Owing to the one-child policy and the legacies of other less-appreciated Chinese development measures over the years, the stage has long been set for today's property bubble. Even more worryingly, much of China’s economic growth over the past decade has been an overdraft on future growth that now may never materialize.
MADISON, WISCONSIN – China’s property sector is the largest asset class in the world – larger even than the US equity or bond market. But there are growing fears that it is a bubble poised to burst. Already, the heavily indebted Chinese property giant Evergrande has filed for bankruptcy protection in the United States, and the real-estate developer Country Garden is battling a liquidity crisis. The failure of either, or both, could well trigger a financial crisis.
But why did a property bubble emerge in the first place? Like so many other problems in China today, this one can be traced back to the one-child policy that the government adopted in 1980 – a decision that would fundamentally reshape the country’s economic, political, and diplomatic trajectory. At the time, Chinese policymakers believed that the country had only around 1.4 billion mu (a Chinese metric equal to 1/15th of a hectare) of arable land, and per capita arable land only 40% the size of India’s. So, they concluded that births would need to be capped, and urban land restricted.
This conclusion proved to be deeply flawed. For starters, in 1996, satellite telemetry revealed that China actually had 1.95 billion mu of arable land. Even if the initial estimate had been correct, however, arable land does not necessarily correlate with grain production, which is affected by many factors. In 2022, China’s arable land area was only 77% the size of India’s, but its grain output was twice as high.
Yes, China still imports one-fifth of its grain, but that is because of agricultural policies and the international market system, not a shortage of arable land. And there is huge potential for China to increase its domestic food production further. Its cereal yield has increased from 196 kg/mu in 1980 to 421 kg/mu in 2021. Reaching the current US yield level would imply an additional 30% increase in cereal production, which is achievable in the near future. A study by the Chinese Academy of Sciences found that China has 850 million mu of undeveloped arable land in addition to the existing 1.95 billion mu of arable land.
China also has two billion mu of desert, some of which could be transformed into arable land through drip irrigation and soil improvements – as is already being done in the formerly barren Maowusu Desert. Similarly, China’s six billion mu of grassland (which is larger than India’s entire land area) has significant potential to produce additional meat and dairy products. The spread of indoor farms and white agriculture (in which microorganisms turn straw into feed) also promises to increase food production dramatically.
Finally, it bears mentioning that eating more is not necessarily better. An excessive food supply can lead to a greater incidence of obesity-related diseases and higher medical costs. Among developed countries, the US has the highest per capita daily supply of calories and protein, but the shortest life expectancy and the highest medical costs, whereas the opposite is true for Japan. For its part, China’s current per capita daily dietary supply is equal to the average between the US and Japan.
Red Line in the Sand
In 2000, China’s census showed a fertility rate of only 1.22 children per woman (2.1 is considered replacement level), meaning that the latest generation was half the size of the previous one. At this stage, abolishing the one-child policy and providing more land for urbanization would have been the logical thing to do.
But China took a different approach. The National Population Development Strategy Group, which included almost all official (government-aligned) demographers, revised the fertility rate to 1.8, predicted that the population would peak at 1.5 billion in 2033, and recommended continuing the one-child policy and protecting arable land. Moreover, in 2006, China drew a protective “1.8 billion mu arable land red line,” setting a standard of “1.2 mu of arable land per person” and strictly limiting the use of land for urbanization.
Although China’s urban development was planned for a population density of 10,000 people per square kilometer, rapid urbanization meant that young people were immigrating to cities faster than they could be accommodated. For example, Shenzhen’s city plan, approved by the Chinese State Council in 2010, envisaged a built-up area limited to 890 square kilometers (343 square miles), with a population of 11 million, by 2020. All residential areas, kindergartens, schools, and other infrastructures were planned around these parameters.
Yet the 2020 census revealed a municipal population of 17.56 million and a built-up area of 956 square kilometers, implying a population density of 18,000 people per square kilometer, with the Futian District rising as high as 27,000 people. (And some districts in Shanghai, Guangzhou, and Beijing have even higher population densities than Shenzhen.) For comparison, the population density of major American cities such as Chicago, Philadelphia, and Miami is just 4,000 people per square kilometer in downtown areas, and 1,000 in the rest of the urbanized area.
