Are China’s Economic Struggles a Problem for the World?
In my Mitch on the Markets columns, I rarely cover Europe, China, or other non-U.S. economies. I tend to focus on domestic issues because they tend to be the biggest drivers of equity returns – after all, the U.S. is by far the largest and most important economy in the world.1
But mounting problems in the world’s second largest economy, China, have become so prevalent that I think it’s important to take a closer look and offer some insight.2
Economic data from China has been sluggish throughout 2023 – exports are falling, consumption has been weak, and property sector woes are well documented. In the past, China has bounced back from dips in output. But some are convinced that this time around, serious economic fractures are starting to form. On August 20, a headline in the Wall Street Journal framed the issue more bluntly, saying that “China’s 40-Year Boom is Over.”
The era of blistering growth had a major impact on the global economy. World Bank data indicates that from 2008 to 2021, China was responsible for 40% of all global GDP growth. Over that time, the world’s per capita GDP grew by 30%, while China’s GDP grew by a staggering 263%.
China’s model for growth was largely powered by state investment – in factories, skyscrapers, low-cost manufacturing, roads, and exports. Between 2008 and 2021, about 44% of China’s GDP was tied to domestic investment in infrastructure and other hard assets, compared to about 20% in the U.S. As these investments propelled the economy and lifted people out of poverty, the state kept borrowing to build – this time in the form of residential real estate, which in some years accounted for over 25% of GDP.
The growth model worked well for decades, but now major problems are starting to emerge. Millions of apartments are unoccupied. According to a 2018 study, about 20% of all units – or about 130 million apartments – sit empty. Major property developers like Evergrande and Country Garden are on the brink of default and bankruptcy. And many parts of China have airports and bridges that barely see any traffic.
Saddled with huge levels of debt and with a return on investment (ROI) that’s been falling sharply, the country has effectively run out of things to build. The path back to growth requires a shift in the structure of the economy from investment to consumption and from manufacturing to services, in my view.
China appears to be doing neither.
Many analysts and economists – including myself – thought that the end of “zero Covid” in China would unleash a spending boom much like we saw in the United States. But that didn’t happen. Instead, households are saving at a much higher rate than they were before the pandemic, with many worried that the flailing real estate market is a threat to the broader economy. And where the rest of the world is dealing with excessive demand driving prices higher (inflation), China is facing the opposite problem – too little demand is resulting in too little inflation.
As for the shift from manufacturing to services, China also appears to be moving in the wrong direction of late. From 2012 to 2020, the services sector in China accounted for all the net job growth, with many landing in the high-skilled, ‘knowledge’ economy. But in the last two years, the service sector has lost a net 12 million jobs, which has also pushed youth unemployment past 20%. So battered are the prospects for college graduates that China stopped publishing youth employment statistics.
To stem the tide of weak consumption and service sector contraction, the government likely needs to implement some level of fiscal stimulus that involves stabilizing the real estate sector and encouraging consumer spending, while also reversing course on regulatory measures that have scared away foreign investors and entrepreneurs. It’s unclear if the government is willing to do any of these things.
Bottom Line for Investors
So, what does this all mean for the U.S. and the global economy?
For one, I believe we can probably put to rest the concern that China will overtake the U.S. economy in size anytime soon. China is approaching the limits to growth that can be fueled by manufacturing and infrastructure/real estate investment, and there appears to be political resistance to transitioning to a services and consumption-based economy. Furthermore, with trade restrictions and new export controls on semiconductors specifically, China is likely to encounter major headwinds on the road to major technological innovation – likely a key source of global growth.
China also has a major demographic problem. The legacy of the one-child policy means that China has a rapidly aging population, such that its roughly 1.4 billion population is likely to drop below 1 billion by 2080 and perhaps below 800 million by 2100. While those numbers are almost certain to change, the trend lower almost certainly will not.
Given China’s previously robust contribution to global GDP, we might reasonably expect to see some moderating growth trends. But it’s also true that other emerging markets can pick up the slack, and the U.S. can—and will—likely remain the world’s most powerful growth engine for years and decades to come. This keeps U.S. stocks in the ‘attractive’ category looking ahead, in my view.