This is Dominic Pino filling in for Jim Geraghty, who is out on vacation. I’ll be back tomorrow, and then Noah Rothman will take over Wednesday through Friday.
On the menu today: China’s weak economy, and what it should teach us about the failures of central planning.
China’s Financial Woes
You wouldn’t know it from many American politicians’ rhetoric, but China’s economy is in big trouble right now. The country’s economy is setting off alarm bell after alarm bell, and its supposedly genius industrial planning is coming undone.
Let’s survey some recent facts about China’s economic performance.
China only loosened its Covid protocols in December, well after the rest of the world got back to normal. The totalitarian control of everyday life spooked many businesses operating in China and spurred them to seek alternatives. And the reopening of the Chinese economy has not gone as well as the reopening of Western economies.
After a brief surge in the early part of this year, the Chinese recovery is sputtering. “China’s consumer-driven recovery is showing more signs of losing momentum as spending slows on everything from holiday travel to cars and homes, adding to expectations for more stimulus to support the economy,” reported Bloomberg on June 25. “The rebound in consumption after China shed its Covid controls has propelled growth so far this year, but confidence is weak and evidence is mounting that the economy may need more help.”
To that end, while most other central banks around the world are raising interest rates in response to inflation, China’s central bank is cutting rates and worried about deflation. “China’s consumer prices did not rise at all in the year to June. The country’s GDP deflator, a broad measure of the price of goods and services, fell by 1.4% in the second quarter, compared with a year earlier. That is the biggest decline since 2009,” reported the Economist on July 27.
Falling prices might sound like a good thing, but it’s bad for an economy trying to catch up to the West. The Economist explains:
In catch-up economies, productivity grows briskly in industries, like manufacturing, that trade goods across borders. Because output per worker rises quickly, firms can afford to pay their workers more without raising their prices, which are pinned down by global competition. Meanwhile, in sectors such as services, which are not much traded across borders, productivity grows more slowly. Service firms must nonetheless compete with manufacturing for the country’s workers. That obliges them to raise their wages to attract recruits. Higher wages, in turn, force these firms to raise prices. These price hikes are required because productivity has not kept up, and possible because services are sheltered from global competition. The hikes also make the country more expensive: the price of haircuts rises in sympathy with the growing wages of increasingly productive manufacturing workers.
As a result of the weakness in prices and slowing growth, the Economist says that Goldman Sachs projects that China’s economy will be 67 percent the size of the United States’ this year, down from 76 percent in 2021. So China is losing ground relatively quickly.
The Chinese stock market is flagging. “The country’s benchmark CSI 300 index lost around a fifth of its value last year, and has risen much less than major indexes in the U.S., Japan and elsewhere in 2023,” reported the Wall Street Journal on July 31. “That is creating a sense of despair among the office workers, civil servants and other ordinary citizens who are responsible for the bulk of trading in China’s stock market.” About 200 million individual investors trade on Chinese markets, and many of them are moving their money to savings accounts despite the central bank’s rate cuts meaning lower rates of return there. A low but positive rate of return is better than a negative one.
The Journal also reported on August 3 that private-equity funds are afraid of investing in China: “U.S. dollar fundraising by private-equity firms that invest mainly in China has all but dried up. The days of large and easy profits are also over, as the country’s internet gold rush has ended. Chinese companies are finding it increasingly hard to go public in Hong Kong and the U.S., limiting many private-equity funds’ exit strategies. Chinese funds’ returns for the last two years have also disappointed investors.” The average annual return for China private-equity funds in 2022 was negative 5.6 percent.
Again, despite lower interest rates, home sales in China are cratering. That’s especially bad in China’s overly real-estate-dependent economy. Home sales from the top 100 developers fell by 33.1 percent year-over-year in July. Developers are worried about default, given the country’s ongoing credit crisis.
“China’s housing market is so bad that homebuyers appear to be flocking overseas to purchase a home in the US,” reported Business Insider on August 3. “Chinese buyers represented 13% of foreign buyer home purchases in the US, up from 6% of foreign buyer purchases last year.” Most of these purchases were of relatively expensive homes, and they were mostly for living in, not renting. That could mean wealthy Chinese are increasingly bearish about their country’s prospects and are seeking alternatives before things get even worse.
Net foreign direct investment in China hit its lowest point in at least 25 years in the second quarter. Bloomberg added:
The slump could be a lot deeper in reality than what both datasets show, analysts including Logan Wright of Rhodium Group wrote in a July report. That’s because the data increasingly measures purely financial transactions — including those by Chinese state-owned companies, rather than foreign corporate decisions, they said.
Youth unemployment is at a record high. The 16–24-year-old unemployment rate was 21.3 percent in June. (U.S. 16–24 unemployment was 7.5 percent in June.) Large numbers of unemployed young people, especially young men, have historically been a cause for concern in authoritarian countries. When the economy is delivering in a poor country, people are more willing to overlook an abusive government. When the economy stops delivering, dictators could be in trouble.
The mighty manufacturing sector is contracting. “China’s factory activity contracted for a fourth consecutive month in July, while non-manufacturing activity slowed to its weakest this year as the world’s second-largest economy struggles to revive growth momentum in the wake of soft global demand,” reported CNBC on July 30. And that’s based on data from the Chinese government’s National Bureau of Statistics, so the real picture might be even worse.
One of the main arguments U.S. politicians use for steel protectionism is that the Chinese government supports its steel industry and reaps great rewards for doing so. Not so much. “China’s leading steelmakers warned the industry faces a very challenging second half as demand disappoints, profitability lags, and pressure to cut costs mounts in the world’s top producer,” reported Bloomberg on July 29. Profitability has lagged for almost a year, and things are not projected to get better in the near future.
The other industry politicians like to talk about related to China, semiconductors, is another example of Chinese failure. China’s industrial-policy efforts in that industry, despite multiple attempts and billions of dollars spent, have yet to yield fruit, as the country still imports about 90 percent of the chips it needs.
All of this comes on top of the long-term problems caused by the one-child policy, which might go down in history as the worst government policy ever. The survival of the communist regime might depend on reversing the declining population that it brought about through its barbaric prohibition on having more than one child. The policy was enforced through decades of abortion and sterilization; now, the government is trying to get people to have more kids. Milton Friedman joked that if you put the government in charge of the Sahara Desert, there would be a shortage of sand. It turns out that if you put communists in charge of China, there will be a shortage of people.
It’s vital for the U.S. to take China seriously. Military, cybersecurity, and espionage issues are extremely important for the U.S. to get right, and the defense of Taiwan should be top of mind. Part of taking China seriously, though, is relying on facts, not rhetoric. China is not “eating our lunch,” as Joe Biden has said, and the country’s economic record is not a reason to jettison free-market principles. A country with newly built, nearly vacant cities is not a model for economic policy.
As Chinese economist Weiying Zhang wrote in his 2021 book, Ideas for China’s Future, “Imagine seeing a person without an arm running very fast. If you could conclude his speed comes from missing an arm, then you naturally will call on others to saw off one of your own arms. That would be a disaster. . . . Economists must not confuse ‘in spite of’ with ‘because of.’” China’s past economic successes have been in spite of its government’s penchant for planning, not because of it.