China's further development has priority

China's further development has priority. Military conquest of Taiwan not an option.

By Wolfgang Müller

[This article posted on June 28, 2023 is translated from the German on the Internet, https://www.isw-muenchen.de/online-publikationen/texte-artikel/5110-chinas-weitere-entwicklung-hat-prioritaet-militaerische-eroberung-taiwans-keine-option.]


China is facing serious economic and social problems that could endanger its internal stability.

In addition, China is confronted with a crusade of the West led by the superpower USA.

What are the priorities of the Chinese government in this situation?

Conflict with the West to distract attention from its own problems?

Or further building up the country?

From the pronouncements of the CCP and the government - whether from the party congress in the fall of 2022 or from the meeting of the People's Congress, China's parliament, in the spring of 2023 - there is no indication of an increasingly aggressive international policy. That Taiwan is part of China has always been emphasized by the Chinese government since the founding of the People's Republic in 1949. Until ten years ago, reunification was also the credo of every Taiwanese government. But despite all the speculation in the U.S. and the West about imminent military action by China against Taiwan, despite the rearmament of the U.S. and its allies in the Pacific: The focus of Chinese policy remains the economic and social development of the country.

After all, this is the top priority for the Chinese and for the government. Despite the enormous successes in economic and social development, there is still a long way to go before China catches up and can also keep up with the rich industrialized countries in terms of per capita economic output. In terms of purchasing power parity, China is already the world's largest economic power and will soon overtake the USA in terms of economic output in currency terms.

But its per capita income is only a quarter of that of the USA. In 2035, China wants to be where Spain is today in terms of per capita economic output. But Spain's economic output will have grown further by then. In addition, the current problems in China show that the further development path is complicated and anything but crisis-free.

Two events of the last few months provide a striking illustration of the many problems facing Chinese society: Social division is high, and the situation of migrant workers in particular has not improved significantly. The economic imbalances are massive, the share of domestic consumption in economic output is too low, and the real estate crisis has not been solved.

For the Chinese Spring Festival, which began in 2023 on January 20 according to the Chinese calendar, there was a huge migration of people, as there is every year. The railroads calculated that there would be over 2 billion rail journeys. Among them were hundreds of millions of migrant workers who worked in China's industrial centers and metropolises and went to their rural homes for the holidays to see their parents again, as well as their own children if they lived with their grandparents in the villages. Because of the Corona pandemic and lockdown policies, there had been little opportunity to do so in recent years. Many migrant workers visit their families only once a year, usually for the Spring Festival. This makes the money they have saved in the metropolises and bring back to their families for the festival all the more important for the migrant workers. In addition, many migrant workers look for a new job after the holidays. Years ago, a German car supplier near Shanghai paid each worker a bonus of several (!) months' wages if he/she returned to work after the holidays.

However, probably millions of migrant workers had problems with outstanding wages in the weeks before this year's Spring Festival. Workers' protests broke out all over China because of this. Many employers were themselves under pressure or insolvent due to the economic malaise caused by harsh lockdown policies and the property crisis that has been going on for years. According to the Financial Times (Jan. 25, 2023), workers in numerous cities protested to demand their back wages. Local authorities reacted strongly and threatened protesters with fines for organizing "extremist protests" such as blocking traffic or in front of rallies in front of government buildings.

There are many reports that employers are not paying workers their wages in some cases. Among them are over-indebted construction and real estate companies that employ many millions of migrant workers. But there are also operators of covid testing centers who have so far not been reimbursed for their expenses by the cash-strapped local authorities. The problems are exacerbated by poor implementation of labor laws. This makes it difficult for workers to get their money legally.

China's local authorities do repeatedly declare that they respect China's labor laws. But apparently this time they have decided to support the employers as the biggest taxpayers. After all, as long as companies are strapped for cash, the local

local governments cannot fund themselves. Due in part to the Covid mass tests ordered by the central government and organized by local governments, the coffers of cities and counties are empty, and the operators of the test centers cannot pay wages because of this either. The Chinese central government, in turn, warned that it would not reorganize the cash-strapped local governments.

