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Is China on the verge of collapse?

China’s economy has become synonymous with growth. Since the 1980’s liberalization of Deng Xiaoping, China’s leader from the late 1970s to 1997, China developed to be the world’s largest manufacturer. It combined high amounts of export with massive domestic and international investments that were made capable by its economy being largely state-run. Between 1980 and 2016, the average growth rate of GDP was 9.7 percent per year, multiplying the size of its economy 30 times. Villages became huge cities with millions of inhabitants and mighty skyscrapers. Hundreds of millions of people were elevated from poverty. China grew from an impoverished agricultural society to a serious competitor for the leadership of the world.

The Chinese economic miracle can largely be attributed to its political structure. The Chinese government, which is led solely by the communist party, has a strict grip on the economy. Despite its liberalizations, there are still clues that remind of the radical communist past. For instance, the Chinese government still formulates five year plans. This centralized control allows the Chinese government to employ resources on a grand scale and force economic growth. However, from the moment China got a communist regime, in 1949, this centralized control was mainly used to oppress.

Only when Deng Xiaoping started liberalizing the economy, the centralized control proved to be a useful tool for China’s growth ambitions. Deng took advantage of the globalization wave that erupted in the 1970’s. Businesses internationalized their supply chain, and the low wages of Chinese workers drew them in. However, unlike other developing countries, China kept strict control of its major industries. This meant large Chinese companies, which in many cases are state property, were supported as they started competing with the more efficient western companies. Where many developing countries saw their young industries being crushed by foreign competition, China only created enough room for its economy to grow, but it’s government remained firmly in charge. This recipe for growth allowed China to perform an economic miracle, and is to an increasing degree an example for other developing countries.

But the recipe is starting to show cracks. The growth rate of GDP is stagnating. In 2016, GDP grew by 6.7%, which seems really high, but is significantly lower than the 10 percent average. One reason is the huge increase in wages. Chinese wages have grown 64% from 2011 to 2017, and have surpassed most Latin-American wages.  At the moment they are approaching wages in European countries such as Portugal. This is decreasing the competitiveness of the Chinese economy. Add to this the demographic pressure that comes forth out of the aging population. This will decline the working population, which again, will increase wages. This development will and already does make producers move their production facilities to cheaper developing countries or automate production at home. The Chinese government is trying to replace these production jobs with service jobs, but has difficulties in creating enough white collar jobs to replace the blue collar ones.

Then, there is the growing financial instability. The IMF stated in a recent report that the Chinese economy faces three main financial challenges. Firstly, the rapid increase of corporate and private debt, that results from the spending sprees that fuel much of China’s growth. This has caused the Chinese debt-to-GDP ratio to rise to 257% in 2017. By comparison, Greece had a debt-to-GDP of 180.8%. Secondly, the underdeveloped nature of China’s financial sector (from which some companies greatly benefit, as this article desribes) results in the development of risky financial assets that are largely unregulated. Thirdly, the guarantees that the Chinese government implicitly gives out. Since companies are financially supported, this promotes excessive risk-taking. All these problems can be led back to the growth strategies the Chinese government adopted. Add the fact that, according to the IMF, 27 of its 33 largest banks do not have sufficient capital to withstand a ‘high stress scenario.’

This situation can be illustrated by its cities. On the one hand, asset prices are rising to extreme levels in major cities. When compared to the median income of its inhabitants, Shanghai is more expensive than New York and London. This is not due to a foreign capital influx, like in London. Real estate is seen as one of the few ways to invest capital since China’s financial markets and capital outflow to other countries are restricted. Billions are poured into what is most likely a price bubble. At the other extreme, complete cities are built that have so little inhabitants that they are called ‘ghost cities’. When growth targets aren’t met in predictions, the standard answer of the Chinese authorities is: build. This anticyclical policy has been very effective, China seemed immune to international economic crises. But, as becomes increasingly more apparent, it has saddled China with massive debt.

In the past decades, China could easily spend itself out of an economic slump. But this spending is getting less effective and less feasible since debt is reaching disturbing levels. The Chinese government therefore hasn’t got an easy way out of this difficult situation. Whether it finds a solution matters to not only the Chinese, but to us all. The integration of the Chinese economy in the world economy has provided many opportunities, but is now making the whole world vulnerable to a Chinese collapse. For instance, the EU-Chinese trade makes up 14.9% of EU trade. Many developing countries are growing increasingly dependent of exports to China. Chinese financial interests have spread throughout the world and companies have invested in China.

This article isn’t meant to make you worried. Although China has big problems, it’s putting it’s best and brightest to work to make up solutions. The last five year plan is aimed at solving the problems mentioned above. But whether the Chinese get out of their economic trouble or not, one thing is certain: Chinese growth isn’t as obvious as it was in the past.


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