The West has often misjudged the economic prospects of communist regimes, at least twice so far, once by overestimating the Soviet economy and again by overestimating the Chinese economy. China’s economic growth over the past 20 years or so was built on a one-time “export boom” and “civil engineering boom” that cannot be replicated, so the boom was a one-time event with no chance of sustainability. Now the Chinese economy has accumulated a series of serious difficulties that are almost insurmountable, making it difficult for the CCP to pursue economic prosperity. Journalists and scholars in the West, unaware of the truth about China’s economy and still steeped in memories and imaginations of its brief economic boom, seem to be repeating the mistakes of their Soviet economic observer counterparts.
I. The painful lesson of Soviet economic research in the United States
Ever since the emergence of communist regimes in the world, there have always been people in the West who have been mesmerized by the apparent achievements of communist regimes. Some of them are believers or enthusiasts of Marxism who only want communist regimes to be strong, but are not willing to pay attention to the plight of communist regimes hidden away. So, did the United States have the CIA and a large number of experts on the Soviet economy who also misjudged the economic prospects of the Soviet Union? The answer is that they did.
The Soviet Union began an economic renaissance after World War II with the vast amount of equipment and technology provided by the United States, combined with the talent and technology looted from Germany. The speed of the renaissance, the change in the appearance of the city, the successive construction of high-rise buildings, and the launch of the first spacecraft dazzled those who did not understand the characteristics of totalitarian regimes. At that time, the head of the Soviet Communist Party also declared that it would soon surpass the United States. But these achievements were not the result of natural economic development under a market economy, but the product of a centralized government that mobilized the nation’s financial and material resources in one fell swoop. In democracies, the government cannot dispose of private resources at will; in the Soviet Union and China, the government can control all resources in its own hands and achieve whatever goals it wants without any consideration of economic efficiency. These superficial “achievements” concealed the internal economic difficulties of the communist state.
According to James Millar, a senior U.S. scholar of Soviet economics, who wrote in 1995 in Beyond Soviet Studies, a collection of conference papers, there were six generations of Soviet economic experts in U.S. history, totaling more than 260. After the collapse of the Soviet Union, all of these individuals’ years of accumulated research collapsed, because although they had done a great deal of detailed research on the Soviet economy, none of them had foreseen its decline or even its collapse. As the scholars did, the CIA did not fare much better. Mira wrote a report for the U.S. Congress in November 1991 assessing the CIA’s analysis of the Soviet economy’s performance from 1970 to 1990. In the report, he wrote that the CIA’s relevant analyses generally resembled the views of U.S. scholars of Soviet economics; the intelligence agency still believed in the first half of the 1980s that the probability of Soviet collapse was very low. That is, the Soviet Union collapsed only a few years after that CIA judgment was reported.
Are American scholars of Chinese economics superior to those of Soviet economics? Not necessarily. They all share a common characteristic: they focus on local phenomena and details, but do not have comprehensive judgment and insight at the macro level. Of course, the reluctance to look down on the economic prospects of the Communist regime due to their professional vested interests is also a factor that Western experts on economic issues in Communist countries will not explicitly state.
Second, can reform and opening up send the Communist Party “to the top”?
The Soviet Union’s unsuccessful economic reforms, China’s abandonment of the Soviet model of planned economy and total public ownership, and its market-oriented economy, coupled with the opportunity to join economic globalization through opening up to the outside world, are institutional conditions that the Soviet Union did not have. However, it would be naive to think that with these conditions, China’s economy will always be “on a high” and “number one in the world”.
From the beginning of this century to 2017, China’s economic boom left a deep impression on the world, and the continuous high growth has created a perception in the international community that a sustained economic boom is the nature of China’s economy; after the epidemic, some European countries even pinned their hopes for economic recovery on the pulling effect of China’s long-term economic boom. In fact, the Chinese media have been talking about the “most difficult year” at the beginning of each year since 2008, and then shut up about it for years because the situation has remained fundamentally unchanged. This terminology is not alarmist, but in fact reflects part of the real state of the Chinese economy, but the international community has overlooked the mystery. Since 2015, the Chinese government has announced that the growth rate of the Chinese economy will be less than 8% in the future, calling such a slowdown the “new normal”.
Is the decline in China’s economic growth rate a normal phenomenon of the boom cycle or a turning point in the long-term trend of the economy? There are various debates in the international community about this. My analysis of China’s economic boom over the past 20 years shows that the boom was mainly composed of an “export boom” and a “civil engineering boom”. Only by understanding their origins is it possible to understand why today’s economic boom is no longer the “norm” and why economic difficulties have become the “new norm”. The formation and disappearance of China’s “export boom” and “civil engineering boom” in the past 20 years is the key to understanding China’s economic difficulties in the future.
