What will be the next driver of growth?

I had to take a break from writing about China for a while because of our newborn baby in the year of Dragon. Although much has been said about the growth of Chinese electric vehicle manufacturers during the time we were away, it wouldn't be wrong to say that there haven't been many favorable developments in the Chinese economy. On top of the ongoing real estate crisis, the decline in domestic consumption, strained relations with the West, and the rising barriers in various parts of the world for Chinese export goods, the number of those getting gloomy has significantly increased. It seems that while crossing the river, the current has gotten stronger, and the rocks have started to harden."

If we look at the story from the beginning, it is a fact that China has achieved great success. As someone who has lived in the region for a long time, I understand China’s success more and more with each trip I take to the developing countries of Southeast Asia. During a brief visit to Jakarta last week, the poverty I saw just outside the city, filled with skyscraper constructions, was deeper than anything you would ever see in China. In the early 2000s, these two countries had nearly the same income per capita, but with the performance China showed after 2000, its GDP per capita is now almost three times that of Indonesia. Naturally, all the countries in the region are now striving to become the next China. We're talking about a China that, in less than 40 years, has lifted 800 million people out of poverty and, as if that weren't enough, has become a tech hub powerful enough to challenge the giants of the West.

Returning to the current crisis, we ended our last article with, 'The government is closely monitoring the process and is actively seeking solutions.' In fact, there were suggestions for alternative solutions. IMF called on the central government to accelerate the completion of unfinished, pre-sold homes to help restore homebuyers' confidence. It also recommended allocating a package of around $1 trillion for this. Although the Chinese government rejected this, it did start a similar project on a smaller scale. With a package of $42 billion allocated from the central government budget, the purchase of completed but unsold apartments within the scope of the social housing project was started. Apart from this, a loan exceeding $100 billion was given to companies that could not complete the houses, again with a fund created by the central government. ?However, given that more than 20 million housing projects are still incomplete, this package can be seen as just a drop in the ocean. Local governments, which are heavily indebted and rely on land sales for a large portion of their revenue, lack the financial resources to support such a project. In other words, there doesn’t appear to be a solution to the real estate crisis in the near future. The state seems to be trying to slowly deflate this crisis, considering its social impact, while aiming to weed out highly indebted companies in the process. Many real estate company founders have already taken their place in state-run rest areas."

How can China sustain its growth?

So who will take care of the Gross Domestic Product (GDP)? For those who know, GDP growth in China is almost sacred, having been the most important guiding star for the party over the last 20 years. It is also the key criterion for local government party leaders to climb the ranks on their way to Beijing, so it cannot be underestimated. With it being so clear that the real estate crisis won't be resolved anytime soon, it's obvious that alternative solutions are needed to keep growth going.

There are four main components that contribute to GDP: investment, consumption, government spending, and net exports. The growth target for 2024 is set at 5%, and growth figures are announced every quarter. Let’s go over these components one by one.

When the contraction in real estate reached 24% in the first eight months of 2024, it became necessary to find new items to offset the decline in investment spending. The first thing that comes to mind here would be government spending, but it can't be said that China is particularly generous when it comes to social spending. Government spending accounts for only 33% of total GDP, whereas in European countries, this figure exceeds 40%. Although there has been an increase in recent years, China still allocates lower proportions of its budget to education and health compared to Western countries. The most significant difference lies in social security payments, with social security cash expenditures in the government budget accounting for about 7% of GDP, while this figure exceeds 20% in the West. Finally, as local governments have slowed down major infrastructure investments due to their high debt, government spending saw a 2% decline in the first seven months of 2024.

In this situation, the only components left to support growth are consumption and net trade.

Production or consumption? President Xi Jinping's choice here is clear: China will not become a Western-style consumer society. To be honest, households don’t have much money left to spend. Almost everyone has a mortgage, with the homeownership rate exceeding 90%. According to 2023 data, household savings account for 33% of total household income, and most of that money goes towards mortgage payments. The decline in housing prices will also erode household wealth. Additionally, due to low pensions and limited social welfare support, everyone wants to save for a rainy day. As a result, the entire burden of growth falls on production and exports.

The growth of production and exports is driven by two separate factors. Let's explain these using two terms coined by Xi Jinping. The first is “New Productive Forces” (新质生产力)—this can be understood as growth coming from high-tech products. The global popularity of Chinese-branded electric cars is actually the most significant indicator of China’s leap in high-tech manufacturing. After his recent visit to China, Ford CEO Jim Farley highlighted this major leap with a statement that could be interpreted as “we’re in trouble.” Walking through the streets of Shanghai, you might feel like you're living in the next decade. The green-plated EVs, which look like they’re from Mars, are astonishing everyone.

Another reason for supporting high-tech manufacturing is the possibility of a conflict over Taiwan and the West imposing sanctions, like what was done with Russia. The U.S. is already conducting a smaller-scale test of this in the chip sector. In 2023, it banned the sale of high-powered AI chips to China. Companies like Nvidia are producing less capable models for the Chinese market. Additionally, the sale of new models of lithography machines, essential for chip manufacturing and led by Dutch company ASML, is prohibited to China. In response, China is trying to produce its own chips, spearheaded by companies like Huawei and SMIC (Shanghai Manufacturing International Company). Green energy and biomedical sectors are also other critical areas identified by the government for self-sufficiency. The effects of such decisions extend beyond China and impact the entire world. For example, one of the key reasons behind the rapid decline in solar panel prices is the government's support policies.

The second production and export category, which actually makes up more than 60% of exports, consists of non-high-tech products. The term used by the President for this is "Establish the new before breaking the old" (先立后破). In essence, it means that before fully transitioning to high-tech exports, we shouldn't abandon the other export products we have. In these categories, Chinese manufacturers benefit from high production capacity, easy access to government support, and a significant cost advantage stemming from the large domestic market.

Rising barriers against Chinese products Manufacturers in countries with small populations or incomplete infrastructure are unlikely to be able to compete with giant Chinese companies. BYD, global EV market leader, exports less than 10% of its total production as China is the largest EV market reaching 11 million units by ?end of 2024 (the global EV market is projected at 16.5 million units).

This applies not only to high-tech products but also to everyday simple goods. At first, China’s aggressive export growth didn’t provoke much backlash; after all, it allowed the whole world to consume goods more cheaply. Walmart shelves in America were full of affordable Chinese products. Especially after the 2008 crisis, China capitalized on global liquidity, achieving significant export growth, and tripling its exports to $3.8 trillion in 15 years. While China now accounts for 17% of global GDP, it produces over 30% of the world’s goods. Many production-dependent jobs around the world started moving to China. Some estimates suggest that since 2001, China has caused the loss of 3 million manufacturing jobs in the U.S. In recent years, China’s exports have shifted more toward developing countries, where the impact has been even greater. For example, in Thailand, 1,700 factories closed in the past year due to the increase in Chinese goods. As a result of this export growth and the closures it has caused, China faced 64 new anti-dumping cases from various countries in the first half of 2024.

China is aware of the increasing backlash and is trying to find solutions. When necessary, it offers incentives to direct its manufacturers to invest in these countries, or it threatens to impose reciprocal taxes. Whatever the case may be, it’s unlikely that China’s production-based growth is sustainable. One of the biggest, and perhaps most crucial, gears of capitalism is consumption. Without it, growth isn’t very likely either.

What do you think—would it be better to find another metric instead of GDP growth? Let’s discuss this in another article.

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