China's Economy, Politics, and Demography

 

 

Overview

China has been a spectacular economic success story. After the death of Mao in 1976, a more pragmatic group of Communist leaders seized power and began to change China. Their model was Singapore, whose population was mostly Chinese. Singapore’s economic growth model was that the dominant political party would direct economic growth. It invested in infrastructure, including condos for most of its population. It directed investment. It invited foreign companies to invest in the country. It became part of the global economy.

China did much of the same but since it was much larger, it had to go further. It liberalized agriculture, going from huge communes to allowing individual farmers to rent land. That doubled food production. Then it concentrated on manufacturing, with favorable laws on taxation. Foreign companies were invited in but they had to partner with a Chinese company, which accelerated China’s absorption of foreign technology and management. After catching up with the technology of large, global corporations, China became a major exporter. But, unlike Japan at the same stage in the 1980s, China went further. The Chinese government’s strategic plan was to make Chinese companies the leading developer and producer of “cutting-edge” products. This included the world’s largest producer of solar panels, batteries, and electric vehicles (EVs). As a consequence, China will probably continue to be the world’s largest exporter.

Foreign companies don’t vote and Chinese companies were expected to follow Party directives. The government controlled much of the financial sector so it could direct loans to favored companies in favored industries. But huge social media and e-commerce companies were not like manufacturing companies; their owners and managers started to act too independently for the Party’s taste. In addition, the Party feared, with some justification, that social media could become an uncontrolled outlet for independent thinking and writing. Even worse, social media could become the outlet for criticism of the government.

In the 2010s, the Party under Xi began to crack down. The most successful and famous entrepreneurs were reigned in. Communist Party cadres were installed in all large companies. The government closely monitors the Internet and closes down sites that annoyed them.

Overriding any economic discussion is that China is a totalitarian state and its political elite will not tolerate any independent source of power or wealth. The Party sees them as an actual or potential threat. All individuals are monitored and rated; a low score can have bad consequences.

A member of Communist Party is planted in every large corporation, and probably many smaller corporations, to watch owners and managers. As a result, many entrepreneurs are scared to make decisions. Many wealthy people want to leave China. A huge amount of wealth is being smuggled out of China.

 

China’s Economy

There is massive excess capacity in many industries, including EVs and solar panels. Also steel and cement because of less construction. Local finances are in deep trouble since revenue is tied to land sales to housing developers and contractors.

 

While China is installing more renewable energy technology than any other country, it is also the world’s largest producer of coal. Chinese cities have some of the worse air quality in the world. China does not like relying on imported oil and natural gas (even from Russia). So China reduces demand by producing EVs and renewable energy technologies. In the future, China will probably use greater renewable sources of energy to reduce coal production.

China’s economic development has been spectacular but growth is slowing down. The development strategy in the past was massive construction, both public and private, joint ventures with foreign companies, exports, and limiting domestic consumption. Internal construction, which includes housing, will probably be less important because of the huge amount of public infrastructure already in place. There will be little growth in housing construction because of low family formation due to a very low birth rate, and a large inventory of unsold apartments, possibly 5-10 housing units. 

China’s economy can continue to grow because of high levels of investment, overcapacity, and a large number of unemployed young people and college grads. The current strategy is to invest heavily in innovative new technologies such as advanced computer chips, EVs, batteries, and solar panels. Investment in these industries will come mostly from domestic sources. 

China is rapidly catching up in areas of chip production. China has rapidly improved its chip technology; it can now produce all but the most advanced chips in the world. U.S. bans on selling advanced chips to China is less effective than it would have been in the past.

Besides these final products, China is developing and controlling their entire supply chain. China intends to dominate global markets and the supply chain of advanced foreign producers. As an example, when Volkswagen opened an electric car assembly plant last year in Hefei, China, it ordered just one robot imported from Germany. VW bought the other 1,074 robots from a factory in Shanghai.

China now has a manufacturing sector that is larger than those of the United States, Germany, Japan, South Korea, and Britain combined. It produces some of the world’s most advanced technology in the “cutting edge” of most manufacturing industries.