A Decade of “Export Boom” Life Span
In 1997, the Chinese Communist Party (CCP) had to give up its protection and reliance on SOEs and started the “restructuring” of SOEs, which was essentially the full privatization of small and medium-sized SOEs and the restructuring and listing of large SOEs (i.e., partial privatization), because of the overall difficulties of SOEs and the financial crisis that dragged the banking system into the financial crisis. The privatization of SOEs laid the foundation for the marketization of China’s economy, which in turn paved the way for China’s accession to the WTO. China finally joined the WTO in 2001, accompanied by the culmination of the introduction of foreign investment, creating the first decade of prosperity for China. During the decade from 2002 to 2011, China’s economy consistently grew by more than 9% per year, with exports becoming the locomotive that drove economic growth during this period. It can be said that the economic boom in the decade after China joined the WTO was the result of the “export boom”.
China started its economic reform in 1978, but until 1993, exports were only tens of billions of dollars per year, which did not give much impetus to economic growth. As Hong Kong and Taiwan companies set up more and more export processing enterprises on the mainland, China’s exports reached US$249.2 billion in 2000. But what really pushed China into the “export boom” was mainly investment from developed countries. In 2013, China’s exports were worth $2,209 billion, almost nine times more than in 2000. During the export boom, foreign companies explored almost every industry in China, from consumer goods to automobiles, from energy to machinery and equipment manufacturing, from real estate to finance, leaving almost no “virgin” land left for investment. China is in an “export boom”.
During the “export boom” years, from 2003 to 2007, China’s exports grew at a rate of more than 25% per year, and in some years by as much as 35%. Can China keep its exports growing at more than 25 percent for decades? Obviously not. Judging from common sense, countries with small populations export small amounts and have minimal influence in international markets, and may be able to maintain long-term trade surpluses with large Western economies; however, the global market appears too small for a superpower with a population like China, whose labor force accounts for 26% of global employment, and even if all industrialized countries in the world stopped production and gave up their markets to China, China’s Even if all industrialized countries in the world stopped production and gave up their markets to China, China’s “export boom” could not continue indefinitely. Therefore, China cannot rely on high export growth to drive its economy in the long run, and the “export boom” will come to an end one day.
The “export boom” is coming to an end
In fact, China’s “export boom” lasted only a few years before it started to suffer a triple blow: First, as the export boom reached its peak, the wages, social welfare expenses, taxes, land prices and energy prices of foreign-funded enterprises in China kept rising, making the costs of export-processing enterprises higher and higher, and the profits of foreign-funded enterprises were gradually eroded. The profits of foreign enterprises were gradually eroded, and some of them had to move away. Second, after the outbreak of the U.S. subprime mortgage crisis in 2008, the economies of developed countries have been hit one after another, and the purchasing power of countries has shrunk significantly, making China’s “export boom” suffer a big impact. Third, the manufacturing industry in industrialized countries has accelerated technological progress, increasing automation capabilities and competitiveness, and other developing countries have also introduced foreign investment, processing exports, and the foreign market for Chinese products is facing increasing challenges.
China, the “factory of the world”, used to benefit consumers in developed countries by producing large quantities of clothing, footwear, toys and consumer electronics at low prices; however, China’s manufacturing industry is large but not strong, with a weak capacity for independent innovation and low-grade products, which is also its Achilles’ heel. This triple pressure is not a temporary impact on China’s “export boom”, nor is it a cyclical phenomenon, but a long-standing and important factor that forces China’s “export boom” to contract.
In 2006, foreign companies started to divest from China, first, Hong Kong and Taiwanese companies manufacturing footwear, garments and toys in Guangdong closed their factories; then many foreign companies producing refrigerators, washing machines, air conditioners, color TVs and small home appliances also withdrew; then, the wave of foreign disinvestment spread further to the Yangtze River Delta, a region with a concentration of foreign companies in electronics and high technology. By 2015, some large foreign-funded enterprises manufacturing cell phones or other electronic products also closed their factories one after another. Hong Kong, Taiwan, Korea, Japan and other evacuated Chinese companies have moved to lower-cost regions, such as Southeast Asian countries and India. China’s “export boom” began to decline in 2012, and in 2016, exports fell by 7.7%. The Chinese economy has since bid farewell to the “export boom”.
V. “Civil engineering boom” prolonged for another decade
When the “export boom” was in decline, the Chinese Communist Party took strong economic stimulus measures to promote infrastructure construction and real estate development, which led to a round of “civil engineering boom”. Local governments at all levels demolished old buildings in urban areas and renovated them into high-end office buildings, commercial areas or luxury housing; at the same time, they built a large number of residential communities on the outskirts of cities through municipal construction such as roads, airports and public facilities. The share of civil engineering-related investment in GDP rose from 18-20% before 2008 to 35% in 2013 and 2014. in 2014, real estate investment alone accounted for 21% of GDP. The perverse spike in civil engineering investment could create a real estate bubble if it continues for years. In Japan, during the Heisei economic bubble, real estate investment accounted for only 9% of GDP; in the United States, when the subprime mortgage crisis broke out, the ratio was 6%. China’s real estate engineering investment scale is equivalent to about 1 times of Japan’s Heisei bubble period, is the United States in 2008 when the subprime mortgage crisis, the scale of real estate investment more than 3 times.
