China’s Dangerous but Inevitable Decline

By Therese Shaheen

Tuesday, February 07, 2023

 

President Biden’s decision to shoot down a Chinese spy aircraft that had transited U.S. airspace exemplifies the near-term challenges the U.S. faces with the People’s Republic of China. Mike Gallagher (R., Wis.), the chairman of the new House Select Committee on China — the formal name is “Select Committee on the Strategic Competition between the United States and the Chinese Communist Party” — recently told Fox News that he views the threat from China in “three dimensions”: military, economic, and ideological. Given the focus on “strategic competition,” it seems likely the committee will prioritize such matters as trade, technology gaps, human rights, the military balance, the defense of Taiwan, and the like. Recent comments from House Foreign Affairs Committee chairman Mike McCaul (R., Texas) that the odds are “very high” of military conflict within two years further suggest the new Congress’s seriousness of intent. It is important for Congress to focus on China’s military capabilities, including asymmetric challenges such as spy balloons and cyber. Whatever actual threat the PRC may pose, our strategy should be capabilities-based.

 

Despite the near-term focus, though, hopefully the members will commit serious time to the real long-term problem posed by the PRC. It will require American leadership. Simply put, it is not China’s possible near-term aggression that threatens global stability but China’s impending long-term decline relative to the rest of the world as other countries grow, develop, and prosper and the PRC fades as a share of global growth. It is time to acknowledge this and start thinking about how the U.S. should best position for it. We’re still dealing today with the effects of the collapse of the Soviet Union, for which there was limited but inadequate planning and preparation by government leaders and strategists in advance. Given our leadership role in the world, we should prepare for the possibility — within a reasonable planning horizon — of the PRC’s implosion on multiple levels. Given China’s role in the global economy and its size, the consequences would likely be more difficult than what we faced at the end of the Cold War.

 

For a short period during the pandemic and its immediate aftermath, most of the world seemed to have come to terms with the fact of China’s structural weaknesses. Unfortunately, global denialism about the PRC’s unresolvable challenges has returned. The news coming out of the recent annual meeting of the World Economic Forum in Davos seemed to be all rainbows and butterflies. The “zero Covid” restrictions have been lifted! China’s back at Davos! China will rebound this year! Vice Premier Liu He promised attendees “proactive fiscal policy,” “prudent monetary policy,” “expanding domestic demand. . . . We welcome more foreign investment.” The Davos set ate it up, as they did a few years back when Xi Jinping came and quoted Abraham Lincoln even as he had begun the purges and social clampdowns needed to achieve the unrestricted grasp on power he achieved in the 2022 party congress.

 

Understanding China’s longer-term challenges can be boiled down to the straightforward acknowledgment that there is nothing more annoying than arithmetic. We got a profound reality check recently when the PRC disclosed that 800,000 more Chinese died last year than were born. Looking back just a few years, we see that most demographic projections for China showed a population decline happening later this decade. But it now apparently is upon us, years before much of the earlier analyses suggested. The scenarios articulated by the Shanghai Academy of Social Sciences show China’s population at 587 million in 2100, an average annual decline of 1.1 percent. Other (non-China) estimates show less of a decline, but it’s hard to chalk that up to anything but wishful thinking.

 

The shrinking population exacerbates China’s other challenges, and it is quite foreboding. Consider future economic growth. The world is buzzing about how the PRC may return to strong growth this year with post-Covid “reopening” and such. Of course, it is impossible to know the true state of China’s national economic reporting, because it is not transparent, and the government willfully misrepresents the facts. But whether there is closer-to-trend economic growth in 2023 is not really the issue. It’s not the next two or three quarters that mean much for China’s future but rather the next two or three decades. And the prospects are not good.

 

Between now and 2040, according to analysis from Nick Eberstadt at AEI, there will be a disproportionate decline in the working-age cohorts on whom economic growth depends. According to his analysis, based on U.N. data, the 15–29 age group will decline by 75 million, while the 30–49 age group will decline by 100 million. These are the peak years for work, productivity, innovation, and managerial expertise. While this is occurring, the share of the population 65 and older will grow in absolute numbers as well as a percentage of total population. In fact, the government estimates that by 2035 the population will be in a state of “severe aging,” with more than 400 million people aged 65 or older. These trends will reduce overall labor productivity and place significant elder-care burdens on families and the government.

 

There is not much that can be done to mitigate this. Eberstadt suggests that one possibility is education, to improve productivity. It would be an obvious remedy but for the fact that the education system in China is simply not up to the task at the scale that is needed. The poor state of education in most of China will be a continued drag. According to research by Stanford’s Scott Rozelle, perhaps the leading Western authority on PRC rural education, more than half of China’s middle-school-age students are unable or choose not to advance to high school. His research has found that a third don’t complete junior high. He estimates that some 400 million, including many urban educated youth, may be classified as “cognitively handicapped,” making them unlikely to be able to produce the productivity improvements needed by a declining workforce for GDP growth to continue.