China is the largest or one of the largest producers of “rare earth” minerals needed as inputs to make EVs and other high-tech products. Some of the rare earth minerals come from rebel-controlled areas of Myanmar; China has supported these rebel groups. Chinese companies have been buying up mineral producers in other countries.

In retaliation to the threat of higher American tariffs, Chinese has banned the export of some “rare earth” minerals to the United States.

Exports are rising but could face higher tariffs and quotas from trading partners, especially the United States.

Net Foreign Direct Investment (FDI) is negative - foreign firms are taking more money out of China than new investment going into China. Again, wealthy Chinese are smuggling large amounts of their wealth out of China.

China’s Housing Crisis

A large part of foreign investment in housing was from Southeast Asians speculating in apartment condos. There were always many empty apartments held for price appreciation. Many Chinese families own two or more units as a form of savings; China has a small social safety net, especially for retired citizens. 

Domestic and international investors in empty apartments are now losing money as apartment prices fall. Maybe a total of 20-40 million apartments are vacant; some estimates are higher.

About 5-10 million families put down payments of 50% on housing that has not been build or is unfinished. Some of these units may never be built. And yes, it was a Ponzi scheme. The Chinese government has some small programs in place to limit the damage, worried that the anger may be directed at the government.

Infrastructure and housing construction will probably be a less important source of economic growth, partly because of the massive investment over the last 40 years.

China’s Automobile Industry

China today has enough capacity to manufacture half of the world’s 80 million cars, or 40 million vehicles. Current production is about 26 million and rising. China’s electric vehicle companies continue to build new capacity. By 2030, China’s capacity could climb to 75% of the world’s volume.

To increase production of electric autos quickly, China is stepping up exports. 

Exports of electric vehicles are rising rapidly, to 6 million vehicles in 2023. (Total U.S. production is around 9 million, although American car companies assemble many cars in Canada and Mexico.) Besides autos with Chinese nameplates, foreign automakers are using China as the manufacturing base for exports under their own names. Foreign companies originally build large plants in China with Chinese joint venture companies to produce for the Chinese market. But falling sales in China have converted these plants to producing for exports. As mentioned above, VW has just completed a large EV plant to hopefully produce EVs that replace falling gas auto sales in China and closed gas auto plants in Germany.

Tesla shipped 344,000 China-built EVs to Canada, Europe and other markets in 2023. Volkswagen, Renault and BMW export made-in-China EVs to Europe. GM’s best-selling Chevrolets in Mexico are produced in China. Hyundai and Kia expect to sell 200,000 cars made in China back to South Korea and into global markets. Ford is exporting about 100,000 trucks and SUVs to Asia, Africa and the Middle East. Chinese joint venture partners make profits from these shipments.

BYD, China’s largest EV producer, may export more EVs than Tesla this year. Huawei has become a major producer in only two years. Another startup, VinFast Pivot, says they will add a new car to their line that will be priced around $10,000. Chinese EVs producers are negotiating to set up assembly plants in Asia and South America.

This discussion of the Chinese auto industry is from Michael Dunne, “When Every Car Is Made in China,” The Dunne Insights Newsletter, May 7, 2024.

China dominates the global supply chain to produce EVs, from mining to mineral processing of rare earth mineral to the production of battery cells.

American car companies in China have falling sales and are losing money. In the past, General Motors and VW were the largest car producers in China. Now they are not even in the top 20. One reason is that half of all cars sold in China are electric vehicles, most of which are produced by Chinese car companies. General Motors just took a $5 billion write-off of their investment in China. Michael Dunne, an observer of the Chinese auto industry, believes that the position of foreign auto producers can only get worse and some, including General Motors, will eventually leave China.

 

Chinese Exports and the Trade War with the United States

 

An American company called Skydio produces drones for the U.S. military and police departments. For obvious reasons, all of its global supply chain is outside China. Except batteries; it is forced by buy imported batteries, a global industry dominated by China.

China is the world’s largest producer of EVs, batteries, and solar panels.

The United States has expanded its ban of sales of hi-tech products, especially computer chips, to China. China is retaliating by rapidly improving and increasing its domestic computer chip industry. Four key Chinese trade associations have recently told its members to stop buying American chips.

