland provinces, particularly in northwestern and southwestern China, lagging behind Guangdong, Jiangsu, and Zhejiang, the powerhouses of China’s export-led industrialization. The inland provinces continue to supply cheap labor to China’s “gold coast,” where migrants endure legalized discrimination owing to the hukou residential system that prevents them from enjoying housing and social security benefits in the areas where they work. 

Overcapacity stalks industry 

China is currently burdened with an overcapacity problem, especially in heavy industry and many medium industries. There has been significant overcapacity in the steel, iron, aluminum, and automobile industries, leading to practically flat prices and causing some analysts to say that China is now suffering from “industrial deflation.”

Since China accounts for a great part of global production and trade in heavy goods, its surpluses in these goods have brought down global prices, contributing to global deflationary pressures.

Overcapacity is a symptom of overproduction and overaccumulation, and it is a product of the Chinese way of capitalism. Specifically, it is due to repression of domestic consumption and excessive investment. Repression of consumption was a policy dictated by the need to channel people’s savings to the industrial export sector. Excessive investment stemmed from the decentralized economic strategy where local areas were given a great deal of autonomy in investment decisions.

Many local authorities, says Ho Fung Hung, perhaps the leading expert in China’s overproduction, act “developmentally,” that is, they pick industrial “winners” and act proactively to set these up at the local level. The sum of these efforts, however, produces anarchic competition among localities, resulting in uncoordinated construction of redundant production capacity and infrastructure.  

As early as the 2000s, in fact, more than 75% of the country’s industries were already suffering from overcapacity and fixed asset investment in industries already experiencing overinvestment accounted for 40% to 50% of China’s GDP growth. The situation, however, has worsened since then, with state media admitting that 21 industries suffer from “serious” overcapacity, including steel, aluminum, cement, shipbuilding, power generation, heavy engineering, solar panels, wind turbines, construction machinery, chemicals, textiles, paper, glass, shipping, and oil refining.

For instance, since 2014, China has produced more than half of all the steel in the world. But of the 1.1 billion tons of steel Chinese factories were capable of making in 2015, only 70% was actually produced. That year, more than half of China’s steel companies posted a loss, and prices were driven so low that, as one account observed, “steel was cheaper than cabbage, as was the popular observation at the time.”

To solve the overcapacity problem, China has tried to shut down the less efficient enterprises and “rationalize” the remainder. This is, however, easier said than done, because officials are scared to death of provoking worker unrest since the ability to maintain social stability is one of the key justifications used by the Communist Party for its continued political dominance. Moreover, shutting down enterprises may be demanded from the center, but it is the local authorities that have to deal with the consequences, and so the natural response of the latter is to resist.  

The end result is that keeping “zombies,” which are mainly state-owned enterprises (SOEs), alive has been extremely costly. Overcapacity brings down prices, bringing down profits throughout an industry.  Indebtedness becomes a permanent condition, so that one can speak of a permanent line of credit to banks which is never repaid. Calculations of the levels of debt of the public and private corporate sector in China are not easy to come by, but China’s companies went from owing $3.4 trillion to $12.5 trillion between 2007 and mid-2014, “a faster buildup of debt than in any other country in modern times,” as a McKinsey report points out. 

Finance: the economy’s Achilles’ heel

Massive indebtedness, mainly to Chinese state banks, clearly poses a threat to the economy. But China is no ordinary capitalist economy. Under normal capitalism, when loans are nonperforming, the banks come calling on the debtor and either collect or force them into bankruptcy.

But in China, the fact that the state enterprises and the banks are owned by the government places the day of reckoning far into the future. As Dinny McMahon writes: “The real advantage of China’s system of state ownership isn’t that the cleanup is easier than in market economies; it’s that the clean-up is easier to put off….Sure bank profits erode – after all, a big chunk of their loans aren’t paying interest – but otherwise no one has to take responsibility for mounting bad loans. And, most importantly, deadbeat companies are kept alive.”

