In light of weak consumer spending, global resistance to Chinese exports, ongoing real estate crisis without a solution in sight, and the pressure from US tariffs on exports, the Chinese economy continues to struggle, facing multiple challenges and difficulties.
On June 9th, China released its May CPI and PPI data, showing that consumer deflation has persisted for the fourth consecutive month, with the producer price index witnessing the largest drop in nearly two years. The growth in consumption during two national holidays was not enough to offset the drag of weak domestic demand. Economists indicate that the deflationary pressure in China currently shows no sign of abating.
In the aftermath of the pandemic, the Chinese economy remains fragile, with consumers becoming more cautious after prolonged stagnation in the real estate market, and businesses being caught in price wars. Despite ongoing US-China trade negotiations, President Trump’s tariffs are reducing the demand for Chinese goods from the US, exacerbating industrial overcapacity in China and intensifying price wars.
Alicia García Herrero, a senior researcher at the independent European think tank Bruegel, summarized the top ten challenges facing the Chinese economy.
During the global financial crisis of 2008, when export demand plummeted, China was able to implement massive stimulus measures. However, this substantial stimulus also led to a continuous expansion of public debt, currently equivalent to 100% of GDP. Compared to countries with similar per capita income levels, this is quite high.
China’s increasing public debt stems from massive fiscal deficits, including borrowing by local governments, primarily used for financing real estate and infrastructure projects.
While the People’s Bank of China (PBoC) still has room for interest rate cuts or even quantitative easing, the reality is that whether due to tight money supply keeping real interest rates high or obstacles hindering monetary injection, the impact of monetary policy is not yielding the expected results.
Two major limiting factors explain this “involuntary” tightening phenomenon. Firstly, the relatively weak Renminbi limits the PBoC’s room to loosen monetary policy. Secondly, Chinese state-owned banks, which already have poor profitability, may struggle to endure further interest rate cuts leading to a further decline in profits.
China’s production capacity far exceeds domestic consumption capabilities. Fixed asset investment in manufacturing industries has grown far beyond GDP growth rates, while real estate investment has significantly decreased. In certain industries, notably the green technology sector, Chinese companies have made massive investments, accounting for nearly 90% of global total investments, such as in the solar panel industry.
China’s imports have been stagnant, resulting in a massive trade surplus crucial for economic growth. However, against the backdrop of rising trade protectionism globally, the surge in manufactured goods exports, and China’s share in global manufacturing output reaching 18%, this trend may be challenging to sustain.
The US has reduced imports from China, coupled with the impact of Trump’s global tariffs, it is difficult to believe that China’s vast industrial capacity can continue to rely on foreign markets as it did in the past.
China’s capacity utilization rate has declined from its peak in 2021, nearing levels seen during the pandemic. Another issue is the sharp decline in the prices of production goods, putting downward pressure on the profit margins of manufacturing enterprises. Unless China can boost domestic consumption, the escalating protectionism worldwide will lead to higher tariff barriers, further exacerbating China’s deflationary pressures.
It is widely believed that increasing private consumption will help address the imbalances in the Chinese economy, but this is easier said than done. China’s private consumption as a share of GDP continues to remain low, especially when compared to fixed asset investments. With investment being high and domestic savings even higher, it reflects a lack of confidence among the Chinese in their future. China still boasts the highest savings rate globally.
Changing this status quo will require significant reforms, such as strengthening the pension system, providing better unemployment benefits, and public health services. However, these reforms are not on the agenda of the Chinese government.
For a long time, the real estate industry has been a primary driver of economic growth in China, accounting for one-third of the total economic growth and fixed asset investments. However, in 2021, with China’s largest real estate developer, Evergrande, facing a crisis, the real estate industry has begun to decline. Since then, real estate’s contribution to economic growth has been negative, with both property prices and transaction volumes continuously decreasing.
China’s high savings have fueled a massive investment boom, but as the main driver of economic growth for an extended period, it has become excessive, with diminishing returns evident. As expected, state-owned enterprises have lower asset returns, and now private enterprises’ asset returns are also low.
The one-child policy implemented in 1980 explains China’s poor demographic structure, but since 2019, the birth rate has rapidly declined, likely due to increased uncertainty about future living environments, leading to negative sentiment about future economic prospects.
The urbanization process is estimated to be completed by 2035, at which point the decline in the labor force will begin to manifest in urban areas, negatively impacting social productivity. Due to labor shortages, China’s annual economic growth is projected to decrease by about 1.3 percentage points.
China and the US are in competition in the innovation sector. The US’s research and development expenditure as a percentage of GDP surpasses China’s, making it difficult for China to surpass the US’s global technological dominance. Additionally, the US is attempting to curb Chinese technological development through various means, including export controls on advanced technologies to prevent China from utilizing them for military and surveillance purposes.
In conclusion, since President Trump returned to the White House, the challenges faced by the Chinese economy have become increasingly severe. Although the Chinese government has announced multiple measures to stabilize economic growth at 5% by 2025, these measures appear to be insufficient to address the challenges.