How much China has improved its chip technology will be seen by the new operating systems Huawei is unveiling on its new smart phones. Huawei intends to challenge the operating systems of Google (Android) and Apple (iOS), which are used on almost all Chinese smart phones. Huawei’s new phones are based on advanced chips made in China. As part of the Chinese government’s strategy to become self-sufficient, it is beginning to ban the buying of foreign phones (read Apple) by government agencies. As the trade war intensifies, there will probably be more internal bans on the usage of American chips and smart phones.

This is part of a concerted effort of China to increase its Research and Development. Besides domestic companies, responding to Xi Jinping’s exhortation for “high-quality growth,” many foreign companies have increased their R&D in China. They include VW, Bosch, Bayer, AstraZeneca, HSBC, and global pharmaceutical companies. Total corporate R&D spending is now equal to that of Europe. On the other hand, some foreign companies, including Microsoft, are closing their R&D operations in China in anticipation that the trade war between China and the United States will become worse.

The American Treasury Department has circulated a draft “that would ban American firms from investing in AI, semiconductors microelectronic and quantum computing in China.” (The Economist, “Research developments:  China is the West corporate R&D lab. Can it remain so?”, July 20, 2024, 49-50.) Both countries see that future economic growth will depend critically on developing new technology.

For decades, China has fairly consistently sold about $4 worth of goods to the United States for every $1 worth of goods that it buys. That imbalance partly reflects Beijing’s many tariffs and informal limits on imports, as well as an enormous government effort during nearly two decades to replace imported manufactured goods with domestic production. 

Sino-American trade has grown rapidly in the past. So the lopsided ratio has translated into a large American trade deficit. But the growth in U.S. deficit from trade with China has slowed down. The deficit in 2023, about $350 billion, was the same as in 2018. What has changed is that China’s trade surplus with the rest of the world has gone from near $0 in 2018 to about $450 billion in 2023. 

The U.S. response is the Inflation Reduction Act to subsidize investments in EVs and battery plants. Supply chain plants are being built in Georgia, Michigan and North Carolina. Europe, like the United States, is considering higher tariffs on Chinese auto imports. German auto companies are fighting this because many of the EVs they intend to sell in Europe will be produced in China.

China has more to lose than the United States does in a trade war. But it is not obvious how high tariffs will affect China. In the past, domestic U.S. producers of substitutes for Chinese imports like solar panels have gone bankrupt or not been able to produce enough to hurt Chinese imports. Also, it will be difficult to find substitute sources for many industrial products in other countries. China has a deep, integrated supply network and superb transportation infrastructure. 

 

The net result will probably be some increase in U.S. manufacturing, a lower trade deficit with China, and higher prices for many goods in America. But the U.S. will still be very dependent on imports for industrial inputs, solar panels, batteries, and many consumer goods. While some production will shift from China to other country, America’s overall trade deficit will probably not go down very much.

 

Demographics

 

China’s most serious long-term problem is not U.S. trade policy. It is a huge decline in total population, particularly in labor force age groups.

 

China's population is slowly falling; the yearly reduction will accelerate in the near future. It is also rapidly aging because of below replacement birth rates since the 1970s. Birth rates were below replacement (an average of 2.1 children per woman) during the "one child" period of the 1970s to 2015. They are even lower now, about 1.1 children per woman. This is one of the lowest birth rates in the world.

China currently has had a relatively young average-age population but the average age is rising very rapidly because of the very low long-term birth rates. This year China’s median age (half above, half below) will pass that of the United States.

Although China’s total population is failing slowly at present, the age distribution is changing faster. The number of children is going down. China’s working-age population is already shrinking. By around 2050, the decrease in work force age groups since 2012 will be about the size of the current U.S. total labor force (170 million).  Or about 25% fewer workers.

The number of Chinese over the age of 60 has been increasing rapidly. China’s over-60 population of over 300 million is already close to the total population of the United States. By around 2050, the over-60 population is projected to be around 500 million, over 35% of China’s total population.