But though put off indefinitely, the day of reckoning will arrive, and it has perhaps been advanced by the negative synergy between the mountain of debt owed by the SOEs and the other vulnerabilities of China’s financial system: a real estate bubble, a roller-coaster stock market, and an uncontrolled shadow banking system.

There is no doubt that China is already in the midst of a real estate bubble. As in the United States during the subprime-mortgage bubble that culminated in the global financial crisis of 2007-2009, the real-estate market has attracted too many wealthy and middle-class speculators, leading to a frenzy that has seen real estate prices climb sharply.

Chinese real estate prices soared in so-called Tier 1 cities like Beijing and Shanghai from 2015 to 2017, pushing worried authorities there to take measures to pop the bubble. Major cities, including Beijing, imposed various measures: they increased down-payment requirements, tightened mortgage restrictions, banned the resale of property for several years, and limited the number of homes that people could buy. 

However, Chinese authorities face a dilemma. On the one hand, workers complain that the bubble has placed owning and renting apartments beyond their reach, thus fueling social instability. On the other hand, a sharp drop in real estate prices could bring down the rest of the Chinese economy and – given China’s increasingly central role as a source of international demand – the rest of the global economy along with it.

China’s real estate sector accounts for an estimated 15% of GDP and 20% of the national demand for loans. Thus, as pointed out by banking experts Andrew Sheng and Ng Chow Soon, any slowdown would “adversely affect construction-related industries along the entire supply chain, including steel, cement, and other building materials.”

The problem is not just a real estate market slowdown having a domino effect on the rest of the economy owing to reduced demand; it is also that so many other industrial sectors are heavily invested in real estate. Because of reduced profitability in the real economy owing to overcapacity, more and more manufacturing companies have started to subsidize their losses by investing in real estate or financial speculation.

Financial repression – keeping the interest rates on deposits low to subsidize China’s powerful alliance of export industries and governments in the coastal provinces – has been central in pushing investors into real-estate speculation. However, growing uncertainties in that sector have caused many middle-class and rich investors to seek higher returns in the country’s poorly regulated stock market.

The unfortunate result: a good many Chinese have lost their fortunes as stock prices fluctuate wildly. As early as 2001, Wu Jinglian, widely regarded as one of the country’s leading reform economists, characterized the corruption-ridden Shanghai and Shenzhen stock exchanges as “worse than a casino” in which investors would inevitably lose money over the long run.

At the peak of the Shanghai market in June 2015, a Bloomberg analyst wrote that “No other stock market has grown as much in dollar terms over a 12-month period,” noting that the previous year’s gain was greater “than the $5 trillion size of Japan’s entire stock market.” 

When the Shanghai index plunged 40% later that summer, Chinese investors were hit with huge losses – debt they still grapple with today. Many lost all their savings – a significant personal tragedy (and a looming national crisis) in a country with such a poorly developed social security system. 

Another source of financial instability is the virtual monopoly on credit access held by export-oriented industries, state-owned enterprises, and the local governments of favored coastal regions. With a significant part of the demand for credit from a multitude of private companies unmet by the official banking sector, the void has been rapidly filled by so-called shadow banks, informal institutions of credit that are unregulated.

The shadow banking system in China is not yet as sophisticated as its counterparts on Wall Street and in London, but it is getting there. Ballpark estimates of the trades carried out in China’s shadow banking sector range from $10 trillion to more than $18 trillion.

In 2013, according to one of the more authoritative studies, the scale of shadow banking risk assets – i.e., assets marked by great volatility, like stocks and real estate – came to 53% of China’s GDP. That might appear small when compared with the global average of about 120 % of GDP, but the reality is that many of these shadow banking creditors have raised their capital by borrowing from the formal banking sector.

These loans are either registered in the books or “hidden” in special off-balance-sheet vehicles. Should a shadow banking crisis ensue, it is estimated that up to half of the nonperforming loans of the shadow banking sector could be “transferred” to the formal banking sector, thus undermining it as well.

In addition, the shadow banking sector is heavily invested in real estate trusts. Thus, a sharp drop in property valuations would immediately have a negative impact on the shadow banking sector – creditors would be left running after bankrupt developers or holding massively depreciated real estate as collateral. 

