Once seen as an unstoppable force, China economy is grappling with significant challenges. The recent military exercises in Taiwan, aimed at asserting its claim over the island, and growing tensions with the USA and other western countries, are emblematic of the broader tensions affecting the country.

Internally, consumers and businesses have lost confidence in the government’s ability to sustain long-term economic growth. This crisis of confidence, combined with an outdated economic strategy and centralized governance, has led to China’s economic downturn.

In this article, we’ll explore the three main reasons that have added to the worries of the China’s economy.

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China Economy Issue 1: Massive Crisis of Confidence Among Private Businesses and Consumers

At the heart of China’s economic woes is a profound lack of confidence among private businesses and consumers. This erosion of trust stems from several key issues:

Opaque Governance and Data Manipulation

The Chinese government has long been accused of suppressing sensitive economic data and presenting an overly optimistic view of the economy. This lack of transparency has made both consumers and businesses wary of future economic stability.

The stimulus package issued by the Government to stabilize the economy is also not transparent in terms of value and size.

Crackdown on Private Companies

Over the last few years, government crackdowns, from real estate to technology to finance, have sent shockwaves through the private sector. Interference in corporate affairs and increasing regulatory burdens have decimated entrepreneurial confidence, making it difficult for businesses to innovate and grow.

Technology Sector

Some of the major events in the technology sector were:

a) Halted the IPO of Jack Ma’s Ant Group in November 2020– Regulators halted the highly anticipated IPO of Ant Group, a fintech company linked to Alibaba.

This marked the start of broader regulatory actions targeting major tech companies like Alibaba, Tencent, and Didi. Concerns about monopolistic practices, data security, and unchecked growth drove the government’s actions.

b) Regulatory fines on Alibaba-In 2021, regulators imposed fines on Alibaba for antitrust violations and reined in companies with dominant market positions, including e-commerce and social media giants.

c) Restrictions on gaming for minors-There were also restrictions on gaming for minors and content regulation, with policies limiting children’s screen time to three hours per week?

Source: South China Morning Post?
Source: The China Project.

Financial Sector

a)Dozens of finance and banking officials have been detained and even punished to death.
Vice-governor of the People’s Bank of China, Fan Yifei, was sentenced to death with a two-year reprieve, according to state media. Former Bank of China boss was arrested on bribery charges.

b) Pay cuts in the financial sector-While few companies have publicly admitted it, pay cuts in banking and investment firms are a hot topic on Chinese social media.

Post-COVID Economic Recovery Disappointment

After the draconian zero-COVID policy was lifted, there was hope for a strong economic rebound. However, rather than a rapid recovery, China has faced sluggish growth, falling real estate prices, and major companies defaulting on debts. The mismatch between expectations and reality has further dampened confidence.

This lack of confidence has led to increased savings and reduced investments, which stifles consumer demand and economic growth. Real estate, which once accounted for 20-25% of GDP, has collapsed as consumers refrain from purchasing homes, contributing to a broader economic slowdown.

In fact, you can see in the graph below, the property sales activity has dropped considerably, however, the price of real estate has not fallen at a similar rate in the last 5 years.

China Economy Issue No. 2-Decades-Old Economic Strategy Focused on Production Over Consumption

China’s economic model, born during its reform era four decades ago, has emphasized more on industrial production, and less on demand (domestic and international).

This has led to an economy where production has exceeded the demand inside and outside the country. Sectors like steel, electric vehicles, solar panels, and robotics have been flooded with investment, leading to massive overcapacity.

Let’s take a look at this overcapacity.

Steel: In the early years of the twenty-first century, it was Chinese steel, with the country’s surplus capacity eventually exceeding the entire steel output of Germany, Japan, and the United States combined. 

Check in the graph below, where Chinese steel production (blue line) has been way ahead of the steel production by other countries including USA (grey line), Germany (red line), and Japan (dark grey).

More recently, China has ended up with similar excesses in coal, aluminum, glass, cement, robotic equipment, electric vehicle batteries, and other materials. 

Solar panels: Since solar panels are one of the priority products for the Chinese Governement, they have increased production to such an extent that the total solar panels produced every year by China are almost double the requirements worldwide. The solar PV production is expected to grow another 50% by 2025. 

This extreme oversupply caused the utilization rate in China’s finished solar power industry to plummet to just 23 percent in early 2024. Nevertheless, these factories continue operating because they need to raise cash to service their debt and cover fixed costs.

Electric Vehicles: A similar trend of overproduction can be seen in China’s electric vehicle industry. As you can see in the graph, between 2020 and 2024, China’s EV production not only met the demand of the domestic market but also exceeded global market needs, leaving the country with excess supply.

Robotics is another sector in which China tried to over-produce in these years. However, it was successful in building a vast industrial base, yet the technology used was not that superior. The result was the over-production of low-end robotics.

This age-old strategy of overproduction of goods and services which is not linked to the actual demand (internal and external), is driven by the Government’s age-old vision of relying heavily on investment and production for economic growth.

Their 5-year plans are heavily focused on industrial production, international trade and technology and very little towards increasing income and household consumption. The balance is missing among all these economic factors of production and consumption.

