The end of China’s runaway growth

Two weeks ago, the concourse outside Evergrande’s glossy headquarters in Shenzhen was thronged by homebuyers, unpaid contractors, and investors chanting what has now become a slogan of China’s debt-saddled, post-reform economy: “Give back our money.” For the past few weeks, Evergrande and its debts have been treated like a fuse for a global crisis — the Chinese “Lehman Brothers.” That analogy is flawed. Evergrande is not like Lehman, said Phil Groves, a distressed debt expert and the president of DAC Management, because Evergrande has physical assets that can be dispersed in the event of a default. “For Lehman, it took years and years and still no one actually knew what the hell they owned, what their exposure was, or how many derivatives they had,” he told me.

Loans to real estate developers are heavily collateralized precisely to hedge against such scenarios. “If Evergrande was liquidated tomorrow,” Dinny McMahon, the author of China’s Great Wall of Debt, told me, “the main lenders — the banks and the trust companies — would get all their money back.” The company, the experts predict, will likely undergo a controlled restructuring. The most likely scenario, which happened with Anbang Insurance Group, HNA Group, and Baoshang Bank, is that those of political importance will survive, foreign investors will take a hit, and top executives might face jail time. “By allowing Evergrande to default, that is the start of a process [in] which you could only imagine that the authorities will be incredibly hands-on,” said McMahon.

Evergrande is not a trigger of calamity, but it is an externality: a sign that the engine of China’s decades-long growth has sputtered, its warning lights flashing for the world to see. Driving across China, you can tell something is not quite right: empty apartment towers fill the expanse between cities; factories lie idle, and real estate prices are prohibitively high. These are not, contrary to the image China presents, signs of a prosperous and strong nation. They are indicators of a country that is registering the weight of an over-leveraged economy.

Across China’s cities, youths are restless, angry, and involuted, with the burdens of career, parental care, and housing wearing away their hopes for the future. In rural areas, China’s migrant workers are at the edge of a tectonic transition that could leave them jobless. All the while, China’s elites like Evergrande founder Xǔ Jiāyìn 许家印 still seem to thrive on borrowing and political connections. “Between the feeling of individual failure and the conspicuous display of national prosperity lies an unbridgeable chasm,” wrote the science-fiction writer Chén Qiūfān 陈楸帆. (Last week, Kangning Hospital, China’s largest psych ward, announced plans for an IPO in Shenzhen on the back of soaring demand for mental health services.)

Xí Jìnpíng 习近平 has made it his mission to steer a new course, but the road map for his leftward pivot is decades old. Back in 2007, the premier Wēn Jiābǎo 温家宝 had called the Chinese economy “unstable, unbalanced, uncoordinated, and ultimately unsustainable.” Five years later, the political commentator Dèng Yùwén 邓聿文 published “The Ten Grave Problems” (十大问题 shí dà wèntí), a list of 10 socioeconomic issues left behind by Wen’s administration. ​​Those points — including inadequate economic restructuring, rampant wealth inequality, environmental degradation, and unstable supply chains — are the moral antecedents to the “Red New Deal.” Xi’s attack on big business is about power, but it is also — as seen in the image of the Evergrande concourse — a rebuke of the China that his predecessors, in concert with developers like Xu, helped forge: a country of unpaid debts, empty lofts, and thwarted dreams.

In an important speech (in Chinese) at the Fifth Plenum last fall, Xi emphasized the need to implement a “New Development Concept,” one that can separate “high-quality growth” from “unbalanced” growth. The recent flurry of crackdowns is an attempt to address the various symptoms of an economic growth model nearing its final breath. Here are five of Xi’s challenges:

1. Debt

“Debt has become the motor at the core of Chinese growth,” wrote McMahon in China’s Great Wall of Debt. After the global financial crisis, China responded with a 4 trillion yuan ($564 billion) stimulus package — 10 times larger as a percentage of GDP than the U.S. stimulus. At the time, China’s debt-to-GDP ratio was 160% and local government debt stood at $1.1 trillion in 2010. These were “still at a range that we could manage,” Wēn Jiābǎo 温家宝 told CNN, “but it is important that we appropriately handle this matter.” In 2016, China’s official debt-to-GDP ratio ballooned to 260%. Local government debt reached nearly $4 trillion in 2020. “Experience shows that when a country accumulates too much debt relative to the size of its economy too quickly, a crisis typically follows,” warned McMahon.