In just ten years, civil engineering has become the leading industry in China’s economy, driving the prosperity of dozens of upstream and downstream industries. At the height of the “civil engineering boom,” China consumed more cement in three years than the United States did in the entire 20th century; China’s crude steel production capacity equaled 49% of the world’s crude steel production in 2008 and accounted for 69% of the world’s crude steel production by 2014. The “civil engineering boom” is accompanied by a rapid rise in real estate prices, with the ratio of housing prices to the average annual income of residents in Shenzhen, Beijing and Shanghai reaching a staggering 58, 56 and 46 times by June of this year, the highest in the world in terms of living space. The working class has to retire at the age of 70 without eating or drinking, without pensioners or children, so that they can afford to buy a house only with their entire income in this life. When the real estate bubble is inflated to this extent, the “civil engineering boom” will come to an end.
In a short period of time, China launched a massive nationwide civil engineering project, which resulted in the modernization of large and medium-sized cities and a much improved cityscape; the opulence of mega-cities such as Beijing and Shanghai far exceeded that of the world’s most famous old cities such as New York, Osaka, Chicago and Los Angeles. To foreigners, all of this seems to symbolize China’s continuing economic prosperity, but this apparent prosperity is actually the result of massive borrowing and over-investment by city governments. This does not happen in democracies. China’s urban modernization is driven first by the mayors’ motivation to rise to the top, subordinated to their motivation to compare and show off their achievements, and is the result of a “tournament” of urban construction among city governments. Second, almost all of China’s city governments have maintained urban construction by borrowing unlimited amounts of money without regard to debt service. In fact, China has completed in just ten years all the urban construction projects that were necessary or completely unnecessary for decades to come.
VI. The Truth About China’s Economy in Perspective
China’s economic growth over the past 20 years or so was built on a one-time “export boom” and “civil engineering boom” that cannot be replicated, so the boom was also one-time and never sustainable. On the other hand, the Chinese economy has accumulated a series of serious and almost insurmountable difficulties that make it difficult for the CCP to pursue economic prosperity.
First, local governments rely heavily on land sales and tax revenues from real estate development for fiscal revenue. On June 4 of this year, the Ministry of Finance of the Communist Party of China ordered that the income from land sales of local governments will be changed to taxation, which will be held by the central treasury; starting from July 1 of this year, it will be implemented in Shanghai, Zhejiang, Hebei, Inner Mongolia, Anhui, Yunnan and other provinces and cities first; starting from January 1 of next year, the whole country will be unified to do so. This measure taken by the central government for lack of money is a fatal blow to local governments. The huge amount of bonds issued by local governments for infrastructure and real estate development will not be repaid and will cause shocks in the securities market.
Secondly, the above-mentioned policy of central finance will also shake up the real estate market. Commercial banks have already invested huge amounts of money in civil engineering, or become home purchase loans for home buyers. Banks are very afraid of the bursting of the real estate bubble, otherwise their bad debts will rise sharply and jeopardize the safety of banks.
Once again, high housing prices have squeezed the working class to scrimp and save to pay mortgage, and the younger generation can hardly buy a house and start a family just by scrimping and saving; at the same time, many industries have laid off a large number of employees because of the recession, and the remaining employees have also taken pay cuts, so the average income of the employed labor force is declining; coupled with the accelerating trend of population aging, the consumption of the elderly is limited, and these three factors together make the consumption of more than one billion people These three factors together make the consumption capacity of more than one billion people no longer able to pull the economy.
The housing market, finance, and banks are in a tight spot. Not only is the economic boom difficult to recreate, but the economic difficulties reflected in the high unemployment rate and low wages are increasing day by day, thus ending the “good old days” of the Chinese economy. The future outlook for China’s economy will never be the same as those two boom years, with high inflation and a deteriorating real economy becoming the new features of the “new normal. The “lie-flat” lifestyle (i.e., not seeking a job, not seeking a spouse, not getting married, and living on their parents’ pensions at the lowest level) that is becoming popular among some young people on the mainland reflects, to a large extent, the pessimism of their generation about the future.
Journalists and scholars in the West, unaware of these truths about China’s economy, are still reveling in the memories and imagination of China’s brief economic boom, and they seem to be repeating the mistakes of their Soviet economic observer counterparts.