As China’s urbanization rate has increased from 19% in 1980 to 65% in 2021, the land made available for urbanization has lagged further behind. In 2021, 25% of the population lived in urbanized areas of counties and towns, and 40% in cities, but the overall urban built-up area of cities was only 62,400 square kilometers (94 million mu), accounting for a mere 0.65% of the country’s land area. No wonder housing prices have risen.
Despite the long-overdue easing of the one-child policy – the government started allowing two children in 2016, and three in 2021 – China’s population began to decline, even according to inflated official figures. After peaking at just 1.41 billion in 2022, the government reports, the Chinese population is on track to fall to 1.2 billion by 2050, provided the fertility rate stabilizes at the current official rate of around 1. I estimate that the actual population is now closer to 1.28 billion, and will drop to one billion by 2050.
In any case, with the standard of “1.2 mu of arable land per person,” even 1.41 billion people would need only 1.69 billion mu, meaning that hundreds of millions of additional mu could be made available for cities. As I show in Big Country with an Empty Nest, China has enough potentially available land for the population of all its cities to fall to the level of Chicago’s. This would cause house prices to decline dramatically.
Nothing Left to Stand on
Drawn at a time when Chinese policymakers were deeply worried about future food security, the “red line” has been a high-voltage one that nobody can touch. The artificial scarcity of land created the illusion of overpopulation, and was used to justify the continuation of population-control policies. Moreover, together with the centralization of fiscal authority under the 1994 tax-sharing reform, it paved the way for “land finance,” a phenomenon unique to China’s urban development.
In 1994, the Chinese central government implemented reforms that resulted in its own share of total tax revenues jumping to 56%, from 22% the previous year. Local governments’ revenues fell proportionally, even as their responsibilities remained unchanged. To make ends meet, they had to fill their coffers through other means, such as by suppressing reproduction. As I concluded in the 2007 edition of Big Country with an Empty Nest, the tax-sharing system thus played an important role in the rapid decline of the fertility rate from 2.3 in 1990 to 1.22 in 2000.
More to the point, after China embarked on housing-market reforms in 1998, income from land sales and development became a key source of local-government revenue. Desperate to generate new revenue streams, local governments started selling off one of the few assets they still controlled. As the land available for development grew scarce, urban land prices rose, promising even greater returns. Local governments started doing everything they could to prevent house prices from falling, and ideally to keep them rising. By 2021, they were generating 49% of their revenues from land sales alone.
Meanwhile, because the one-child policy reduced family size and needs, and increased parents’ concerns about retirement, Chinese household consumption has continued to decline. China’s savings rate averaged 47% between 2005 and 2020, compared to 18% in the US and 24% worldwide (excluding China). In the absence of other investment options, a large share of these savings has gone into property. With no property taxes and an expectation that housing prices would only go up, real estate came to be seen as the best investment for Chinese savers. At the same time, selective abortion of female fetuses, as a result of the one-child policy, set the stage for the current bachelor crisis, which has made buying a new home a must for marriage. As of 2021, 69% of China’s household wealth was tied up in housing, compared to just 35% in the US.
Denial and Delay
I have been watching these problems mount for years. From 2004 to 2010, I predicted repeatedly – in published articles and appearances on Chinese television – that 2012 would be a demographic and economic turning point for China. The next year, in the 2013 edition of my book, I warned that the rapid decline of the home-buying population would take the air out of China’s real-estate bubble. I also predicted that, in the meantime, high and rising housing prices would undercut China’s efforts to boost the fertility rate, because families would not have more children if they could not afford decent accommodations.
Then, in January 2015, Su Jian of Peking University’s China Center for Economic Research and I published an industry report warning of a real-estate crisis. Among the dozens of media outlets that covered my keynote speech at the report’s launch was the official People’s Daily, which ran its story under the headline: “Industry report: China’s demographic dividend ends, housing prices peak.” I then published a commentary in the official Global Times, arguing for reforms to increase the urban land supply. If Chinese authorities had heeded any of these warnings or suggestions, the current real-estate crisis could have been avoided.
