After rapid growth at the beginning of the year due to the reopening, China’s economic recovery has hit several challenges, including a weak property market, sluggish external demand, and decreased confidence among both corporations and households. Thanks to the authorities’ efforts to stimulate the economy, GDP stabilized at 4.9% year-on-year in Q3, in line with this year’s official target of 5%. It still points to a weak recovery, given the low base of last year’s GDP growth outturn, merely 3%.
The lacklustre performance of China’s economy has raised concerns that it could face a fate similar to Japan’s lost decades in the 1990s. On the surface, China and Japan share similarities, such as both experiencing property market bubbles. This has led many to believe that China is on a path of “Japanification,” a term used by economists to characterize long-term stagnation following a burst real estate bubble.
However, a closer examination of the details reveals that China may not be doomed to the same fate as Japan. Chinese authorities have been aware of and prepared for the risks associated with a housing bubble. Having learned from Japan in the 1990s and the United States in the 2000s, China implemented various measures to curb real estate bubbles before they burst, including restrictions on direct purchases, higher minimum down payment requirements, and housing price caps on new homes in overheating areas.
These tightening measures not only mitigated associated risks but also provided policy flexibility when the bubbles started to deflate. For example, the minimum down payment requirement for homebuyers was set at 30%, reducing banks’ exposure to the housing market through mortgage loans. Additionally, higher down payment ratios enabled households to better withstand shocks from housing price fluctuations.
Regarding the corporate sector, China has strict regulations on listed firms’ real estate asset holdings, discouraging excessive exposure to the real estate market. This approach helps prevent significant losses when the real estate market experiences deep corrections. In contrast, many Japanese listed firms held substantial real estate assets during the housing bubble period, leading to serious contagion from the real estate market to the equity market and the overall financial system when property prices plummeted in the early 1990s.
Given these factors, China’s authorities have a better chance of containing the adverse impact of a housing bubble burst on the economy and financial system. By implementing pro-growth measures such as monetary easing, expansionary fiscal policies, and lifting existing tightening measures on the housing market, the Chinese government can help restore growth.
However, policymakers in China should not become complacent. According to official statistics, China’s per capita GDP reached around US$12,700 in 2022, close to the global median of US$12,300. The country remains a middle-income nation facing challenges similar to other emerging markets. Many middle-income economies have fallen into long-term stagnation, known as the middle-income trap, due to a fragile financial system, high income disparity, unsustainable growth models, and premature deindustrialization.
China also faces challenges associated with the middle-income trap, in addition to the risks posed by property market bubbles. Its financial system is vulnerable due to corporate sector indebtedness and shadow banking activities. Income disparity in China is also a significant issue, with a large number of Chinese earning low salaries, as highlighted by former premier Li Keqiang in 2020. The lack of direct subsidies to households during the Covid-19 pandemic may have exacerbated the situation. Furthermore, China’s old growth model, which relied heavily on government-led investment and external demand, is no longer sustainable for achieving rapid growth.
To address these challenges, structural reforms must be prioritized. Policymakers should revive the reform agenda announced at the third plenary of the 18th National Congress of the Chinese Communist Party, which was disrupted by the unexpected US trade war and the Covid-19 pandemic. A key aspect of these reforms should focus on state-owned enterprises (SOEs), ensuring a level playing field for all Chinese firms regardless of ownership structure. This will rectify resource misallocations and increase overall productivity, facilitating the transition to a more sustainable growth model. Additionally, the authorities should strengthen the financial regulatory framework and social security nets to ensure that the benefits of economic and social development are shared by the entire population, rather than a few interest groups.
Deindustrialization concerns in China are primarily linked to the US trade war and tech embargoes, particularly in areas such as advanced chip-making, artificial intelligence, cloud computing and quantum computing. It is essential for China’s authorities to develop key technologies in these areas to maintain a competitive edge. However, it is equally important for China to continue its policy of opening up and cooperate with other countries across a broader range of sectors.
China’s reform and opening-up policy, which has been in place since 1978, has played a significant role in transforming the country and lifting billions of people out of poverty. Faced with the challenges associated with the middle-income trap, China will need to rely on this policy to navigate the path ahead.
Le Xia, Chief Economist for Asia Pacific, BBVA Research