Real estate, which constitutes 40% of all bank loans, epitomizes the debt problem. For decades, property developers raised debts through unregulated channels known as “shadow banking” to finance massive construction booms. Families funneled their savings into real estate to get in on the action. Speculative buyers bought up houses with abandon, leaving one-fifth of China’s total housing stock in big cities empty. But the build, build, build days have reached their natural limit. In August, 15 half-built apartment towers in the southwestern city of Kunming were reduced to rubble after developers ran out of cash and abandoned the project.

A centerpiece of Xi’s new development philosophy is an emphasis on “innovative growth drivers” and the “real economy.” As such, regulators have stepped up to rein in the shadow-banking sector, and place caps on reckless borrowing and speculation. The “three red lines” policy in August, which limited borrowing for property developers, had immediate consequences: Evergrande had run afoul of all three lines, and of the country’s 15 biggest developers, only one was in full compliance. But Beijing is prepared for a painful reckoning now in order to nurse the sector back to health. At a work meeting held by the People’s Bank of China (PBOC) last week, regulators vowed to quit using real estate as “a short-term tool to stimulate the economy” and to “implement long-term approaches for the property market.”

2. Corruption and rampant inequality

The PBOC announcement is welcome news for Yuen Yuen Ang, a political scientist at the University of Michigan and the author of China’s Gilded Age. A primary feature of China’s dizzying rise, she argues, is the marriage between debt-fueled growth, especially in the property sectors, and rampant inequality, a dynamic she calls “crony capitalism.” “Crony capitalism” is built on a scaffold of corruption, a venal relationship between robber baron capitalists and politicians. For decades, those connections acted like an economic steroid, incentivizing politicians to assist developer friends to execute ambitious building projects. But this also funneled wealth to China’s elites. In 2012, China’s Gini coefficient, the standard measure of income inequality, surpassed America’s.

Ang compares China’s current predicament with the end of the American Gilded Age in the late 19th century, when public backlash against corruption triggered economic and social reforms that ushered in the Progressive Era. On this rubric, Xi Jinping’s most recent calls for “common prosperity” have their roots in the anti-corruption and anti-poverty campaigns of a decade prior. “In the last two months, Western investors have abruptly awoken to Xi’s calls for ‘common prosperity,’” Ang told me. “But Xi’s socialist mission actually began in 2012, when he vowed to eliminate rural poverty and simultaneously launched the largest anti-corruption drive in the CPC’s history.” All of these, Ang says, are attempts to rectify China’s own Gilded Age.

3. Empty factories

The decadence among China’s wealthiest coincides with a looming peril for China’s poorest. Like the departure of manufacturing jobs from the U.S., China has seen a mass exodus of low-wage manufacturing jobs to South Asian countries. China’s latest three-child policy is, in part, a corrective to the decline of surplus rural labor, which drove up wages and pushed factories to seek cheaper labor overseas. In the past decade, hundreds of thousands of jobs from conglomerates such as Apple, Nike, and Samsung migrated from China to Vietnam, whose workers are generally seven years younger, on average, and twice as cheap. Labor-market mismatches are not uncommon among developing countries, and many economies, including South Korea, Taiwan, and Ireland, have navigated them in the past, a problem known as the “middle-income trap.”

Scott Rozelle, a professor at Stanford and the author of Invisible China, argues that a common feature of the “middle-income trap” is the disparity between the fast pace of economic growth and the slow buildup of education: In 2015, 70% of China’s working-age adults were high school dropouts. Whether migrant workers have the skills to help China transition from a manufacturing hub to a high-income economy depends on bringing those numbers down. For Rozelle, China’s migrant worker predicament amounts to a crisis in human capital: “The key to avoiding the trap is for the top levels of government to give priority to rapidly expanding education for the entire population,” he writes.