But the government’s official demographers have continued to exaggerate population figures, suggesting that China’s demographic dividend will persist for a long time to come. Using these official figures, government-aligned economists such as Justin Yifu Lin, a former chief economist at the World Bank, and David Daokui Li have calculated, as recently as this summer, that the Chinese economy has the potential to grow by 8% annually until 2035, and by 6% annually from 2036 to 2050. That would make China’s overall GDP double or even triple that of the US.
Such predictions have long delighted Chinese leaders, leading them to make the egregious strategic miscalculation that, “The East is rising, and the West is declining,” and feeding into the notion that China’s inevitable ascent puts it on a collision course with the prevailing superpower (the so-called Thucydides Trap). But, in fact, China’s economic growth rate began to decelerate in 2012, falling from 9.6% in 2011 to 6% in 2019, and then to 4.5% in 2020-22.
No Bubble Is Forever
This relative slowdown is the inevitable result of the country’s demographic trajectory. To achieve the “potential growth rate” needed to realize the “Chinese Dream of the great rejuvenation of the Chinese nation,” the authorities have been encouraging heavy investment in real estate, producing the skyrocketing housing prices that we have seen since 2015. By 2022, the prices of new homes sold in Beijing, Shanghai, Guangzhou, and Shenzhen were 1.73 times, 1.81 times, 1.80 times, and 1.97 times their 2014 levels, respectively.
From the one-child policy and the “red line” to the tax-sharing reform and the government’s more recent political ambitions, the stage has long been set for a real-estate bubble. But even worse, much of China’s economic growth over the past decade has been an overdraft on future growth that now may never materialize – at least not at the levels that were previously anticipated.
After all, the value of China’s housing market is four times the country’s GDP, compared to 1.6 in the US and 2.1 in Japan. Accounting for more than one-quarter of all economic activity and two-thirds of household wealth, China’s property sector has become a danger to the entire economy. If the property dam collapses, it will not only trigger an economic downturn and a local government debt crisis; it also may wash away China’s debt market and banking system, leading to widespread social unrest and potentially even a global financial crisis.
The Chinese government is very good at covering up small problems. But these often pile up into much bigger problems that can no longer be ignored. Chinese authorities can keep trying to reinforce the property dam, but they will be delaying the inevitable and precipitating an even greater demographic collapse as home-buying and child-rearing become unaffordable to more and more young people.
Japan has the highest fertility rate in East Asia, partly because its housing bubble burst back in the 1990s, resulting in lower prices and lower urban population density. Now that China’s total population is shrinking, especially the home-buying-age cohort, the collapse of the property dam seems inevitable. How it collapses, and how quickly, will profoundly affect China’s socio-economic position and global geopolitics in the coming decades.
China’s exceptional growth in recent decades has influenced the education and career choices of young people and their families. But now that high-skilled jobs are drying up and recent graduates are struggling to find work, there is a growing mismatch between expectations and new realities.
CHICAGO – China’s youth unemployment rate, after rising every month this year, reached a record high of 21.3% in June. Faced with hypercompetitive work environments and grim job prospects, many of the country’s young workers and middle-class professionals have embraced the “lying flat” movement – which means opting out of the culture of overwork and consumerism – while others have quit to become “full-time children.” In the wake of these startling trends, the Chinese government has stopped publishing monthly youth-unemployment data, triggering a stream of negative headlines about China’s economic “collapse.”
But is China’s economy really in dire straits? The short answer is no. Since emerging from COVID-19 lockdowns last year, the country’s rebound has been relatively strong. The Chinese economy grew by 6.3% year on year in the second quarter of 2023, outpacing the average annual growth rate of OECD countries.
Moreover, the International Monetary Fund expects China’s GDP to expand by 5.2% this year and 4.5% next year – much higher than its forecasts for the United States (1.6% and 1.1%, respectively), the United Kingdom (-0.3% and 1%), and Germany (-0.1% and 1.1%). Even the rise of jobless young people in China is less concerning when compared to OECD countries like Spain, Italy, and Sweden, where youth unemployment rates have hovered around 20% for many years.
