China Stumbles but Is Unlikely to Fall

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China Stumbles but Is Unlikely to Fall

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Bibliographic details

• Authors: Eswar Prasad
• Published: December 1, 2023

Overview

• China’s economic performance over the past three decades has been "stellar," achieving high growth that moved the economy from low-income to upper-middle-income status.
• Measured at market exchange rates, China’s GDP was $18.3 trillion in 2022, "73 percent of the GDP of the United States and 10 times more than the 7 percent of US GDP it registered in 1990."
• China’s per capita income is "roughly $13,000, approximately 17 percent of US per capita income—compared with less than 2 percent in 1990."
• Over the past decade and a half, China accounted for "35 percent of global nominal GDP growth," while the United States accounted for "27 percent."
• Despite structural weaknesses (an inefficient financial system, weak institutional framework, limited market orientation, and a non-democratic/open government), China avoided collapse until the COVID-19 pandemic disrupted growth.
• While significant fragilities exist—high domestic debt, an unraveling property market, and a shrinking labor force—the author contends that "an economic and financial collapse is not inevitable."

Sources of growth

• Growth has relied largely on investment growth financed by "an inefficient banking system."
• Investment surged after the 2008 global financial crisis; "increased investment accounted for about two-thirds of GDP growth during 2009–10."
• China’s capital-to-labor ratio is much lower than that of advanced economies, implying "more rather than less investment is probably desirable."
• Much investment has been driven by the public (state) sector rather than the nongovernmental sector; "state-owned enterprises...collectively receive a disproportionate share of bank credit" and "typically have not generated strong returns on those investments."
• The Chinese government set the objective of rebalancing the economy to:
  • "Reduc[e] reliance on investment-heavy growth and get household consumption to be the key contributor to GDP growth"
  • "Generat[e] more growth from the services sector than from low-skill, low-wage manufacturing"
  • "Shift[] away from physical-capital-intensive growth in a manner that improves employment growth"
• Recent structural shifts:
  • "Household consumption has in fact become the main contributor to growth."
  • "The services sector now accounts for more than half of annual GDP and close to half of aggregate employment."
  • Progress toward rebalancing has been "uneven" but significant: household consumption as key driver and services more prominent than manufacturing.

Growth prospects

• Forecasting is difficult; forecasters use factor growth inputs as indicators.
• Demographics: China’s labor force (population aged 15–64) is shrinking; "By 2030, it is expected to decline about 1 percent a year."
• Investment: "Higher investment growth could pick up some of the slack, but that carries many risks." Nongovernmental investment growth has recently declined; "state investment accounted for much of the growth in overall fixed asset investment outside the property sector in 2022."
• Productivity:
  • Historically, China averaged "a decent 3 percent growth in total factor productivity" over past decades.
  • Productivity growth "has slowed to about 1 percent a year over the past decade."
  • The author states: "China’s growth will run aground without an improvement in productivity growth."
• Dual circulation policy: Government emphasizes continued global engagement plus "greater reliance on domestic demand, technological self-sufficiency, and homegrown innovation."
  • Challenges: "China still needs foreign technology," and rising economic/geopolitical rifts could "limit China’s access to foreign technology and hi-tech products, as well as to markets for its exports."
  • Government crackdowns in sectors such as "technology, education, and health" have "had a chilling effect on entrepreneurship."

Potential pitfalls (debt, real estate, household exposure)