In Chongqing, there were clashes between hundreds of workers and police in January when a covid test production company demanded that employees take unpaid leave. Workers said they had tried everything peacefully to claim their wages, but it was not working. In one county in Guangdong province, the Human Resources and Welfare Bureau threatened protesting workers with criminal charges if they disproportionately criticized government officials or if they threatened to harm themselves. People must choose reasonable means to assert their interests, he said. Malicious methods are strictly forbidden, he said. Police in Linyi County in eastern China's Shandong Province arrested five workers who had complained to upper levels of the county or provincial government about outstanding wage payments. It is absolutely unacceptable to go to higher levels of government with complaints. This disturbed the social order.

But some workers were not deterred. In Zhengzhou, the capital of central China's Henan Province, a construction worker camped out for days in the real estate developer's showroom. He refused to leave the showroom until he received three months' back pay. The police threatened to arrest him. But he explained, "I don't mind spending days and weeks behind bars if I get free food and free housing."

There are no reports that Chinese state unions played a useful role in these protests and in supporting the workers. To be sure, their policies are less focused on enforcing collective rights (e.g., collective bargaining agreements) than on helping to enforce personal claims - which include outstanding wage payments. But presumably they have subordinated themselves to local authorities.

In early February, in the megacity of Wuhan in central China, thousands of pensioners demonstrated in front of the city government headquarters on the Yangtze River. They were demanding the reversal of the cuts in reimbursement for medical services decided by the city government. Police had cordoned off the office building. "Ripping off ordinary people like us? Why don't you public servants start with yourselves first and cut your benefits in half?" (Financial Times, 2/9/2023) Other protesters surrounded police vehicles and chanted the Internationale. Some were also arrested. Most of the demonstrators were former employees of Wuhan Iron and Steel (WISCO, now merged with state-owned Baosteel) and other state-owned corporations. They were protesting a significant cut in reimbursements for health services as part of a reform of the public health insurance system. The Wuhan municipal government had announced plans to reduce the reimbursement of health care costs from the previous 260 RMB per month to 88 or 82 RMB. The maximum reimbursement amount was to fall from 4,000 RMB to 1,300 RMB.

Pensioners announced further demonstrations if the cuts were not reversed. According to reports, the reform has since been halted. A comment on Sina Weibo, a Chinese social media platform, read, "Pensioners are usually a timid group who want a quiet life. When even retirees demonstrate out of desperation, the policy needs to be reviewed." Another commented, "When I think about my future pension, this reform discourages me from continuing to pay into Social Security."

Slump in employment and private consumption

The news from China's labor market is not uplifting: unemployment among urban youth between 16 and 24 had risen to 19.9% in July 2022; it had averaged 14% a year earlier (Caixin, 8/16-22). So one in five youth registered as residents of, say, Shanghai (and thus not migrant workers) was unemployed. The unemployment rate for all Shanghai urban residents was 12% (Caixin, 7/21/22). Then Premier Li Keqiang described the employment situation in China as "complex and grim."

Unemployment is particularly high among college graduates. Nearly 11 million, 18% more than the previous year, entered the labor market in 2022. Less than half already had a job offer in April. At the same point in 2021, 60% of college graduates already had a job offer. Starting salaries are significantly lower, at RMB 6,500 or the equivalent of US$970, down from RMB 7,400 last year (Economist, 5/28-22). Entry-level industrial wages in China's "factory of the world" in the Pearl River Delta metropolitan area of Shenzhen and Guangzhou have fallen to 9 to 10 RMB per hour (Caixin, 7/7/22). Financially strapped public employers have cut bonuses to workers, which make up a significant portion of salaries.

While there are significantly more job seekers - exacerbated by the return of about 1 million Chinese students from abroad due in part to the Corona pandemic in the West - China's economy has slumped: Due to the numerous lockdowns that have hit China's economic metropolises in particular, the national economy as a whole grew by only 3% in 2022 compared with the previous year, even though industrial production and exports continued to increase. The government has scrapped the growth target of around 5% set for 2022. China's service sector, where most university graduates are placed, contracted year-on-year. Increasing government regulation of the technology sector (compare Socialism 11/20) - e.g., a 9-month ban on new computer game licenses - led to many thousands of layoffs in the industry. Moreover, Xi Jinping's education policy announcement of the "two reductions" - less homework in schools for China's chronically overburdened students and, at the same time, curtailing the business of the bloated private tutoring industry, which is supposed to make students fit for the entrance exams of the best universities for expensive money - which is correct in principle, has closed an important job valve for college graduates. That's because more than 6 million - mostly recent college graduates - were working as tutors in China's tutoring industry in 2021. By the summer of 2022, over 11 million candidates had registered for entrance exams to teach in government schools, a new record. For many years, Chinese college graduates steered clear of the civil service and especially schools because companies and especially the private sector paid better.