 

Perhaps the most straightforward way to understand the mid- to long-term impacts of the declining workforce is to consider each component of GDP — consumption, investment, government spending, and net exports — and think through the likely impacts of each on economic growth. Consumption is the component most obviously affected. There is great anticipation among analysts about a near-term rise in consumption as the Covid lockdown ends and economic activity picks back up.

 

There may indeed be something of an economic sugar high as the urban populations resume a more normal pattern of spending. But over time, other factors will work against that. One is history and tradition: The PRC has long lagged Western developed economies in consumption as a percent of GDP. The collapse of property markets in China’s urban areas will have a dramatic effect on consumer spending. Given the absence of a meaningful social safety net, residential property has been a forced wealth-building and savings mechanism for many. As long as prices kept rising, consumers kept flipping their pooled investments into new properties. Rapidly constructed, shoddy overbuilding finally caught up in the construction bubble that burst during the pandemic. By one estimate, as of 2017 there were 65 million vacant homes. The situation has worsened since. The property crisis will result in lower consumer spending over time as consumers increase savings to offset the loss-of-wealth effect from the bust in property values. This already has begun; according to data from the People’s Bank of China, as reported in the Financial Times, household savings deposits grew in 2022 by a record $2.6 trillion, about double the previous year.

 

If consumption is not a panacea for China’s GDP growth, it also is doubtful that rising investment will be available to spur it. One important driver is direct foreign investment in China from the rest of the world. The realignment of global supply chains will put continued downward pressure on that as companies diversify away from the PRC toward other providers. Even if the world’s companies adopt a “China plus one” strategy of supply-chain diversification, it is obvious that the industrial world’s marginal investment dollars are headed elsewhere.

 

Other factors, too, will depress Western investment in China. There is greater scrutiny by Western consumers and democratically elected officials seeking to expose companies that put profits ahead of human rights, environmental sustainability, and other priorities. Also, the capricious manner in which the communist government interfered with Alibaba, TenCent, Didi, and other Western darlings has rightly discouraged Western capital providers.

 

In reaction to depressed consumption and investment, the government certainly will attempt to tighten the shortfall through public spending. But there will be limits to Beijing’s ability to reflate the economy through government spending. China already has one of the highest total debt-to-GDP ratios in the world, at more than 300 percent; nearly a third of that is government debt. It is likely that the government will have to recapitalize the banks to cover loan losses caused by the real-estate crisis and the lingering impacts of zero-Covid. Government spending is delivering diminished marginal returns at this point. Additional government spending on empty buildings, unused high-speed rail systems into the Gobi Desert, and other wasteful infrastructure projects will not contribute to GDP growth, and government at every level faces significant fiscal pressure. According to reporting by Bloomberg, total government spending last year was up 3.1 percent. Revenues are down due to reduced economic activity during the shutdown. Local governments and their off-book funding vehicles are overwhelmed due to increased borrowing costs. Bloomberg estimates that government deficits are up more than 50 percent based on Ministry of Finance data. Government spending at current levels is unsustainable, let alone increased spending to offset a slowdown in consumption and investment.

 

This leaves exports, and the PRC has long depended upon exports to help drive growth. This, too, is changing. China continues to have a positive trade balance with the world within a fairly consistent band over time. The surplus has declined of late as the cost of commodities that China must import (notably energy and food) has risen. But isolating the value of what China exports to the world tells an even more challenging story. In 2006, exports peaked at about 36 percent of GDP. That figure declined steadily in the following years, and was cut in half to 18 percent in 2019. It has rebounded somewhat to about 20 percent. The value of exports to total GDP rose a bit during the pandemic as economic growth slowed. They can recover somewhat more, but it is not possible for rising exports to offset declining consumer spending and investment.

 

The simple reality is that the PRC’s economic challenges at every turn, caused by failed command-and-control policies and exacerbated by collapsing population, gives the government few effective policy choices to stem long-term decline. The immediate future may see an uptick as economic stimulus coming out of the pandemic lockdowns provides a near-term burst of consumer activity and government spending and stimulus. But over the longer term, slowdown and a decline relative to the rest of the world seems inevitable. This is a dangerous situation for the country, but also for the region, for the U.S., and for the world.

 

The Gallagher committee will provide an important service to the country in its focus on the “military, economic, and ideological challenges” that the chairman is prioritizing. But it is just as important for the committee to consider how the U.S. should be thinking about a world in which China is in sustained, irreversible relative decline. How well-prepared will we be for the tail risks of such a scenario, including regional instability, social unrest, military adventurism? It would be a mistake to push the analogy with the Soviet Union too far, but China’s estimated population decline over time relative to its current population is the same as or greater than what Russia experienced in the breakup of the Soviet Union. Through much of the Cold War, the Soviet Union had the second-largest GDP in the world in nominal terms. Present-day Russia is not in the top ten.

 

Much of the world believed not only that China had avoided the global financial crisis but that it would benefit from the impacts of the crisis on the U.S., the EU, Japan, and other advanced economies. That’s not what happened. It would be a mistake for us coming out of the pandemic to lull ourselves into another false sense of security that China will emerge and resume its important role in the global economy. That’s over. The question is this: Do we have sufficient imagination to consider what that will mean for the U.S. and the world in the next ten, 20, or 30 years?