This gap between perception and reality can be partly attributed to how China’s exceptional economic performance over recent decades has influenced the public’s expectations. For more than 20 years, the economy grew by about 10% per year, a streak so unusual that it was coined the “Chinese growth miracle.”
But such miracles cannot last forever, and Chinese policymakers have anticipated the inevitable slowdown for over a decade. In 2013, economists (both in China and around the world) predicted that growth would gradually fall to 3-5% by 2030, but that high-skilled sectors like tech would continue to expand. The decline in GDP growth, however, came much sooner and was much sharper than expected, owing to policy decisions, the trade war with the US, and the COVID-19 pandemic, which caused more severe and longer-lasting economic disruptions in China than in other large economies.
Besides failing to predict the timing and magnitude of China’s slowing growth, economists and policymakers misjudged who would suffer the most. It was widely assumed that high-skilled jobs, especially in tech, would be protected from the decline. After all, tens of millions of blue-collar workers were laid off from unprofitable factories during China’s transformation from a low-productivity command economy to a high-productivity market-driven economy in the late 1990s and early 2000s.
The instability of blue-collar jobs is one reason why Chinese parents push their children toward academic success and entry into a selective university. Acceptance rates at top Chinese universities are estimated to be below 0.01% for students in some provinces and around 0.5% for those in major municipalities such as Beijing and Shanghai. For comparison, Harvard College had an acceptance rate of 3.41% this year.
Traditionally, the rewards have been worth the sacrifice. In contrast to lower-ranked schools in China, a degree from a top university opened doors to the best firms and almost guaranteed low levels of employment volatility. Even as unemployment steadily increased, graduates of elite institutions could count on opportunities in tech and finance – the sectors that were supposed to fuel China’s growth. But now even this cohort is facing a tough job market.
Recent economic policy decisions have not helped. Years of regulatory action to rein in Big Tech, including a crackdown on the well-financed ed-tech industry, had a chilling effect on potential growth industries; the government’s evolving approach to globalization and shifting attitudes about the market economy have spooked investors; and the ongoing real-estate crisis has constrained investment. Banks and tech companies are rapidly cutting costs, leading to a dearth of high-wage, high-skilled jobs for recent graduates in these industries.
During China’s large-scale privatization process, older workers struggled to find new employment in the rapidly changing economy. But now, employers are reluctant to lay off older workers – both because they have valuable experience and because they are protected by labor laws. The contraction in jobs therefore is felt most acutely among young people. Recent Chinese graduates face stiff competition for positions that often pay less than before.
This is a hard pill to swallow. Many graduates applying for these jobs have been studying intensively and doing hours of homework daily since early childhood. Their parents, and sometimes even their grandparents, invested money in tutors, starting as early as preschool, and spent countless hours cajoling them to study more. But what was the point if the jobs they were working toward no longer exist?
That said, soaring youth unemployment does not spell economic apocalypse for China. After decades of high economic growth, today’s youth – even with fewer people working – will be wealthier than any other generation in China’s history. The problem that youth unemployment poses for China comes down to one question: How will the mismatch between expectations and reality manifest itself?
Young people and their families may come to accept that the goals for which they have strived are unattainable, at least for now, and find satisfaction elsewhere. If they do not find such satisfaction, youth unemployment could fuel unrest and cause political instability, as it has done in the Arabworld and Africa. Chinese economic policymakers will need to tread carefully.
While there is little doubt that the era of sustained double-digit growth is over, China is well positioned to achieve a significantly higher growth rate than most developed economies in the foreseeable future. The key to success lies in macroeconomic policy.
BEIJING – China’s economic performance has been inspiring considerable pessimism lately. In the second quarter of 2023, the Chinese economy grew by just 6.3% from a year earlier – a figure that is disappointing because of the low base in the second quarter of 2022, when pandemic restrictions were still suppressing economic activity. And in July, China’s consumer price index (CPI) entered negative territory for the first time since 2021, sparking fears of a deflationary spiral.
Whether all the pessimism is warranted ultimately depends on the answer to one crucial question: Does the recent decline of China’s GDP growth rate reflect fundamental changes to economic conditions – such as population aging, diminishing returns to scale, the deterioration of the latecomer advantage, and rising environmental costs – or can it be addressed with more effective macroeconomic policies?