The job woes of college graduates mask another, larger problem that is usually forgotten in light of the many laudatory reports in the West about the eagerness of China's students to learn. According to data from the OECD and the National Bureau of Statistics, only 36.6% of the working-age population (between 25 and 64) had completed high school or a comparable vocational school, or had an academic degree, according to the 2020 census. Most workers have completed only nine years of compulsory schooling, and older workers even less. This is 20% less than the average for the G20 countries, far below the figures for Brazil, Mexico, South Africa or Turkey. Although international comparisons of educational standards are fraught with problems, it can be said that China will face a productivity problem because most working-age workers lack solid vocational training. For this reason, the Chinese government's change of course in education policy also relies on increased (vocational) practical training.

The Chinese government's zero-covid policy affected not so much industrial production as private consumption. Chinese consumer confidence in the summer of 2022 was at its lowest level since records began in China (Economist, Aug. 18, 2022). Household consumption, which the government aims increasingly to replace exports as the driver of the national economy, fell in inflation-adjusted terms in 2022.

Distant goal of "shared prosperity"

In January 2021, Xi Jinping, party leader and state president, declared, "We cannot allow the gap between rich and poor to continue to grow ... We cannot allow income inequality to become unbridgeable." "Common Prosperity" is the officially stated goal of the CCP and the Chinese government. In his report to the 20th Party Congress in October 2022, Xi Jinping stated, "We must strive to increase the share of population income in national income and increase the share of wages in primary distribution ... It is necessary to promote equality of opportunity, increase the incomes of low-income earners, and increase the group of average earners." [1]

The clear messages have so far been followed by little action. If anything, the government's zero covid policy pursued until the end of 2022 has further worsened the situation of poorer Chinese. However, this calls into question one of the pillars of the CCP's legitimacy: namely, the promise of a standard of living for all Chinese that ensures at least basic needs. According to the interpretation of many Western scholars of China, there is an implicit social contract between the CCP and China's 1.4 billion people. This social consensus is that the party will provide jobs, housing, food and security. In return, the rule of the party and the restriction of political rights are accepted at the same time.

Better social integration of migrant workers or migrant laborers is an ongoing theme in Chinese politics. But the real numbers are depressing: More than a quarter of China's 280 million migrant workers do not have their own toilet. 80 million migrant workers are now over 50 and have no long-term job prospects and, above all, no pension prospects. China's social security system is organized regionally and favors permanent workers (with registration as urban residents). According to a 2016 study, between 16 and 27% of students in parts of rural China suffer from anemia because they lack vitamins and iron. At the same time, according to a count by the U.S. business magazine Forbes, China had 698 billionaires in 2021, just a few less than the U.S. with 724. Estimates are that by 2025, the number of super-rich in China will double again.

The Chinese government has also so far failed to meet its own goals in improving the situation of migrant workers: in its 2014 plans for better urbanization, it set a target of increasing the percentage of urban residents with hukou by 2% by the end of the decade - that is, 2020. For better understanding, in absolute terms, this would have benefited about 30 million migrant workers. This was intended to reduce the gap between "proper" urban citizens (in 2014, it was 35% of China's total population) and urban residents (then 53.7% of the total population). However, the gap has widened by another 1% by 2020 (Economist, 9/24-22).

China's officially measured Gini coefficient, an internationally accepted measure for calculating societal inequality, is 46.5%, higher than in the U.S. or other developed economies. A Gini coefficient of zero means perfectly equal distribution. With a Gini coefficient of one, one person collects all the income or wealth. According to World Bank data, China's Gini coefficient is lower because the World Bank includes lower prices in China's rural areas in its calculations. Researchers led by Thomas Piketty, on the other hand, arrive at an even higher Gini coefficient for China than the official data (Economist, 2.10.21).