This unbalanced approach has given rise to a number of issues including:

Debt-laden local governments and businesses: To sustain this production, both local governments and companies have taken on massive debt. Real estate developers, for example, borrowed heavily to fund projects that were never completed or sold, triggering a crisis in the property market. Likewise, manufacturers continue producing excess goods to cover debts, even when profits are falling.

According to an investigation by The Wall Street Journal, in July, the total amount of off-the-book debts held by local governments across China now stands at between $7 trillion and $11 trillion, with as much as $800 billion at risk of default.

Deflation: Since the production is so massive as compared to the actual demand, businesses compete on the price of the items. In the race to produce more goods, local governments, and businesses produce the same items, negating any effort to innovate and complement each other.

Growing rivalry with the trade partner countries like the USA and European Nations: China’s overproduction has led to accusations of unfair trade practices. Chinese products, sold at significantly lower prices than global competitors, have sparked trade tensions with the U.S. and Europe. These countries have responded by erecting trade barriers, which have further limited China’s access to international markets and hurt its export-driven economy.

This strategy has also neglected domestic consumption, leaving China’s economy overly reliant on exports. Without robust household spending, the economy has struggled to maintain growth in the face of declining global demand.

USA: In May 2024, US President Biden increased tariffs on Chinese products across strategic sectors such as steel and aluminum, semiconductors, electric vehicles, batteries, critical minerals, solar cells, ship-to-shore cranes, and medical products.

European Union-In July of 2024, EU placed provisional duties of up to 38% on Chinese EV imports, despite an outcry from manufacturers and Chinese business groups.

China Economy Issue No. 3-Governance Structure with majority power at the Centre

China’s governance structure, where power is highly centralized, has played a significant role in exacerbating its economic problems. This system has several detrimental effects:

Local Government Debt and Overinvestment: Local government debt in China is a growing concern, fueled by overinvestment in sectors like electric vehicles and renewable energy.

Local officials are often pressured to implement large-scale projects in these strategic sectors to align with the central government’s political objectives. However, these projects frequently lack market demand and are instead motivated by political considerations aimed at bolstering the careers of local officials.

Since the majority of funds are controlled by the central government, local governments resort to raising loans off the books to fund these projects. This has led to enormous debt accumulation.

According to recent estimates, the total local government debt could be as high as $11 trillion, with around $800 billion at serious risk of default. This debt stems from overinvestment in sectors that are prioritized by the central government, without careful consideration of economic viability, leading to the possibility of defaults?.

The graph below depicts the increasing debt-to-GDP ratio in China. Debt to GDP ratio is the ratio of a country’s debts to its gross domestic product. It indicates how likely and easily the country will be able to pay off its debts. A higher ratio is undesirable for a country, as a higher ratio indicates a higher risk of default. In a study conducted by the World Bank, a ratio that exceeds 77% for an extended period may result in an adverse impact on economic growth.

The resulting financial instability is a significant challenge for China’s economy, with large debts putting pressure on local governments while they struggle to manage projects that are not yielding the expected economic returns.

Competition Among Provinces: Instead of complementing each other, Chinese provinces often compete to outproduce one another in priority industries, leading to redundant factories and overcapacity. This competition results in unnecessary duplication and wasteful spending, pushing both local governments and businesses further into debt.

Lack of Coordination: The centralized nature of governance means that local governments have little autonomy, often implementing projects that serve political rather than economic purposes. The drive to meet central government targets has led to misallocation of resources and poor investment decisions. As a result, local governments are burdened with unsustainable debt levels.

This centralized governance structure has not only led to financial mismanagement but also contributed to the overall decline in economic efficiency, as decisions are made for political reasons rather than sound economic rationale.

The Current Scenario: Growing Tensions and Economic Stimulus

In response to these issues, the Chinese government has attempted to stimulate the economy through various measures, including bond issuances and stimulus packages. However, these efforts have been insufficient to restore confidence or reverse the downward trajectory. The growing tensions with major trading partners, such as the U.S. and European nations, have added further strain, as trade barriers limit China’s ability to export its surplus products.

Conclusion: What Can Be Done?

Well what I have read and as per my understanding, there are potential steps the government can take to address the economic downturn:

1. Shift Focus to Domestic Consumption: China must transition from an export-driven model to one that prioritizes domestic consumption. This will require policies that encourage household spending and reduce the economy’s reliance on overproduction.
2. Decentralize Economic Decision-Making: Empowering local governments to make more independent economic decisions, rather than simply following central directives, could reduce wasteful spending and foster innovation.
3. Debt Restructuring: Local government debt needs to be addressed through restructuring programs that offer long-term sustainability. This would allow local governments to focus on economically viable projects rather than politically driven investments.
4. Rebuild Confidence in the Private Sector: Reducing government interference in the private sector and offering more transparency could help rebuild trust among businesses. Encouraging entrepreneurship and innovation will be critical to reviving growth.
5. Repair International Trade Relations: China must address accusations of unfair trade practices by engaging in more balanced trade agreements and reducing overproduction in key industries. Restoring healthy relationships with trading partners is essential for economic recovery.

China’s economic future will depend on its ability to adapt to these challenges. While recovery may be slow, a course correction that prioritizes domestic consumption, decentralized governance and restructuring the debt can set the country back on a more sustainable path. In fact the country has risen from downturns in the past also that can be replicated.