In fact, while there is little doubt that the era of sustained double-digit growth is over, China is well-positioned to achieve a significantly higher growth rate than most developed economies in the foreseeable future. After all, China’s per capita GDP is still less than a quarter that of the United States.
The key to success lies in policy: while staying the course of reform and opening up, China must use fiscal and monetary levers to respond to growth and price data. Should both growth and inflation be sluggish, fiscal and monetary expansion are in order. Conversely, if inflation rises sharply, a tightening should follow, even if it results in lower growth.
For now, barring black swan events, a surge in inflation appears unlikely. China’s CPI has been hovering around 2% since May 2012, and its producer price index has been negative for the better part of the past decade. PPI fell into negative territory in March 2012, remaining there for 54 months. It was then negative for 16 of the next 17 months, beginning in June 2019. It remains in negative territory now, having been so since last October.
Meanwhile, China’s GDP growth rate has been on a consistent decline, falling from 12.2 % in the first quarter of 2010 to 6% in the fourth quarter of 2019. From 2020 to 2022, China’s average annual growth rate was about 4.6%. Amid this combination of weakening growth and low (or even negative) inflation, the case for growth-boosting fiscal and monetary expansion is strong.
Over the last decade, however, the Chinese authorities have taken a cautious approach to growth, setting annual targets a few basis points below the previous year’s actual growth rate. The government argues that keeping growth targets conservative affords it more space to pursue reforms aimed at upgrading China’s growth pattern and improving the quality and efficiency of economic development. But whether the pursuit of higher GDP growth would actually impede this effort is a matter of debate.
What is clear is that China’s government is committed to limiting fiscal imbalances. That means keeping government bonds below 60% of GDP, and the budget deficit below 3% of GDP – often by a significant margin. While the budget-deficit-to-GDP ratio stood at 2.8% of GDP in 2009, it was cut to 1.1% in 2011, as the government rushed to exit its CN¥4 trillion ($555 billion) stimulus cycle. Many Chinese economists and government officials are proud of having done a better job than most European countries at following the fiscal rules set by the Maastricht Treaty. While there is no denying that the Chinese government’s contingent liabilities are high, owing to local government debt, China’s fiscal position is still much stronger than most Western countries’.
To be sure, China’s budget-deficit-to-GDP ratio has risen since 2015. But this has been largely the result of tax cuts, not an increase in government expenditure. Though few Western observers would acknowledge this, supply-side economics is more influential in China than in the US.
As the government has pursued a cautious fiscal policy, the People’s Bank of China has been juggling too many objectives: economic growth, employment, internal and external price stability, financial stability, and even allocation of financial resources. In particular, it has had to respond to the cyclical changes in the housing price index: if the index rises sharply, the PBOC pulls back the monetary-policy reins. More broadly, the PBOC has committed not to pursue “flood irrigation” – that is, flooding the economy with liquidity – but instead to stick to a “precision drip-irrigation” approach.
Undoubtedly, China could have achieved higher growth over the past decade with a more aggressive macroeconomic-policy approach. While it is too late to change the past, China can still achieve a more dynamic future, but only if it implements a carefully designed fiscal and monetary expansion focused on boosting effective demand and, ultimately, growth.
Fortunately, there is reason to hope that Chinese policymakers will move in this direction. The government recently identified insufficient demand as a key macroeconomic challenge facing China, and declared that China should “take advantage of the improving momentum, step up macro policy adjustments, implement the prudent monetary policy in a precise and forceful manner.”
This is perhaps the most important change to China’s macroeconomic-policy guidelines in recent years. If the Chinese authorities translate it into effective policy, higher and more stable growth will follow.
While China was an early mover in regulating generative AI, it is also highly supportive of the technology and the companies developing it. Chinese AI firms might even have a competitive advantage over their American and European counterparts, which are facing strong regulatory headwinds and proliferating legal challenges.
HONG KONG – If a Chinese tech firm wants to venture into generative artificial intelligence it is bound to face significant hurdles arising from stringent government control, at least according to popular perceptions. China was, after all, among the first countries to introduce legislation regulating the technology. But a closer look at the so-called interim measures on AI indicates that far from hampering the industry, China’s government is actively seeking to bolster it.
