China Pays for Economic Mismanagement

The bill is coming due for Beijing’s rejection of free enterprise in favor of communist ideals

By Mickey D. Levy. Mr. Levy is senior economist at Berenberg Capital Markets and visiting scholar at the Hoover Institution. Excerpts:

"Mr. Xi began clamping down on free enterprise in 2012, mistakenly believing China’s socialist ideals were consistent with sustained economic health. Beijing set unrealistically high targets for gross domestic product even as China’s potential growth slowed naturally as its labor force and capital approached capacity, production costs rose, and productivity slowed. Constraints on big tech and social-media firms were particularly damaging.

China set GDP targets way above potential and hit them—despite slower consumer spending, private investment and exports—with aggressive government investment focused on real estate. The unhealthy high gross capital formation that has been maintained above 40% of GDP and diminishing productivity have signaled resource misallocation and future problems.

China’s fiscal policy is administered largely by local governments, as dictated by leaders in Beijing. Local governments met their growth targets by relying heavily on land sales to real-estate developers, construction and massive bond issuance supporting stimulus. Those bonds have been purchased by local government financing vehicles and shadow banks that rely on fragile, unstable funding sources to bear the risk.

The government-driven excesses in real estate and debt began unraveling in late 2021, as land sales and construction fell. Since then,

Evergrande

and more than 50 Chinese developers have defaulted on their debt. Chinese households know the value of their real estate has fallen much more and the economy is in far worse shape than rosy government statistics suggest. Cash-strapped local governments have limited resources for stimulus. Some are having trouble servicing their debt and need financial support from Beijing. Global demand for Chinese goods is falling, reflecting weak economies and efforts to reduce exposure to China supply chains. Reduced production for export means fewer high-paying manufacturing jobs."

"China’s potential growth and productivity are significantly diminished. Estimates of a nation’s potential growth are framed by expansion of its labor force, capital and productivity. China’s population and labor force are falling owing to its one-child policy. Its capital stock may continue to rise rapidly, but under the current regime it will be driven by low-productivity government investment, including allocating resources to state-owned enterprises. Leaders in Beijing and the nation’s sprawling regulatory apparatus suppress the innovative and productive private sector."

"Current attempts to achieve GDP growth above 2% to 3% would lead to more undesirable excess. Chinese leaders must deal with the social fallout, and global economies must adjust to the realities of China’s diminished potential."