This persistent reliance on older economic models has not only exacerbated China’s substantial debt burden but also worsened issues related to industrial overcapacity. As a result, concerns and skepticism about the nation’s economic future have gained prominence.
Some experts predict a slow drift towards a stagnation scenario, similar to Japan’s experience, while others warn of a more severe economic downturn. William Hurst, Chong Hua Professor of Chinese Development at the University of Cambridge, told Reuters, “Things always fail slowly until they suddenly break,” highlighting the significant risk of a financial crisis looming over China in the near term. “Eventually there’s going to have to be a reckoning,” Hurst said.
The Bursting Bubble: Why and How
The bursting of China’s economic bubble can be attributed to a complex interplay of factors that have accumulated over several decades. China’s rapid transformation from a Maoist planned economy in the 1980s into an industrial powerhouse involved heavy investments in factories and infrastructure. However, by the time the global financial crisis struck in 2008-09, China had largely fulfilled its investment requirements relative to its level of development.
While China experienced substantial nominal economic growth, this expansion was accompanied by a massive increase in overall debt, which expanded ninefold. To sustain this growth, China doubled down on investments in infrastructure and property, diverting resources away from household consumption. Consequently, consumer demand remained weaker as a portion of GDP compared to most other countries, and the job market became concentrated in less attractive sectors for young university graduates.
This policy focus also inflated China’s property sector, accounting for a quarter of its economic activity, and left local governments heavily reliant on debt. The recent slump in the property market further worsened the situation, curbing demand for building materials and causing economic ripples. The COVID-19 pandemic exacerbated these existing issues, hindering the economy’s ability to recover despite China’s efforts to reopen.The Road Ahead: Challenges and Possibilities
China finds itself at a critical juncture as it seeks to navigate a precarious economic path. The looming threat of a massive property market collapse potentially dragging down the financial sector underscores the urgency of the situation. Economists have outlined three potential paths for China’s way forward.The first path involves a swift and painful crisis that entails writing off debt, addressing industrial overcapacity, and deflating the property bubble.
The second is a more gradual, decades-long process in which China slowly unwinds these excesses at the cost of slower growth.
The third, though seen as unlikely, involves actively transitioning to a consumer-led model through structural reforms that may entail short-term pain but offer the potential for a faster and more robust recovery.
While the time appears ripe for China to take an economic pivot, there is also a “great fear of provoking an economic crisis,” as noted by Hurst. As China grapples with these challenges, the world watches closely, aware that the outcome will not only affect the nation but also have far-reaching implications for the global economy.