The Four Horsemen of China’s Macroeconomic Slowdown
(1) Real Estate, (2) Local Government Fiscal Constraints, (3) Insufficient Domestic Demand, and the (4) Chinese Economic Bureaucracy.
After decades of double-digit growth, China’s economy has achieved significant size, but is grappling with a prolonged secular slowdown. The economic model China has relied on to drive much of its growth—namely, debt-fueled investment in real estate and infrastructure—is becoming increasingly untenable. China’s related macroeconomic slowdown can be broken down into four main issues.
The Four Horsemen of China’s Macroeconomy
First, China’s real estate sector. Following the 2008 global financial crisis, China leaned heavily on real estate-related investment to fuel growth. The proportion of real estate-related activities in China’s GDP surged from below 20% in 2008 to nearly 30% by 2013.1 As labor and capital were redirected into real estate and related industries (e.g., construction), productivity growth stagnated throughout the 2010s.2 The decline of the real estate sector, partially triggered by the Chinese Party-state’s own policies (the Three Red Lines), accounts for much of China’s macroeconomic slowdown.3 Beijing, no longer content to see resources channeled in this manner, has been willing to endure the challenges of reducing the sector’s prominence.
Second, China’s local governments face serious fiscal constraints and debt burden and are increasingly unable to maintain their GDP-boosting activities. To support public services, local governments in China have heavily relied on revenue from land sales and other real estate taxes. In 2022, land sale revenue and land-related tax revenue amounted to 6.7 trillion RMB ($931 billion) and 1.9 trillion RMB ($264 billion), respectively, out of a total local government income of 19.4 trillion RMB, taking up 31% of total fiscal revenue for local governments in 2022 (down from 37% in 2021).4 This dependence creates a precarious cycle with the performance of the real estate sector. While China’s central government debt may be low at 22% of nominal GDP, its local governments bear a much heavier burden at over 70%.5 Local governments have been deploying local government financing vehicles (LGFVs)—funding mechanism and off-balance-sheet entities—to finance infrastructure projects.6 With little revenue and heavy debt, local government investment projects are increasingly difficult to sustain, contributing significantly to China’s slowdown.
Third, China’s economy is marred by insufficient domestic demand. For years, analysts have urged Beijing to boost consumption’s role in China’s economy, to little avail.7 The 5.2% increase in consumer demand in 2023, largely attributed to a low base effect from pandemic consumption levels, may not persist into 2024.8 Retail sales have shown recovery, with a 7.1% increase in urban regions and an 8% increase in rural regions in 2023, reversing the declining trend of 2022. This may also be a reflection of the base effect.9 Consumer reluctance to spend is evident from the increase in household deposits from 2022 to 2023, despite falling prices.10 This caution, combined with stagnant income growth, suggests ongoing challenges for domestic consumption.11 Some analysts argue that an annual consumption growth of 6-7%, combined with an investment growth of 0-1%, is necessary for transitioning towards a more sustainable economic model.12 However, significant income redistribution from local governments to households appears politically unattainable under China’s current economic and political direction. Additionally, the 8% decline in real estate investment at the end of 2023 further highlights weak points in domestic demand.13
Fourth, the Chinese economic bureaucracy has been increasingly centralized during Xi Jinping’s tenure, as he moved economic decision-making bodies under Party commissions. The creation of two new finance commissions (the Central Finance Commission and the Central Financial Work Commission) and a new technology-focused commission (the Central Science and Technology Commission) during the March 2023 National People’s Congress indicates a top-down effort to control finance and direct resources from real estate to strategic emerging sectors.14 As Arthur Kroeber noted in a September 2023 Harvard lecture, Beijing’s increasing prioritization of economic security over growth and concomitant development of a more centralized system to pursue this priority is a drag on dynamism.15
The creation of two new finance commissions (the Central Finance Commission and the Central Financial Work Commission) and a new technology-focused commission (the Central Science and Technology Commission) during the March 2023 National People’s Congress indicates a top-down effort to control finance and direct resources from real estate to strategic emerging industries.
The Three Hardest Hit Sectors: Real Estate, Services, and Manufacturing
Amid these challenges, the real estate, services, and manufacturing sectors bear the brunt of the economic headwinds.
Real estate stands out as China’s most critical sector, accounting for 29% of the country’s economic output.16 Fixed asset investment in real estate has declined, negatively affecting overall economic growth.17 As China adjusts to a collapse in demand, new construction starts measured by floor area went from a decline of 2% in 2020 to 39% in 2022.18 Upstream sectors that feed the real estate sector, such as steel, glass, and cement, are bogged down by overcapacity and hit hard by real estate downturn.19
China’s manufacturing sector is also facing challenges. While China accounts for a sizable percentage of global manufactured output (31%), a substantial 55% of China’s manufacturing output is directed toward domestic demand, which has been on the decline, spurred on by dwindling investment.20 This trend is underscored by a sustained drop in the official purchasing managers’ index, which has remained below 50 since summer of 2023.21 Sluggish investment has also taken a toll on China's manufacturing share of GDP, as shown by declining industrial profits.22 In addition, imports and exports contracted in 2023.23 As the geopolitical climate deteriorates, advanced economies are unlikely to be as accommodating to China’s export machine as they were in the past. This may create additional headwinds for Beijing, even while it retains a pivotal role in global manufacturing supply chains.