Although the official Gini coefficient has decreased since 2008, the social experience that China is an extremely unequal society has not changed. This may be due to the personal experience that social advancement in China works less and less, a trend that has been reinforced in the pandemic. It is true that the income gap between urban and rural areas has narrowed relatively. But the first thing that stands out is the income differences in one's own living environment - e.g., within the city or in a neighborhood. Moreover, everyone calculates in real money and not in Gini percentages: It is true that in 2014, the top fifth of Chinese households had per capita incomes nearly 11 times higher than the bottom fifth of households. This ratio has fallen slightly by 2019, but in hard money terms the difference per capita was RMB 69,000 in 2019 compared to RMB 46,000 in 2014.

Covid policy has exacerbated social inequality

The Chinese government's zero covid policy, which is in place until the end of 2022, has made it even harder for hardworking poor Chinese* to get ahead. Pathways to the middle class are increasingly blocked. One example: In January 2022, Beijing city authorities released the records of two Corona-infected people for contact tracing purposes. A 44-year-old migrant worker named Yue worked as a day laborer at 30 (!) different construction sites in 18 days. He had a large family to support. In contrast, a young office worker surnamed Li, who was also infected, spent the first weeks of January skiing and shopping at Dior, among other places. The release of this data generated a lively debate on social media. (Economist, 7/9/2022) There are particular problems in China's platform economy, where the profits (or at least sales) of start-ups, etc., are based on the low-paid labor of formally self-employed suppliers, usually migrant workers. There are always protests and strikes. In the fall of 2022, the offices of the delivery service MissFresh were besieged by unpaid suppliers.

Most migrant workers work in the service sector, such as restaurants, hotels, and laundries. With the lockdowns, many lost their jobs and had to take casual jobs with much lower pay. According to research by Chinese social scientists, since the beginning of the pandemic, the reserves of low-income households have continued to fall from quarter to quarter, while the assets of higher-income households have continued to rise. With registration (hukou) as rural residents, migrant workers are hardly eligible for social benefits. They are the last to receive assistance from municipal authorities. During the long lockdown in Shanghai, many had to live on the streets because they could not afford rent. At the same time, going back to the village is not an alternative for them either. This is because they feared that they would not be able to return to work in the urban centers due to lockdowns, quarantines, etc.

For hundreds of millions of Chinese, the pandemic and years of government lockdown policies have destroyed the fragile balance between working and making money in the city and their family in the countryside. Poorer families and especially their children, most of whom live in the villages with their grandparents, have been affected. According to UN figures, as early as 2020 - the first Corona year - 1.5 billion school children worldwide were affected by school closures; one-third of students had no access to online education. But the problems faced by the approximately 290 million school children in China are particularly severe because the school closures went on for more than three years. In the years leading up to 2020, China had at least made progress: The education gap between the more affluent Chinese in the cities and the poorer Chinese in the countryside was narrowing - through heavy government investment in schools in rural areas and through central government funding of teachers' salaries rather than financially strapped local governments.

With the end of the Corona policy, it is clear that these children from poorer households and in China's villages will be the main long-term sufferers of the Corona policy. As a result, social inequality will continue to worsen. Young people raised in poorer households will also suffer particularly from record youth unemployment.

Just as in other countries and proven by many studies, children from poorer families in China in particular have fallen behind with online education. Except that in China, the restrictions went on for several years. In affluent families, parents were able to make up for the deficits with face-to-face tutoring. In contrast, the "left-behind" children of migrant workers live apart from their parents for many months. Their education, the only path to social advancement, is blocked. Even after the first lockdown in 2020, researchers at Jinan University in eastern China had found that the learning gap between students whose parents had a university education and those whose parents had only a secondary school diploma had widened significantly. This is also the empirical evidence from Chinese teachers after nearly three years of online teaching (Financial Times, Jan. 3, 2023).

Fighting the economic crisis with infrastructure stimulus

The Chinese government wants to overcome the current economic crisis with large infrastructure programs. As early as May 2022, Premier Li Keqiang declared in a video call with thousands of regional officials that investments in the transportation sector, for the conservation of water and for the renovation of old residential neighborhoods should provide a strong boost for the economy and for the employment of migrant workers. This includes 102 key projects listed in the current five-year plan, including flood controls, new ultra-high voltage lines and high-speed rail lines, and four-lane expressways, including one to the famous city of Shangri-La in southwest China's Yunnan province.