China has a special problem that could affect future demographics. Chinese youth, ages 19-24, have a very high unemployment rate, probably over 20% and possibly much higher. The government stopped publishing statistics and then came out with a new series with a lower unemployment rate. Colleges graduates in particular are finding it hard to get a decent position; many are unemployed, accepting menial jobs just to earn small amounts of income, or moving in with relatives. The government's policy is to tell the unemployed youth to "eat bitterness." 

At a minimum, this will probably affect future demographics and economic growth – lower income, later marriages, fewer children. This is in addition of a dearth of females because of the past “one child” policy that led to tens of millions of abortions of female embryos and female infanticide.

The latest long-run population projections indicate that China’s current population of 1.4 billion people has peaked and will fall to about 750 million in 2100! China will account for most of the global decline in population for the rest of the century. 

As in the United States, a stagnant or declining population is not spread evenly across the country. Government policies to help rural and inland areas do not seem to be working. Between 2010 and 2020, 1,240 counties and county-cities out of 1,866 saw their populations shrink, maybe by up to 35%, as birth rates fell to record lows in many rural regions and people continued to go to cities in search of work.

The Economist, “China’s last boomtowns show rapid growth is still possible,” July 30, 2024.

This will increase the problems associated with urbanization. China is already highly urbanized. Shanghai has four times as many people as New York City. Twelve cities in China have more people than New York City.

 

China’s first reaction to these trends has been to slowly raise their low retirement ages over the next 11 years. For men, the retirement age is being slowly raised from 60 to 63. For women, from 55 to 58 for white-collar workers and from 50 to 55 for blue-collar workers. A related reason is that the public pension costs are “squeezing” government budgets. Chinese economists believe that public pension funds will run dry over the next 10 years (sound familiar?). The long-run effect might be slowing down the fall in the size of the labor force as Chinese will have to work more years before retirement.

       The Economist, "Sunset Delayed," September 21, 2024, 38-40.

This policy will be unpopular. Traditionally, families were multi-generational and children (daughters and daughters-in-law) were expected to care for aging parents. But hundreds of millions of the working-age population have migrated from rural areas to cities, leaving their children in the care of grandparents. A rising percent of women in the cities are working. If retirement ages are raised and grandparents in both the cities and countryside have to work longer, there may be less baby-sitting. This might lower the birth rate even more. In addition, China has strong age discrimination, so that the older population might have to wait longer between employment and receiving a retirement pension.

 

Summary

Like Japan after their bubble economy collapsed in the 1990s, China is facing adverse demographic trends, the collapse of a real estate bubble, excess capacity, and high and rising public debt.

While China’s future demographic path is like Japan’s, China is not like Japan in other respects. The big difference is that China continues to invest in new, cutting-edge technology. Industries like EVs, batteries, computer chips, and solar panels drive economic growth and exports. Unlike Japan, China has invited in foreign companies with needed capital and technology. They are not needed as in the past. China will continue to be an exporting powerhouse unless tariffs and quotas begin to bite. But there are ways around most restrictions – trans-shipments and building plants in other countries. Because so many of the inputs that the United States and Europe need come from China, tariffs and quotas will probably be selective. Maybe mostly limited to EVs and high-end computer chips and software.

The future of China is a race to solve internal, domestic problems and continue to grow the economy through investments in import substitutes, new technology, and exports. In the longer run, the demographic decline plus an aging population presents serious problems, although there are possible solutions. The solutions will be more difficult if China continues to have an authoritarian regime for whom control is the main objective.

In the long run, China will have to continue to move away from labor-intensive manufacturing as a source of growth. This trend may intensify of the long-run demographic trend of fewer workers leads to higher wages. This implies much more automation and movement to the information economy. Also, Chinese companies may be able to move some of their operations to other, lower wage countries, which are the primary source of increased exports. But critically it means innovation; whether China can do this in a regime of political control of entrepreneurs and information is an open question.

For a summary of statistics from many sources and an excellent discussion of China’ current problems, see John Mauldin, “Broken China,” mauldineconomics.com, October 26, 2024. 

For excellent ongoing coverage of China, see The Economist at economist.com.