Finance is the Achilles heel of the Chinese economy. The negative synergy between an overheating real estate sector, a volatile stock market, and an uncontrolled shadow banking system could well be the cause of the next big crisis to hit the global economy, rivaling the severity of the Asian financial crisis of 1997-1998 and the global financial implosion of 2008-2009. 

Environmental wasteland

Not surprisingly, China’s infrastructure-intensive, smoke-stack-industries-dependent high-speed growth has been accompanied by widespread and chronic environmental crises, with perhaps the dangerous air pollution levels in Beijing being the most widely discussed internationally.

Water scarcity, desertification, deforestation, soil erosion and degradation, and soil and water contamination have all contributed to a greater concern about the environment, especially among the middle class. Yet that same middle class is the source of much of the problem. Reliance on fossil fuels contributes significantly to air pollution and climate change.

Prosperity has made China the world’s biggest car market, with the consequent rise in unhealthy levels of airborne pollution in the cities. Owing to its price competitiveness, coal, the dirtiest fossil fuel, continues to be the fuel of choice for generating power, accounting for 65% of electricity use.  

Apart from their massive negative impact on the environment and public health, fossil fuel-driven industrial processes have increasingly boomeranged on the economy. Economists have estimated that environmental degradation and pollution cost the Chinese economy the equivalent of 3% to 10% of GDP owing to work days missed, crops lost to pollution and contamination, decline in tourism, and other problems. A recently published retrospective analysis by the Chinese Academy of Sciences placed the figure higher, at 13.5% of GDP in 2005. 

From relative equality to gross inequality

China’s breakneck capitalist growth relying on cheap labor has had two contradictory effects on the socioeconomic conditions of its people. On the one hand, people living in poverty declined from 88% in 1988 to 2% or 3% at present.  On the other hand, it has converted it from one of the world’s most egalitarian societies during the Mao period to one of the world’s most unequal societies.

Research by Branco Milanovic, one of the world’s leading experts on inequality, shows that in the period 1988 to 2008, income inequality in China rose far more rapidly than in any other region in the world.

Estimates of China’s Gini Index or Gini Coefficient, the most commonly used measure of inequality, range from 0.47, the government’s estimate, to 0.55. The government figure, it has been pointed out, would make China’s income inequality substantially greater than is the case in all developed countries.

Class-related inequality has recently been joined by gender-related inequality as a great source of concern. Ironically, as China has become more prosperous, the gap has increased between women’s incomes and economic status and those of men. With the headlong rush towards capitalism, the earnings of women went down from 80% those of men at the start of the reform era to 67% in the cities, and 56% in the countryside. 

The drivers of this regression from the status of women during the Mao period are a graying population and the demographic imbalance produced by the controversial one-child policy, when male children were favored over females, resulting in widespread abortion and infanticide.  

Gender is now one of the most important factors determining income inequality in China, perhaps more so than even the longstanding divide between the cities and the countryside. 

What is alarming is that discrimination against women is now accepted, if not promoted, by the country’s leadership. Mao famously told women that they held up “half the sky,” and despite turmoil and the persistence of patriarchal traditions, they entered the work force in record numbers and began to enjoy greater rights.

Now, in a break with the Marxist ambition of liberating women, President Xi has openly called on women to embrace their “unique role” in the family and “shoulder the responsibilities of taking care of the old and young, as well as educating children.” No party leader would have been caught saying something like this in the past, but the breaking of the taboo apparently stems from the male party leadership’s push to raise the birth rate owing to its obsession with China’s looming demographic crisis.

China’s rapid growth has produced prosperity and reduced poverty. It has also generated less wholesome economic, social, and ecological consequences which are now catching up with it, making the much-vaunted Chinese model increasingly less attractive for developing economies. –

This is the third of 7 articles on China’s political economy based on the study titled China: An Imperial Power in the Image of the West published by Focus on the Global South and authored by Walden Bello, retired Professor at the University of the Philippines and currently the Adjunct Professor of Sociology at the State University of New York at Binghamton. The study can be accessed here.

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