Whether China still needs these infrastructure investments or whether "white elephants" are being placed in the country with a lot of concrete is another question. According to an analysis published by the World Bank in 2020,[2] China's stock of infrastructure and public capital grew from 64% of economic output in 2007 to 107% in 2016. This sharp increase in infrastructure and housing may explain the slowdown in productivity growth over the past decade. Comparing an economy's infrastructure to the country's economic output makes sense: a larger economy needs a larger infrastructure base. According to this model, infrastructure is an input according to the economy's performance.

But according to this logic, poorer countries have poorer infrastructure because their economic output is lower. In contrast, the ratio of infrastructure to population is a better criterion. By this logic, China's often very modern infrastructure is less impressive: China has 120 km of highways per 1 million inhabitants, France has 179 km, and the United States has 326 km. China has 106 km of railroads per 1 million inhabitants, while Germany has 400 km. China's metro networks are 20 times longer in total than those in France, but more than 20 times as many people live in cities with populations over 500,000 in China than in France. By some estimates, China has only 4.4 intensive care unit (ICU) beds per 100,000 population compared to 14 in the U.S. - a dire shortage that explains the drastic policy responses to the covid outbreaks.

What this means is that without the Chinese government's spending programs, there would be insufficient demand in China to keep its labor force and capital productively employed. A recession would be worse.

To combat the economic crisis, the central government is also cracking down on other entrenched interests: In April 2022, the CCP and the State Council, the government's cabinet, publish a joint document calling for a single national market. Given the Chinese economy's successful shift away from a one-sided focus on exports - China's exports as a share of total economic output fell to 14% in 2020 - the implementation of a unified domestic market is particularly important. The longer-term problem is the special interests of local cadres (Economist 7/23-22).

Arguably China's greatest advantage, however, is its still largely closed capital market: private capital can only be withdrawn to a very limited extent, thereby destabilizing the financial system. In almost all emerging market financial crises, capital flight has been one of the biggest problems [...] In China, it is different because lending there is almost entirely done by domestic financial institutions. Moreover, lending is almost exclusively in domestic currency."

Real estate bubble and mortgage strikes

Depending on the calculation, China's construction and real estate sector, including construction companies and suppliers from the steel and cement industries and the furniture industry, manufacturers of construction machinery, etc., has so far contributed between 23 and 29 percent to the country's total economic output. This share of total economic output - whether 23 or 29% - is huge by international standards and anything but sustainable. It is true that China had (and still has) an enormous pent-up demand for housing, intensified by rapid urbanization, as well as for built infrastructure. But privatization of the real estate sector combined with the financing needs of municipalities, whose main source of income is the sale (for a time) of municipal land to real estate corporations, and the interest of private households in making a good investment, have for many years driven an engine that has covered the entire country with high-rise housing developments. About 70% of private savings are now in real estate, whose prices have known only one direction: up! Many households have two or more properties. Of course, China's state-owned banks have also been involved in the big wheel.

Now there has been a crisis in the real estate sector for years: housing prices are falling, in July 2022 by 28% compared to the previous year, large real estate developers are insolvent. The heavily indebted real estate groups have stopped construction or the start of projects that have long been sold. In turn, frustrated homebuyers across China have begun to default on their mortgages until construction is underway. According to documents published on the Internet, the halt in mortgage payments now affects 319 projects in 93 cities (Economist, 7/23/22). According to Deutsche Bank data, the boycott has so far affected about 5% of the total mortgages issued. If the boycott spreads further, smaller regional banks in particular could run into difficulties.

Down payments from buyers have been one of the most important sources of liquidity for China's real estate groups so far. In 2021, 90% of all properties were sold before construction began, compared with only 58% in 2005. It was a kind of Ponzi scheme: with the buyers' money, real estate developers were able to buy more land from local governments and at the same time secure financing from banks to complete the projects.

Given the huge importance of the real estate sector, however, a financial crash seems unlikely. For their part, many local authorities whose financial position depends on land sales to developers have begun to press for the completion of projects already paid for and started, and to restructure the assets of insolvent developers. The Party chief of central China's Hunan province tried to stimulate the purchase of apartments with the astonishing announcement that one could own more than two or three apartments. Xi Jinping, on the other hand, had repeatedly announced that real estate was there for living, but not for speculation.