The services sector—including sub-sectors like retail, catering, and transportation—has shouldered the impact of Zero-Covid restrictions and is faltering under increasing macroeconomic slowdown.24 The non-manufacturing PMI declined from 51.7 in September 2023 to 50.6 in October 2023, indicating a slowdown in services.25 Despite Beijing’s concerted efforts to stimulate domestic demand, the services sector has not experienced a significant boost.26 Several contributing factors to this stagnation include demographic trends, such as high youth unemployment and an aging population, along with diminishing returns on investment intended to drive growth in the services sector.27 These challenges post a significant hurdle for China’s efforts to revitalize this sector.
A critical question going forward is whether state-directed economic upgrading can generate economy-wide productivity enhancements significant enough to offset China’s broader failure to shift toward consumption or rely more on market mechanisms.
Outlook for China’s Economy
The future of these sectors hinges on China’s overarching political and economic trajectory. While short-term measures like interest rate cuts, cash injections, and fiscal stimulus packages are being implemented to stimulate economic recovery, achieving sustainable growth necessitates structural changes.28 The Party-state has established new party institutions to tighten control over financial and technological affairs, signaling its intent to pivot the focus of growth away from the real estate sector. The end-2023 Central Economic Work Conference underscored this shift, where the Party-state elevated the importance of industrial development and growth and relegated boosting domestic demand to a secondary focus.29 With a full rebound of the real estate sector out of the picture both economically and politically, some analysts estimate the highest recovery of the sector to be at 40-50% of its previous peak.30 Currently, no alternative sectors are poised to fill the gap left by declining real estate-driven growth.
(h/t to Gerard DiPippo’s analysis and tweet: https://x.com/gdp1985/status/1687069495586594816?s=20)
The Party-state’s lack of political will to adopt consumption-oriented policies suggests that consumption-driven growth will likely remain modest. Beijing is pinning its hopes on strategic emerging industries, including specialized manufacturing sectors like new energy automobiles. While these sub-sectors have shown rapid growth in recent years, their scale is insufficient to replace the real estate sector in driving overall economic growth.31 As of mid-2023, higher-value add sectors—including advanced materials and tools, and electric vehicles—constituted just over 13% of China’s GDP.32 With these constraints, China appears to be headed toward a period of slower growth. The Party-state’s increasing control and direction of resources may enable high-value and high-technology sectors to continue growing, even as the broader economy slows. A critical question going forward is whether state-directed economic upgrading can generate economy-wide productivity enhancements significant enough to offset China’s broader failure to shift toward consumption or rely more on market mechanisms.
Kenneth S. Rogoff and Yuanchen Yang, “Peak China Housing,” Working Paper 2797, August 2020, https://www.nber.org/papers/w27697.
FRED, “Total Factor Productivity at Constant National Prices for China 2000 - 2019,” St. Louis Federal Reserve, accessed on October 31, 2023, https://fred.stlouisfed.org/series/RTFPNACNA632NRUG.
Dorothy Chan, “China’s ‘Three Red Lines’ Policy to Safeguard the Property Sector Isn’t Working Yet,” The China Project, June 13, 2022, https://thechinaproject.com/2022/06/13/chinas-three-red-lines-policy-to-safeguard-the-property-sector-isnt-working-yet/.
Tianlei Huang, “Local Governments in China Rely Heavily on Land Revenue,” Peterson Institute for International Economics, July 5, 2023, https://www.piie.com/research/piie-charts/local-governments-china-rely-heavily-land-revenue.
“China Government Debt: % of GDP: 2014 - 2023,” CEIC, accessed on October 31, 2023, https://www.ceicdata.com/en/indicator/china/government-debt--of-nominal-gdp; “Exclusive: China Tells Banks to Roll Over Local Government Debts as Risks Mount – Sources,” Reuters, October 17, 2023, https://www.reuters.com/world/china/china-instructs-banks-roll-over-local-government-debt-sources-2023-10-17/.
These LGFVs accounted for a significant 40% of GDP in 2022. Additionally, China is burdened by substantial hidden debt accumulated by local governments, with some analysts estimated this hidden pile to approach nearly $10 trillion, read more here: Yu Hairong, Cheng Siwei, Zhang Yuzhe, and Han Wei, “China’s Effort to Cut $10tn of ‘Hidden Debt’ Faces Uphill Climb,” Nikkei Asia, https://asia.nikkei.com/Spotlight/Caixin/China-s-effort-to-cut-10tn-of-hidden-debt-faces-uphill-climb.