This should not be surprising. Already a global leader in AI (trailing only the United States), China has big ambitions in the sector – and the means to ensure that its legal and regulatory landscape encourages and facilitates indigenous innovation.
The interim measures on generative AI reflect this strategic motivation. To be sure, a preliminary draft of the legislation released by the Cyberspace Administration of China (CAC) included some encumbering provisions. For example, it would have required providers of AI services to ensure that the training data and the model outputs be “true and accurate,” and it gave firms just three months to recalibrate foundational models producing prohibited content.
But these rules were watered down significantly in the final legislation. The interim measures also significantly narrowed the scope of application, targeting only public-facing companies and mandating content-based security assessment solely for those wielding influence over public opinion.
While securing approval from the regulatory authorities does entail additional costs and a degree of uncertainty, there is no reason to think that Chinese tech giants – with their deep pockets and strong capacity for compliance – will be deterred. Nor is there reason to think that the CAC would seek to create unnecessary roadblocks: just two weeks after the interim measures went into effect, the agency gave the green light to eight companies, including Baidu and SenseTime, to launch their chatbots.
Overall, the interim measures advance a cautious and tolerant regulatory approach, which should assuage industry concerns over potential policy risks. The legislation even includes provisions explicitly encouraging collaboration among major stakeholders in the AI supply chain, reflecting a recognition that technological innovation depends on exchanges between government, industry, and academia.
So, while China was an early mover in regulating generative AI, it is also highly supportive of the technology and the companies developing it. Chinese AI firms might even have a competitive advantage over their American and European counterparts, which are facing strong regulatory headwinds and proliferating legal challenges.
In the European Union, the Digital Services Act, which entered into force last year, imposes a raft of transparency and due-diligence obligations on large online platforms, with massive penalties for violators. The General Data Protection Regulation – the world’s toughest data-privacy and security law – is also threatening to trip up AI firms. Already, OpenAI – the company behind ChatGPT – is under scrutiny in France, Ireland, Italy, Poland, and Spain for alleged breaches of GDPR provisions, with the Italian authorities earlier this year going so far as to halt the firm’s operations temporarily.
The EU’s AI Act, which is expected to be finalized by the end of 2023, is likely to saddle firms with a host of onerous pre-launch commitments for AI applications. For example, the latest draft endorsed by the European Parliament would require firms to provide a detailed summary of the copyrighted material used to train models – a requirement that could leave AI developers vulnerable to lawsuits.
American firms know firsthand how burdensome such legal proceedings can be. The US federal government has yet to introduce comprehensive AI regulation, and existing state and sectoral regulation is patchy. But prominent AI companies such as OpenAI, Google, and Meta are grappling with private litigation related to everything from copyright infringement to data-privacy violations, defamation, and discrimination.
The potential costs of losing these legal battles are high. Beyond hefty fines, firms might have to adjust their operations to meet stringent remedies. In an effort to preempt further litigation, OpenAI is already seeking to negotiate content-licensing agreements with leading news outlets for AI training data.
Chinese firms, by contrast, can probably expect both regulatory agencies and courts – following official directives from the central government – to take a lenient approach to AI-related legal infringements. That is what happened when the consumer tech industry was starting out.
None of this is to say that China’s growth-centric regulatory approach is the right one. On the contrary, the government’s failure to protect the legitimate interests of Chinese citizens could have long-term consequences for productivity and growth, and shielding large tech firms from accountability threatens to entrench further their dominant market position, ultimately stifling innovation. Nonetheless, it appears clear that, at least in the short term, Chinese regulation will act as an enabler, rather than an impediment, for the country’s AI firms.
If Chinese savings remain at their current level (over 40% of GDP), but investment falls to 30% of GDP, China would have to maintain a current-account surplus of ten percentage points of GDP to keep its economy in equilibrium. At nearly $2 trillion, that would be enough to affect the global savings/investment balance.