The central government is counting on a gradual correction of the overheated real estate market, the normalization of the sector's share of the Chinese economy and the gradual liquidation of the mostly highly indebted real estate groups. It is about completing projects that have already begun, which would require a total effort of about 2 to 4% of economic output. Not about a guarantee that all real estate bought on paper will be built. That would be a blank check for the real estate corporations.

Moreover, the central government has to be very careful in solving the real estate crisis because land sales by local governments to real estate corporations have so far accounted for a large part of municipal financing. China's local governments finance over 30% of their budgets through land sales. (Economist, 9/4/2021) Land has been social property since the founding of the People's Republic in 1949; there is no private land ownership. Since the economic reforms of the 1980s, Chinese authorities have practiced the leasehold model: for a maximum of 70 years, private individuals and companies can acquire a title to a piece of land and do with it as they please. Auctions, in which the pieces of land are sold to the highest bidders, are common.

But 2021 was the first year that most Chinese local governments' revenue from land sales fell. In 13 of China's 31 provinces, revenue from the sale of land use rights actually fell by more than 20%, including in Xinjiang in northwest China and in the heavy industry-heavy northeast Chinese provinces of Heilongjiang, Jilin and Liaoning (Caixin, Dec. 29, 2021). In the process, local governments had already eased the rules for land auctions to attract private real estate developers with tight liquidity. In the final quarter of 2021, average land prices in 300 large and medium-sized cities were only 3% higher than minimum bids. Just six months earlier, the average price premium over minimum bids had been 17%.

China's smaller cities (still very large by our standards) have been particularly hit by the property market price slump. To boost sales, they have lowered the land transfer tax or are directly subsidizing home purchases. In some regions, rural residents are also encouraged to buy properties in the city, even though they do not have a certificate as urban residents, known as hukou (Caixin, Dec. 25, 2021).

China's housing issue: housing as a commodity and as a financial investment

With the market-economy reforms after the end of the Cultural Revolution, the CCP also addressed the housing issue with the instruments of the market - with the result that the People's Republic has one of the highest home ownership rates in the world, but on the other hand, after 40 years, it has to deal with massive economic distortions and social dislocations. CP leader and State President Xi Jinping has felt compelled to repeatedly state since 2016: "Housing is for living, not speculation."

In 1980, nearly 80% of Chinese still lived in rural areas. Agricultural collectives - the people's communes that were later dissolved - provided housing for peasants. Internal migration, and thus the influx of rural residents into the cities, was virtually impossible. In the cities, the state enterprises and the authorities provided housing for their employees and their families. The apartments were usually very small. Families lived extremely cramped in one room, but housing cost practically nothing. Young single people lived in dormitories.

A personal experience illustrates the housing shortage in China's cities at the time: In the summer of 1979, when wall newspapers were still allowed as instruments for public discussion and complaints, a wall newspaper hung outside the headquarters of the CPC Central Committee in Beijing. It was addressed to Wang Dongxing, then one of the most powerful men in the CPC. On it, the author asked for the hand of the party leader's daughter. For she lived with her father in a villa behind the walls on the grounds of the party headquarters. He would never bother the party leader's daughter, he just wanted a small room in the villa. This is because he himself has to live with his parents and two small siblings in a one-room apartment and cannot even bring a girlfriend home.

The reforms initiated by Deng Xiaoping also included the development of a housing market - together with the temporary 70-year lease of land and thus the privatization of land use. Land, however, remained social property. The first step in the development of the housing market in the cities and industrial centers was the privatization of the housing stock of state bodies and enterprises in the 1980s and 1990s. They were to be freed from the burden of managing and costly maintenance of the housing stock and concentrate on their core business - or so the official reading went. At that time, state employees and employees of state-owned enterprises could buy the apartments they lived in at sensationally low prices - for example, a 50-square-meter apartment in downtown Beijing for the equivalent of a few thousand euros, which today costs several million euros.

The land reforms that began around the same time - the gradual dissolution of the people's communes and the privatization of land use - not only provided a productivity boost in agriculture. They simultaneously released latent rural overpopulation. Within a few decades, several hundred million Chinese left their villages and moved to the urban metropolises and the huge industrial areas and export zones at the mouths of the Yangtze or Pearl Rivers, for example. But the migrant workers kept their land titles and their houses in the villages at the same time. Officially, most of them are still rural residents, even if they have lived and worked for many years in Beijing or Shanghai, for example.