In the early 2000s, China’s leaders took action. In 2006, the government made public schooling free and mandatory from grades one through nine for every child in the country. By 2010, middle school attendance was nearly universal, compared with only 60% 20 years earlier. In 2017, Xi Jinping pledged to go a notch further, launching a national effort (in Chinese) to universalize high school education by 2020. The “New Development Concept” does not explicitly address education, but recent regulations of the private education sector appear to be imperfect attempts at expanding public education access.

4. Supply chain instability

Although China brought its initial outbreak of COVID-19 under control as early as last March, its manufacturers continue to bear the costs of the pandemic’s disruption to global shipping. In a visit to factories in Zhejiang last year, Xi remarked on how “many companies were forced to suspend operations” and made his call for a new development model. “I realized just how much things had changed,” he said in his speech at the Fifth Plenum. “The environments and conditions that had facilitated large-scale imports and exports were no longer in place.”

As a major manufacturing hub for the world, China is especially vulnerable to supply chain disruptions. Rising tensions with the U.S., along with subsequent tariffs and export bans, have also created a new global environment where many key technology components can suddenly become difficult to procure. At the May 2020 Politburo meeting (in Chinese), China’s leaders formulated the strategy of “dual circulation” (双循环), which is evidently another component of the New Development Concept. The strategy aims to bolster domestic demand in order to allow China’s economy to be more self-sufficient and resilient to external turbulence by extension.

5. The environment

To glimpse the environmental costs of China’s decades-long growth, one only need a visit to Baogang Tailings Dam in Inner Mongolia, widely dubbed the “world’s dystopian lake” due to its role as a waste bin for China’s rare earths industry, which makes up about 80% of the world market. From 1990 to 1997, the cancer mortality rate in the surrounding mining districts rose 50% and the three leading causes of death in the area were cancer, unspecified poisoning and accidents, and infant mortality. Air pollution, water pollution, and mismanaged packaging waste pose significant health risks to Chinese citizens and have historically been a source of social unrest.

As a result, “green development” is now a core component of Xi Jinping’s “New Development Concept.” In a speech to the United Nations General Assembly on September 21, he promised to end funding for coal-fired power plants outside of China. Satellite imagery of the Tailings Dam in Inner Mongolia suggests the government has begun to drain it. “When I was living in China in the early to mid-2000s, the way officials and planners talked about solutions [was] as if you had to pollute first and clean up later,” said Julie Klinger, the author of Rare Earth Frontiers. “Now cleanup time has come.” The cleanup has come for plastic waste as well: A sweeping regulation — what state media has called the “strictest plastic ban” in history — began last September, albeit with mixed results. Most of all, Xi is known for his ambitious plan to peak emissions by 2030 and go carbon neutral by 2060.

The time is now

Growth has been a paramount priority for the Communist Party since the Third Plenum of 1978, when China officially adopted Dèng Xiǎopíng’s 邓小平 reform and open policy. But as Wen and Deng Yuwen’s comments reveal, the antithetical, ultra-leftist creed never vanishes. It brews under the surface and erupts occasionally in seething, impassioned diatribes, only to retreat back into the shadows.

But as the five challenges outlined above festered, China’s prior leaders swept them under the rug with stopgap solutions. Meanwhile, the growth imperative has lost all of its original sheen. From the eradication of poverty to the triumphalism of a vanquished pandemic, China is ostensibly at its strongest point in modern history — it is, in some ways, already grown. The allure of short-term growth, that quick-fix-mentality attributable to a scrappy, up-and-coming nation, is gone.

“We are being affected by both ‘Right’ and ‘Left’ tendencies,” Deng acknowledged during his renowned Southern Tour in 1992. “But it is the ‘Left’ tendencies that have the deepest roots.”

After four decades of miraculous growth at the expense of a compromised socialism, those roots have finally borne fruit.