How’s China Doing?

• overall: china’s growth is slowing
• property:
  • despite government support, property prices still struggling
  • falling demand => tighter financing => unfinished projects
• prices are going down—deflation!?

Involution (Neijuan)

• Dropping household wealth => more cautious purchasing.
• Young unemployment rate still elevated

Major Challenges

1. demogratic change
2. changing the growth model: state sector restructuring seems to have stopped
3. shifting to more domestic demand driven by consumers
4. changes in financial system—how can banks avoid over-lending
5. changes in fiscal system (how to find sources of revenue)
6. reducing corporate debt, LGFV debt, etc.

options are not great

• older model has had diminshing returns
• exports and trade surplus may not last
• more limited access to technologies and foreign direct investment
• high debt levels requires many years of debt logistics
• changes to population structure / aging limits consumptino and savings (so increasing domestic demand is hard)
• any fast shift to new growth model will bring a bit of depression

New Direction

1. maintain: focus on investment driven by state industrial policy
2. shift: investment from housing sector to optimized manufacturing (high tech)
3. expand: manufacturing capacity overall—but efficiency
4. double-down: on exports even if tariffs

ambitious and a huge gamble

Challenges

1. Return to comprehensive market reform: return to pre-2008 path to system reform, greater role for private sector, tighten bank lending, fiscal reform; investment driven growth, improve consumer demand
2. develop new productive forces: shift from real-estate to new technologies, try to dominate global markets

Demographic Change—Biggest Liability

• higher pension
• health costs
• lower savings

must be fulfilled by increasing productivity, higher results on investments. since…

1. less capital
2. lower household savings

Three Scenarios

• Turnaround: shift to a portfolio of system reforms / changing industrial policy toward a new growth model; resume high growth and reduction of debt
• Crisis: meltdown because of debt burden and financial contagion
• *Slowing growth: no big crash, but stagnation / near stagnation

Comprehensive System Reform

This requires giving up control, which China is not willing to do.

1. enterprise downsizes, investment shifts to private sector
   • go back to what worked in 90s, compel SoE managers to close them through bankrupcy or sell them out
   • allocate bank loans / bonds / equities more efficiently
   • reduce politician role in management
2. Change lending behavior of banks: lower tolerance to non-performing loans; don’t bail out bank
3. Improve bankruptcy process
4. shift tax system to tax private wealth
5. strength retirement and health insurance
6. reduce export orientation, internal circulation

Reach to Technological Frontier

• shift from infra/housing to cutting-edge technology
• dominate global markets: EV, batteries, solar panels, new materials
• deploy AI in manufacturing (“great leap” productivity)

China is already doing this; still high investment. Export orientation is hopefully still feasible.

Techno-utopianism.

China’s Still Investing / Exporting

fixed asset investment percentage:

• manufacturing increasing
• infrastructure increasing
• real-estate decreasing

export volume by product

ev increasing, etc.

“Comprehensive Reform”

• extend retirement to 65

• abolish hukou

• lower entry barriers

• reduce negative list

  etc.

Fed’s analysis

• while central government has surplus to handle debts (and thus can offboard), the main problem is local debt
• financing for local governments have broken down (with little possibility to repay)
• central government may eventually need to assume all local government debt

Given this; the best China can hope for is a 2.7% growth, falling slowly to 9% growth, assuming….

1. China’s productivity growth is average for all conutries from China’s incoming level
2. investment declines to 25%
3. labour quality inccreases at similar levels

Sustained 4% annual growth requires gains in productivity, and continuing high investment levels which have never been seen before.

Off-Boarding

Essentially, the sudden off-boarding of debt may result in depression, which rips up performance legitimacy.

Best-possible scenario: slow growth, but no improvement.

Japanification?

Period of slow growth is very likely without decisive action.

Pros

• China’s much less urban than Japan in 1990s, so con increase growth through urbanization
• China has a much larger domestic market
• China’s capital less liberalized, so less chance of fire sales
• Housing price decline less than Japan b/c government intervention

Cons

• China’s housing market + Debt + Aging is similar to Japan in 1990s
• China’s trade surplus similar to Japan in 1980s, similar backlash with trading partners

Avoiding Japan Trap

• China’s savings rate needs to decrease
  • Government expenditures must be funding fare
  • pension and retirement systems must be built out
  • greater coverage, greater benefits
  • diverting investment from production to public services

Takeaways

1. China’s GDP catching up with the US is likely low
2. limited reforms and debt limits catching up
3. limited reform forever, China would never catch up
4. China entering a period of slower growth

… this will likely not a be a disaster (see Japan.)