The urbanization push created an enormous demand for new housing. Added to this was the urban population's need for more housing with higher standards, which further increased the demand for housing. Moreover, there had been little construction before, during the years of the Cultural Revolution.

The privatization of the housing stock in the cities was the blueprint for the development of the real estate market in China. Private real estate developers sprang up. They built high-rise complexes, each with many thousands of condominiums, on land that they had bought at auction from the municipalities for a limited period of time. At times, real estate speculators dominated the lists of China's super-rich. Private industrial companies and even state-owned corporations that had just privatized their staff housing acquired real estate subsidiaries in order to profit from the exorbitant profit opportunities.

The business of China's real estate developers is essentially to buy large plots of land in urban centers. Real estate is then immediately developed there, usually high-rise complexes with many floors. The apartments are sold to interested parties. Often, all the apartments are sold before ground is broken. With the money raised, new properties are bought and more projects are developed. This kind of snowball system can work as long as real estate prices are stable or rising and as long as apartments are used as investments and for speculation.

The transformation of housing into a commodity was the basis on which the mixture of the real demand for housing, which had been growing for decades, cheap financing and the interest of the ever larger Chinese middle class in real estate became a turbo for the economy due to the lack of other attractive investment opportunities. Whenever the economy weakened, there were government infrastructure programs for the construction sector. All of this promoted the rise in real estate prices, which knew only one direction: upward. Today, housing prices in the cities are between 5 and 13 times the average annual income. Construction and real estate account for nearly 30% of China's economic output. In developed economies, the share is usually just half.

The vast majority of households own their homes, but many millions live in rented accommodation. The homeownership rate in China is more than 90% of households, compared to about 65% in the U.S. and less than 50% in Germany. More than 20% of homeowners in China even own more than one property. What's more, real estate ownership as a percentage of household assets is above average in China at 70%, far higher than in Western economies. Home ownership is not just a roof over one's head, it serves as security and a nest egg. Home ownership is also a speculative investment, is the bride price or the ticket to a good school.

However, the fact that 90% of households in China own their homes does not mean that most of them live in their own four walls. That's because it also includes the houses in the home villages of the hundreds of millions of migrant workers who live and work in China's metropolises. There, they usually live in cramped conditions for rent. In many large cities, it has been impossible for rural residents to buy their own homes, even if they had the money to do so, because they worked as well-paid IT specialists, for example. But even in view of the many vacant properties, these restrictions have fallen in many cases in recent years.

In the urban centers, rental relationships are the order of the day; 70% of the newcomers live in rented apartments. This cannot be any different in view of the dynamics of Chinese society with its huge internal migration and a labor market in which new jobs are constantly being created - whether for specialists from Internet companies, for example, or as low-cost jobs with delivery services. In addition, about 11 million university graduates enter the labor market every year who do not have the money to buy a condominium.

The Chinese government has understood that the housing issue cannot be solved by promoting home ownership alone, but that the rental housing market must be regulated. In September 2021, the government capped annual rent increases in cities at a maximum of 5%. Even before that, many cities and provinces had enacted regulations to this effect. In addition, the government is increasingly focusing on publicly subsidized housing in the cities: more affordable rental apartments are to be built.

Until now, real estate has been a kind of savings book for many people in China, not only in well-paid jobs. As early as 2010, a bus driver in Chengdu in Sichuan province told us that he now owned three properties. This is because real estate prices have risen every year, many times over within two decades. For decades, the population was blinded by the illusion that real estate would continue to increase in value.

In addition to a lack of safe investment opportunities, this was the main reason why the Chinese continued to carry their savings into the real estate sector despite the already absurdly expensive market prices. The fact that a large share of private savings is in real estate forces a cautious restructuring of the real estate sector. Beijing must proceed cautiously if it does not want to trigger more protests from savers. According to a study by the Chinese central bank, more than half of Chinese now only expect house prices to remain constant. This is a first for China.

