China: zombie economy

Image: Zhang Kaiyv
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By HO-FUNG HUNG*

The country's gradual decline began more than a decade ago

In the early 2010s, economist Justin Lin Yifu, a former World Bank director linked to the Chinese government, predicted that the Chinese economy would have at least two more decades of growth above 8%. He calculated that since the country's per capita income at the time was roughly on par with Japan's in the 1950s, and South Korea and Taiwan in the 1970s, there was no reason why China couldn't replicate past successes. these other East Asian countries.

Justin Lin Yifu's optimism has echoed among Western commentators. The magazine The Economist, projected that China would become the world's largest economy by 2018, overtaking the United States. Others fantasized that the Communist Party would embark on an ambitious program of political liberalization. At the The New York Times, Nicholas Kristof, in 2013, wrote that Xi Jinping would “lead a resurgence of economic reform and probably some political easing as well”.

Many predicted that Mao's body would be removed from Tiananmen Square under Xi Jinping. Liu Xiao Bo, the Nobel Peace Prize-winning writer, would be released from prison. Political scientist Edward Steinfeld also argued in 2010 that China's acceptance of globalization would fuel a process of "self-obsolescent authoritarianism" similar to that of Taiwan in the 1980s and 1990s.

Ten years later, the naivety of these predictions is evident. Even before the onset of COVID-19, the Chinese economy had slowed down and entered a domestic debt crisis, visible in the collapse of major real estate developers such as Evergrande. After Beijing lifted all pandemic restrictions in late 2022, the widely expected economic recovery failed to materialize. Youth unemployment rose above 20%, outpacing that of all other G7 countries (another estimate puts it above 45%).

Data on trade, prices, manufacturing and GDP growth point to deteriorating conditions, a trend that fiscal and monetary stimulus has failed to reverse. The Economist,, now claims that China may never catch up with the US; moreover, it is universally acknowledged that Xi Jinping is not a liberal, as he has doubled down on state intervention in the private sector and in foreign companies, silencing dissenting voices (including those previously tolerated by the Party).

It would be a mistake to think that external factors have radically altered China's prospects. Instead, the country's gradual decline began more than a decade ago. Those who looked closely at the data, beyond the busiest business districts and flashy building developments, detected this economic malaise as early as 2008. I wrote then that China was entering a typical overaccumulation crisis.

Its growing export sector has accumulated a huge amount of foreign exchange reserves since the mid-1990s. In its closed financial system, exporters have to hand over their earnings abroad to the Central Bank, which creates the equivalent in “renminbi” (RMB) to absorb foreign exchange. This led to the rapid expansion of renminbi liquidity in the economy, mainly in the form of bank loans.

Because the banking system is tightly controlled by the party-state, with state-owned or state-linked enterprises serving as fiefdoms and cash cows for elite families: the state sector enjoyed privileged access to state-owned bank loans, which were used to feed a wave of investments.

The result was an increase in employment, a tree temporary and localized economic and windfall gains for the elite. But this dynamic also ended up leaving redundant and unprofitable construction projects: empty apartments, underutilized airports, excessive coal plants and steel plants. This, in turn, resulted in falling profits, slowing growth and worsening debt in large sectors of the economy.

Throughout the 2010s, the party-state periodically made new loans in an attempt to curb the slowdown. But many companies simply took advantage of easy bank loans to refinance their existing debt without adding new spending or investment to the economy. These companies eventually became addicted to borrowing. And as with any addiction, increasing doses were needed to generate diminishing effects.

Over time, the economy lost its dynamism as zombie companies were kept alive just to support their debts: a classic case of the “balance sheet recession” that rocked Japan after its tree ended in the early 1990s. However, just as these issues became increasingly clear to experts in the early 2010s, they were censored in official media, expanding Justin Lin Yifu's optimistic assessment.

Meanwhile, in the Western world, a network of Wall Street bankers and corporate executives had reason to suppress the most skeptical reviews as they continued to profit by luring investors to China. The illusion of unlimited high-speed growth was the watchword at the very moment when the economy entered its most serious crisis since the beginning of the era of market reform.

Beijing has long known what needs to be done to alleviate this crisis. An obvious step would be to initiate redistributive reform to increase household income and therefore household consumption, which, as a percentage of GDP, is among the lowest in the world. Since the late 1990s, there have been calls to rebalance the Chinese economy in favor of a more sustainable growth model, reducing its dependence on exports and investment in fixed assets such as infrastructure construction.

This led to some reformist and redistributive policies under Hu Jintao and Wen Jiabao from 2003 to 2013, such as the New Labor Contract Law, the abolition of the agricultural tax, and the redirection of government investment to inland rural regions. But the weight of vested interests (state-owned companies as well as local governments that thrive on construction contracts and state-owned bank loans that feed these projects) and the impotence of social groups that would benefit from such a rebalancing policy (workers, peasants and families of middle class), prevented reformism from taking root.

Minimal gains in reducing inequality in the Hu-Wen period were duly reversed after the mid-2010s. More recently, Xi Jinping has made clear that his “common prosperity program” is not a return to Mao-era egalitarianism, or even a restoration of welfare. Rather, it is an affirmation of the state's paternalistic role vis-à-vis capital: increasing its presence in the technology and real estate sectors and aligning private entrepreneurship with the broader interests of the nation.

The party-state has been preparing for the social and political repercussions of this dire situation. In official political discourses, “security” has become the most pronounced word, eclipsing the term “economy”. The current leadership believes it can survive an economic crisis by tightening its grip on society, rooting out elite autonomous factions, and adopting a more assertive stance on the international stage amid rising geopolitical tension, even as such measures serve to exacerbate its development woes. .

This helps explain the 2018 abolition of presidential term limits, the centralization of power in the hands of Xi Jinping, the relentless campaign to root out Party factions in the name of fighting corruption, the building of an ever-increasing surveillance state. and the changing pillars of state legitimation: beyond the effects of economic growth and into nationalist fervor.

The current weakening of the economy and the hardening of authoritarianism are not easily reversible trends. They are actually the logical result of China's uneven development and capital accumulation over the past four decades. This means they are here to stay.

*Ho-Fung Hung is a professor of political economy at Johns Hopkins University. Author, among other books, of Clash of empires.

Translation: Eleutério FS Prado.

Originally published on the portal Sinpermiso.


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