While governments in the United States and Europe have mishandled one disaster after another – from the 2008 financial crisis to the failed efforts to contain COVID-19 – even advocates of liberal democracy have looked with envy at Chinese policy makers who have sailed in the same troubled waters with apparent ease.
But the cracks in China’s governance model are starting to show themselves as its real estate sector faces the ramifications of a slump in the housing market and as its zero-Covid policy falters in the face of rapidly spreading new variants.
“There was a kind of envy in the West for what appeared to be the extraordinary competence of Chinese policy makers, but at the moment the emperor has no clothes,” said Jeremy Mark, senior fellow of the Atlantic Council and expert on Asian economies. .
While Chinese President Xi Jinping looks set to secure an unprecedented third five-year term when the Communist Party of China holds its 20th Party Congress starting October 16, the next few months could be crucial for the country and its efforts to achieve that. status of a world-class power.
The end of China’s miraculous growth
The importance of the Chinese economy to global growth was made evident in the years following the 2008 financial crisis, when the economies of the United States and Europe were under the weight of a severely wounded financial sector, falling real estate prices. and rising unemployment which has weakened consumer demand.
Not only was China’s economy kept safe from financial contagion, it barely lost vigor, growing nearly 10% annually from 2008 to 2011 as local governments borrowed large loans to finance a new one. massive wave of infrastructure development.
Although Western demand for Chinese artifacts faded after the financial crisis, its economy continued thanks to a $ 575 billion tax incentive package – which at the time was equivalent to 13% of China’s GDP – which was largely spent on infrastructure projects and encouraged easy lending to the real estate sector.
The stimulus package and subsequent policies built on the success of the previous three decades, when the government was able to encourage double-digit economic growth through necessary infrastructure spending. It also set the stage for another decade in which the Chinese economy would overtake the West and provide the global economy with the lion’s share of its growth.
Not to be missed: China throws another trillion yuan in economic stimulus after promising it will not unleash large tax packages
But these policies also hid a serious problem: China was running out of means to invest productively in roads, bridges and other infrastructure. Michael Pettis, a professor of finance at Peking University in Peking, argues that this reality has posed a fundamental problem for Chinese politicians that they have yet to solve.
After China “bridged the gap between the investments it had and the investments the economy could absorb productively … China should have drastically reduced the production quota it reinvested,” Pettis wrote in a recent report. essay for the Carnegie Endowment for International Peace.
However, the rebalancing of the Chinese economy from an investment-driven to one dominated by domestic consumption spending has met with political opposition as vested interests in maintaining the current model have stalled the necessary reforms.
“Political priorities are central to understanding the decisions made by the Communist Party of China,” said Marks of the Atlantic Council. “Politics took precedence over other considerations in defining economic policy.”
A slow debt crisis
Property bubbles are common in economic history, and the bubble that formed in China’s real estate sector is not all that different from that formed in the United States and Europe in the 2000s.
In the United States, homebuyers and builders feasted on the easy credit provided by investor demand for supposedly safe mortgage-backed securities, and the rise in house prices eventually triggered an onslaught of speculation that brought those prices forever. higher until the bubble burst.
In China, according to Pettis, the government has granted easy credit to the real estate sector as it sought to stimulate economic activity to achieve unsustainable GDP growth targets.
A further wrinkle to the story is the widespread practice by Chinese developers of pre-selling homes that have yet to be built and using those funds not to complete the promised home, but to buy more land.
“Like real estate prices [in China] has grown year after year, it has changed the behavior of companies in ways that have in turn distorted prices, “Pettis wrote, adding that rapidly rising prices have benefited companies that have taken the most risk by grabbing the most real estate. they could to anticipate future needs.
Just as the real estate market in the United States was dominated by speculators in the 2000s, so too has China’s in recent years.
Pop the bubble
Chinese officials have long recognized its housing bubble and debt growth that fueled its inflation as an issue that requires serious attention.
In 2020, Beijing introduced new regulations that significantly limited access to credit to the real estate development sector, preventing developers from borrowing to mask liquidity shortages and preventing some from completing projects for which buyers of houses had already paid.
Real estate developers such as China Evergrande Group EGRNF,
they have struggled to meet their commitments with buyers and lenders over the past year and tensions in the real estate sector have hit speculators hard, with real estate prices in China falling for the 11th straight month in August.
Brad Setser, a former senior adviser to the U.S. trade representative and a member of the Council on Foreign Relations, told MarketWatch in an interview that the problems of the Chinese housing crisis are unlikely to pose a risk to the financial system because it is already a state run. and the Chinese government has shown willingness to recapitalize banks in the past.
But the bursting of the housing bubble could pose a serious obstacle to the Chinese economy even in the absence of a financial crisis, given the importance of real estate development for the Chinese economy.
“Real estate investments accounted for a much larger share of the Chinese economy than in the US context,” Setser said. “It’s like the whole economy is Nevada and Arizona and some of the expanding and building states before our crisis.”
Clean up the clutter
The job of Chinese politicians is to somehow halt the cycle of declining property prices and sales and to stabilize real estate development companies so that they can finish the houses they have promised to build.
Tom Orlik, chief economist at Bloomberg Economics, estimates that the value of mortgages attached to unfinished properties in China is about $ 230 billion, or 1.4% of the country’s GDP. If homes continue to be completed at the current rate, that amount will rise to $ 632 billion in 2024, a whopping 4% of GDP.
A growing number of Chinese have begun to boycott mortgage payments on unfinished homes where developers have halted construction, according to Houze Song who leads Chinese economic research for the MacroPolo think tank.
Song said in an interview with MarketWatch that it is difficult to know how widespread these protests are because the Chinese government has been working to stop the spread of information about boycotts, in traditional media and on social media, although there is evidence that the government is taking. seriously the protests.
Beijing recently announced $ 29 billion in loans to troubled developers, although Song warned that “the size probably isn’t enough to solve the problem.”
The regime is in a difficult position because officials both want to stabilize the real estate sector without sending the message that private actors will be bailed out by the government if they take too many risks, Song added.
This means that the government is likely to distribute support slowly and will try to force real estate companies and local governments to bear as much burden as possible.
Current stimulus plans “will only be enough to get away with it,” but uncertainty and the decline in housing problems will continue to weigh on consumer and business confidence and economic growth, Song said.
Another obstacle for China is its so-called zero-COVID policy, which involves the progressive blocking of major cities in an attempt to completely rid the country of the virus.
“Without loosening COVID zero, there will be no stabilization of the housing market,” Carl Weinberg, chief economist at High Frequency Economics and a veteran of China, told MarketWatch.
The policy is defensible on moral grounds, especially when compared to the United States, where more than one million deaths from COVID contributed to an almost unprecedented three-year drop in average life expectancy.
Coronavirus Update: Life expectancy in the United States has seen its biggest two-year decline during COVID in nearly a century, the report finds.
But it lays bare that China’s manufacturing and launching of vaccines has been less successful in the West, while betraying the Communist Party’s authoritarian tendencies at a time when its international reputation has been damaged by the events in Hong Kong and Xinxiang. .
See: The Chinese think tank argues that the “zero COVID” policy must change to free the economy from danger
Recent polls by the Pew and Eurasia Group show that a growing share of the world’s population has negative views on China, while countries from India to Nigeria and Brazil say they prefer the United States to China for the role of leading superpower.
However, China’s most important decisions are ahead. The standoff between Western powers and China over Taiwan’s fate will define the perception of China’s economic and political strength for decades to come, Weinberg said.
“A successful repatriation of Taiwan would give it control over the global chip market and a stronger voice on the international stage,” he said. “The stakes are very high.”