Have We Reached Peak China?

By Marc Joffe

Tuesday, May 17, 2022

 

China’s ascension to world domination may not be as inevitable as many of us think and fear. Events of the last year have revealed significant vulnerabilities within the country, which could foreshadow a period of economic stagnation, reminiscent of what Japan began to experience in the 1990s. If that happens, American pundits may need to rethink their admiration of China’s decisive form of technocratic closed-loop governance.

 

Those of us who were around in the 1980s will recall the literature celebrating Japan’s economic might and projecting that the “Land of the Rising Sun” would soon eclipse America as the world’s dominant economy. Yet as Adam Thierer’s extensive review of the contemporary literature showed, American observers proved too quick to lionize Japan’s industrial policy, led by its Ministry of International Trade and Industry (MITI). That body’s efforts to predict the future and fine-tune Japan’s economy to meet it seemed enlightened to American intellectuals and business leaders. In the final analysis, though, MITI’s crystal ball proved cloudy as it misdirected capital into analog high-definition television and so-called fifth-generation computing based on an artificial-intelligence operating system.

 

At Japan’s peak in 1989, the grounds of the Imperial Palace in Tokyo were thought to be worth more than all the real estate in California. Between the beginning of 1980 and the end of 1989, the Nikkei 225 index rose by a factor of six. But, ultimately, the sharp rise in Japanese asset valuations proved to be a debt-fueled bubble from which the country has never fully recovered.

 

That may well be the case with China in the early 2020s. According to data from the International Monetary Fund, China’s total public and private debt rose from 133 percent of GDP in 2008 to 269 percent in 2020 (a level that may be significantly understated due to the large volume of hidden debt). This borrowing appears to have levitated asset prices, especially in the real-estate sector. In Beijing, the home-price-to-income ratio surpassed 25, roughly triple the level reached in the United States at the peak of its subprime-housing bubble.

 

In 2021, Chinese residential real estate began to fall, while Evergrande and other highly leveraged developers struggled to service their debt loads. These companies depended on property buyers’ prepaying for their homes before construction: something that buyers are much less willing to do in a flat or declining market.

 

Japan was slow to resolve its debt overhang in the 1990s. Instead, policy-makers and banks kept weak, overleveraged firms operating with low interest rates and loan extensions. The failure to allow Japan’s zombie companies to reorganize or liquidate through the bankruptcy process led to the inefficient use of capital and slow growth.

 

There are signs that China will pursue similar policies. Evergrande, for example, has not been forced into bankruptcy despite its inability to consistently meet its voluminous debt-service obligations amid declining sales. Many of China’s zombies will be state-owned enterprises and local governments that may be deemed too big to fail.

 

While Japan’s policy-making appeared to be wise during the run-up, the flaws became apparent during the country’s lost decade. This, too, might be consistent with China.

 

In late 2020, China’s management of the Covid-19 pandemic appeared to be far superior to that of the U.S. or any other major Western nation. A regime of hard lockdowns, extensive testing, and hi-tech contact-tracing allowed most Chinese citizens to live normally most of the time, with very low reported case and death rates (although we cannot be certain that Chinese health statistics are reliable, especially given its initial efforts to cover up the pandemic).

 

But more recently, the bloom has come off the rose. Rather than soften its selective lockdown policies as vaccines became available and as milder but more-virulent variants replaced the original SARS-COV-2 strain, Communist Party leadership has stuck with the same policies. The result has been the shambolic lockdown of Shanghai and other major cities, which is fanning popular resistance to authority and driving out expatriates, who help link China to the outside world.

 

Despite being clearly incompatible with a Western perspective that emphasizes personal liberty, China’s 2020 pandemic policies are sometimes defended as a testament to the strength of the country’s centralized, authoritarian system. Western countries, and especially the U.S., could not mount such a vigorous response to Covid-19 and appear to have suffered many more deaths and severe illnesses as a result.

 

But the Chinese system has proven insufficiently adaptive. It was unwilling to take advantage of more effective vaccines developed outside China and has continued to pursue zero-Covid strategies despite their massive social cost.

 

Although the U.S. and some other Western democracies initially responded to Covid-19 in ineffective and incoherent ways, they ultimately benefited from a policy dialogue that included a wide range of views. Public pressure and input from nongovernmental organizations persuaded even the most vehement advocates of zero-Covid strategies in government to adopt more-balanced approaches. While messy, a vigorous policy debate often yields better results than the decisions of a closed autocracy resistant to external feedback.

 

The combined impact of renewed Covid lockdowns and falling real-estate valuations (not to mention government interventions that have hurt China’s tech giants and killed the private tutoring business) is slower economic growth. But given doubts about the accuracy of Chinese economic statistics, it may take some time for us to determine just how much growth is declining.

 

The Chinese government is addressing its current economic malaise by ramping up infrastructure investment. China’s ability to rapidly complete large projects confers an advantage over the U.S., which has largely lost the ability to build public infrastructure on schedule and on budget. But Chinese infrastructure projects vary in the amount of value they create, and the country appears to be well past the point of diminishing marginal returns.

 

Consider high-speed rail, for example. The connections between Beijing and Shanghai and between Shanghai and Guangzhou appear to have provided significant net benefits. Each year, tens of millions of people travel between these megacities and points in between. But as China builds more and more high-speed rail lines, it is obliged to add lower-demand routes. At the opposite extreme is the 1,776-kilometer line connecting Langzhou and Urumqi. Recently, only three round-trip departures were scheduled on this line each day. Fares are not sufficient to pay for the train’s electricity consumption, let alone cover employee salaries, debt service, or maintenance costs.

 

With per capita GDP so far below advanced-economy levels, it may seem that China has a lot of room for catch-up growth. But poor macroeconomic management and malinvestment of capital into zombie organizations and ill-conceived infrastructure projects may mean China’s ceiling is much lower than that of Japan, South Korea, Taiwan, or others that have enjoyed substantial catch-up growth spurts before. If we have indeed reached “peak China,” some may need to reconsider their admiration for autocratic technocracies and learn to love the untidiness of competing ideas.