Charmaine Jacob, “China Should Consider Boosting Consumption as Real Estate Slump Drags On, IMF Says as it Downgrades Forecast,” CNBC, October 12, 2023, https://www.cnbc.com/2023/10/12/china-should-boost-consumption-as-real-estate-slump-drags-on-imf-says.html#:~:text=China's%20old%20economic%20model%20of,of%20its%20World%20Economic%20Outlook; “China’s New Consumption Plan May Do Little to Boost Growth,” Bloomberg News, July 1, 2023, https://www.bloomberg.com/news/articles/2023-07-18/china-unveils-package-to-boost-consumption-as-growth-loses-steam?embedded-checkout=true.
Thomas Hale, Wang Xueqiao, Nian Liu, and Andy Lin, “China’s Consumer Tighten Belts Even as Prices Fall,” Financial Times, February 11, 2024, https://www.ft.com/content/e06124dc-157f-4dfb-b051-7f93f3195911.
Xinhua, “China Retail Sales Up 7.2 Pct in 2023,” English.gov.cn, January 17, 2024, https://english.www.gov.cn/archive/statistics/202401/17/content_WS65a73b30c6d0868f4e8e32d7.html#:~:text=Retail%20sales%20in%20the%20country's,15.43%20trillion%20yuan%20last%20year; Evelyn Cheng, “China’s Consumer Spending Isn’t Roaring Back to Pre-Pandemic Levels Yet,” CNBC, October 11, 2023, https://www.cnbc.com/2023/10/11/chinas-consumer-spending-isnt-growing-as-fast-as-it-did-pre-pandemic.html#:~:text=China's%20retail%20sales%20fell%20by,they%20are%20spending%20the%20money.
The People’s Bank of China, “China Deposit: New Increased: Household Saving,” CEIC, https://www.ceicdata.com/en/china/deposit/deposit-new-increased-household-saving#:~:text=China%20Deposit%3A%20New%20Increased%3A%20Household%20Saving%20data%20was%20reported%20at,RMB%20bn%20for%20Nov%202023.
Thomas Hale, Wang Xueqiao, Nian Liu, and Andy Lin, “China’s Consumer Tighten Belts Even as Prices Fall,” Financial Times, February 11, 2024, https://www.ft.com/content/e06124dc-157f-4dfb-b051-7f93f3195911.
This is only one of Michael Pettis’ scenarios for China’s investment vs. consumption rebalancing. See four other rebalancing scenarios laid out at: Michael Pettis, “Can China’s Long-Term Growth Rate Exceed 2-3 Percent?” Carnegie Endowment for International Peace, April 6, 2023, https://carnegieendowment.org/chinafinancialmarkets/89466.
Tom Hancock, “Goldman, Morgan Stanley Expect China’s Housing Slump to Persist,” Bloomberg, December 27, 2023, https://www.bloomberg.com/news/articles/2023-12-27/goldman-morgan-stanley-expect-china-s-housing-slump-to-worsen?embedded-checkout=true.
Frank Tang, “China’s Financial Overhaul Brings More Power to the Party, with US $58 Trillion in Assets at Stake,” South China Morning Post, March 18, 2023, https://www.scmp.com/economy/china-economy/article/3213938/chinas-financial-overhaul-brings-more-power-party-us58-trillion-assets-stake; “Xi Tightens Communist Party Grip Over China in Major Revamp,” Bloomberg News, March 16, 2023, https://www.bloomberg.com/news/articles/2023-03-16/xi-tightens-communist-party-grip-over-china-in-major-overhaul; William Zheng, “China’s New Communist Party Body to Drive Tech Self-Reliance is Up and Running,” South China Morning Post, August 26, 2023, https://www.scmp.com/news/china/politics/article/3232316/chinas-new-communist-party-body-drive-tech-self-reliance-and-running.
Arthur Kroeber, “Has China’s Economy Hit the Wall?” Lecture at Fairbank Center for Chinese Studies at Harvard University, September 22, 2023,
Kripa Jayaram, Sumanta Sen, Pasit Kongkunakornkul, and Jitesh Chowdhury, “The Massive Scale of China’s Property Sector,” Reuters, September 26, 2023, https://www.reuters.com/graphics/CHINA-PROPERTY/SCALE/znpnzjdqapl/.
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Laura He, “China’s Economy Will Be Hobbled for Years by the Real Estate Crisis,” CNN, October 6, 2023, https://www.cnn.com/2023/10/06/economy/china-economy-real-estate-crisis-intl-hnk/index.html.
Jamil Anderlini, “China has ‘Wasted’ $6.8 Trillion in Investment, Warn Beijing Researchers,” CNBC, November 27, 2023, https://www.cnbc.com/2014/11/27/china-has-wasted-68-trillion-in-investment-warn-beijing-researchers.html.
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