• Aggregate debt and composition:
  • "Gross debt levels are not out of line with those of other major economies, such as the United States and Japan."
  • "Public borrowing as a percentage of nominal GDP is lower in China than in other major economies."
  • Corporate debt is "about 131 percent of GDP."
  • External debt is "estimated to be a modest 16 percent of GDP," with "less than half of it...denominated in foreign currencies."
• Real estate sector concentration:
  • Real estate investment has become a bulwark for the economy and local government revenues are tied to land sales.
  • A fall in real estate prices could produce "knock-on effects across other sectors, local government finances, and even household wealth."
• Household exposure:
  • Household debt rose from "about 30 percent of GDP a decade ago to more than 60 percent."
  • Property is "a mainstay of Chinese household wealth" and households are exposed to house price fluctuations.
  • Nevertheless, "total household debt is less than total household deposits in the banking system."
• Systemic risk assessment:
  • Because debt is mostly financed by domestic savings and many creditors/debtors are state-owned, "a financial shock is unlikely to set off a financial crisis or a collapse in growth."
  • Concentration of bad loans and inefficiencies mean the bigger risk is "major inefficiencies and waste because of a broken system of allocating capital."
  • Recent property developer distress (examples cited include Country Garden and Evergrande Group) and exposures in financial institutions increase downside risk but "a systemic meltdown is not in the cards."
  • State-controlled major banks "can provide infusions of cash to troubled corporations," potentially postponing problems.

External risks, market reforms, and policy credibility

• External vulnerability:
  • Concerns about capital flight and currency crashes are raised but judged unlikely because the banking system is largely state owned and the government can "back all deposits" and "choke off the conduits for large capital outflows."
• Reform imbalance:
  • Many reforms focused on financial sector and capital markets; fewer reforms in "state enterprises and the institutional framework," creating risks.
• Financial sector reform priorities:
  • Fixing the banking system involves "recognizing and removing bad loans from banks’ balance sheets" and reforming state enterprises, including "weaning them off dependence on bank credit."
  • Greater financial sector liberalization is needed to allocate capital to "the more productive, dynamic, and employment-generating parts of the economy."
• Policy uncertainty and market intervention:
  • Government oscillation between supporting markets and allowing discipline has "had the perverse effect of heightening market turbulence."
  • Market-oriented reforms without accompanying broader reforms can "backfire, adding to volatility and generating more risks."
  • Needed improvements include "more transparency in its policymaking process, better corporate governance and accounting standards, and more operational independence for the central bank and regulatory authorities."
  • The government encouraged stock and corporate bond markets but "has done little to improve corporate governance...or their accounting and auditing standards," contributing to market opacity and volatility.
• Reconciling contradictions:
  • The government's dual impulse—"more freedom for markets but with a heavy hand of government intervention to maintain 'stability and order'"—poses difficult trade-offs and transitional risks.
  • Poor communication of policy intentions can increase uncertainty and reduce public support for reforms.

What the future holds (outlook and dilemmas)

• Track record: The government has repeatedly managed severe stresses and "maneuvered the economy around the seemingly inevitable prospects of a banking crisis, massive currency devaluation, housing market meltdown, and economic collapse."
• Costs of past interventions include:
  • "A huge buildup in domestic debt"
  • "Loss of $1 trillion in foreign exchange reserves during 2015–16"
  • "Highly volatile prices of stocks, property, and other assets"
• Policy dilemmas the government faces:
  • "How to continue reducing debt while maintaining growth"
  • "How to reduce energy-intensive production while the economy continues to rely on heavy industry"
  • "How to get markets to exert financial discipline even as the government tries to strengthen state control"
  • "How to restrain wealth inequality while relying on the private sector to generate more wealth"
  • "How to encourage private sector innovation while cutting successful private enterprises down to size"
• Likely trajectory:
  • Continued "stumbles and accidents" are expected as the government navigates contradictory impulses.
  • Short-run uncertainty and volatility could "reduce public support for much needed reforms to bolster long-term productivity and growth."
  • Structural constraints—"unfavorable demographics, high debt levels, and an inefficient financial system"—will constrain growth even if crises do not occur.
  • Alternatively, with prudent policy choices, "one could equally well envision a more benign future for the Chinese economy—with moderate growth that is more sustainable from an economic, social, and environmental perspective."

ESWAR PRASAD is a professor of economics at Cornell University, a senior fellow at the Brookings Institution, and author of The Future of Money. His latest book, The Doom Loop: Why the World Economic Order Is Spiraling into Disorder, will be published in February 2026.

Content in this bundle

• F&D: China’s Bumpy Path
  • F&D: China’s Bumpy Path (Markdown version)
  • F&D: China’s Bumpy Path (PDF)