MILAN – China’s ongoing economic slowdown has elicited a variety of explanations. But forecasts largely have one thing in common: while the short-term data are somewhat volatile – annual growth rates have been distorted by the legacy of the authorities’ draconian zero-COVID policy – most observers expect Chinese GDP growth to continue trending downward. The International Monetary Fund, for example, expects growth to reach just 4.5% in 2024 and fall to 3% by the end of this decade – better than most advanced economies, but a far cry from the double-digit rates of a decade ago. Yet growth is only part of the story.
Of course, the focus on it is understandable. For decades, China has accounted for a significant share of global GDP growth. Moreover, the size of China’s economy – a key determinant of its ability to continue expanding its military capabilities – will shape the evolution of the balance of power with its main rival, the United States. But growth is not the only – and probably not even the main – channel through which the Chinese economy affects the rest of the world. The balance of savings and investment also matters, perhaps even more.
One of the Chinese economy’s distinguishing characteristics is its extraordinarily high investment and savings rates, which exceed 40% of GDP. This is double the level in the European Union and the US, and higher even than the rate in Asia’s other high-savings countries, such as Japan and South Korea.
Investment – particularly in high-quality infrastructure – has been integral to maintaining China’s rapid GDP growth. China built the world’s largest high-speed rail network in record time. Today, even medium-size cities have metro lines, and China’s numerous shiny new airports put the aging terminals seen in the US and Europe to shame.
But, as Harvard’s Kenneth Rogoff has pointed out, such investment generates diminishing returns. This is best illustrated by the construction sector’s woes. Over the last decade, so much housing has been built in China that about 40 square meters (430 square feet) per person already exists – about as much as in Germany or Japan. In other words, China has built the capital stock of a developed economy, effectively meeting housing demand – before reaching the associated income level.
This severely limits investment’s potential to drive further increases in income. At this point, further housing construction would simply create more ghost cities – shiny, new, and empty. And because the additional housing stock – and infrastructure more broadly – has a long life span, this will not change significantly any time soon.
To be sure, China’s government will probably be able to find new ways to support the construction sector, including by finding infrastructure projects that can at least be made to appear worthwhile – for example, in the poorer and rural inland provinces. But, overall, investment can be expected to decline gradually from now on.
Japan faced a similar problem a few decades ago. After its real-estate bubble burst in the late 1980s, the government attempted to lift the economy out of a severe downturn by channeling vast funds toward infrastructure investment. But most of the new roads led to nowhere, so after a few years of heavy spending, the government had to give up.
In China, the response to lower investment might seem simple: the Chinese could consume more. But recall that China’s savings ratio is also extraordinarily high, and has remained so despite the authorities’ efforts over the last decade to foster domestic consumption as a driver of growth. A significant rise is thus unlikely in the foreseeable future.
Beyond consumption, China could channel savings toward investment in renewable energy sources like solar and wind. But with such investment already approaching $300 billion annually – far more than in the US or Europe – the ability of renewables to absorb Chinese savings is limited.
Amid declining investment, China’s high savings spill out into the rest of world via current-account surpluses. In China, these surpluses are even larger than those of other countries with excess savings, like Germany or Japan, because of the magnitude of the potential excess and the sheer size of the economy.
If savings remain at their current level (over 40% of GDP), but investment falls to 30% of GDP – still a very high ratio – China would have to maintain a current-account surplus of ten percentage points of GDP to keep the economy in equilibrium. With China’s GDP set to reach $20 trillion soon, this would amount to nearly $2 trillion. That is several times larger than the previous surpluses of Germany or Japan, and large enough to affect the global savings/investment balance.
One spillover effect of China’s savings surplus – downward pressure on interest rates – would be relatively benign. But another, bigger dangers looms: large Chinese current-account surpluses would fuel an already-accelerating trend toward protecting domestic industries against Chinese competition.
This does not have to be the case. With their investments in technologies like batteries, solar panels, and electric vehicles, Chinese exporters are on track to gain an ever-greater advantage in capital-intensive green industries. Europe and the US could welcome cheap green imports as a means of reducing the costs of their own climate policies. But this seems unlikely in today’s climate of geopolitical confrontation. Instead, we can look forward to more protectionist policies, which will increase costs and do nothing to reduce Chinese savings.