Weak private consumption and poor social safety net

As the above-mentioned demonstrations by pensioners in Wuhan have shown, China's social security systems have so far been a major construction site. The health care system is deficient by international standards. Despite statutory health insurance, private co-payments for operations, treatments and medications are high. There is a statutory unemployment insurance system, but its benefits are low and not enough for low-income earners and precarious workers-most of them migrant workers-to live on. Many self-employed people lost their sources of income during the lockdowns, but statutory welfare benefits are minimal compared to the cost of living. There are stark differences in retirement benefits: farmers receive only a meager pension; they still have their land, after all. For employees in the private sector, employers pay pension contributions (which does not always happen). In addition, the pension funds are organized at the provincial level, which used to mean that migrant workers lost their pension rights when they changed jobs to another province, for example. In contrast, the pension system for state employees and employees in state-owned enterprises is comparatively good. To date, the official retirement age is 55 for women and 60 for men.[3]

China's poorly developed social systems explain in large part the very high household savings rate by international standards, which was over 36% in 2021. This is a massive economic problem: because high savings reduce domestic demand, private consumption. With a share of less than 40 percent of China's total economic output, private consumption is far below the levels of other countries at a comparable level of development - such as Turkey or Mexico. By contrast, China's investment ratio - the share of economic output that is invested - has been extremely high for many years. When East Asia's so-called "tiger economies" such as South Korea or Taiwan started their economic catch-up decades ago and deliberately kept wages and thus private consumption low in order to promote investment, the disparity between consumption and investment was not as extreme as it still is in China today.

These distortions, which had existed for several decades, and the question of how to significantly increase domestic demand in China were high on the agenda of the CCP's Central Economic Conference in December 2022. The conference focused on a program to stimulate China's economy. As early as October 2022, Xi Jiinping had declared at the Party Congress that China must strive to increase the share of household income in national income and increase the share of wages and salaries in primary distribution.

Sun Liping, a well-known social scientist in China, discussed the issue of domestic demand on his blog: [4] "Whether private consumption in China will recover after the end of the pandemic is a major concern for many in the business community. In my estimation, demand for essentials will gradually return to normal. Demand for spontaneous spending will also recover, but that won't last long. By contrast, demand for durable goods is entering a long-term downtrend. That's why, in my estimation, the problem of private demand is very serious. Until the problem of domestic demand is solved, it doesn't matter how much we invest or produce. What's the reason for that?"

Sun's central theses are simple: first, we need to make people feel confident about the future. We need to increase their real incomes. We need to preserve and maintain people's wealth, their savings. Second, China does not have the domestic demand at all to utilize its productive capacity. This is a huge long-term problem, given the growing international trends toward decoupling and intentions to reverse globalization.

In this context, social scientist Sun Liping dispels the judgment that the Chinese are particularly thrifty. He points out that the problem of lack of domestic demand in China is an old one:

"In the late 1990s, we said that the Chinese have a habit of saving. Later we said that was the case with the older people, but the younger people were happy consumers. I mean, that's not a key factor in the lack of domestic demand. An example from the late 1990s: at that time, households in Beijing started to buy telephone lines. At that time, a telephone connection cost the equivalent of between US$750 and US$900. In smaller cities, a telephone connection cost between US$300 and US$750. But at the same time, people were earning only a few hundred RMB (100 RMB at the time was about $12) a month. When people spend almost a year's salary on a phone line, can it really be said that they find saving better than spending? In the first decade of the 21st century, cars became widespread. Using a VW Santana as an example, that meant putting down four to five years' salary for the car while giving up food and drink. Can we seriously say that the Chinese do not want to consume, but prefer to save? The picture is even clearer when it comes to private housing purchases.

So we cannot say that the Chinese are too modest, too frugal and too stingy. That's not true, even if we're only talking about the older generation. The fact is that people are spending like crazy. But it's still not enough for the necessary domestic demand ...

But where are the roots of the problem? A significant part of budgetary spending has been used to control and prevent the pandemic over the last three years. That has been expensive. The government has also spent a great deal of money on testing centers, quarantine facilities, vaccines, and building control teams. But many overlook how much households have paid for and, in some cases, spent uselessly. Households have stockpiled food and medicine, things that normally would not have been necessary. That's why statements that the pandemic has dampened private demand are incorrect. Many families are not spending less, they are spending on other things, not normal expenses. Household spending did not become less.

At the same time, the incomes of a significant portion of the population have fallen. Under the influence of the pandemic and due to other factors, the number of unemployed has risen dramatically in recent years, even to over 70 million according to some figures. If college graduates are added, the number of unemployed could be around 80 million. A significant proportion of small and medium-sized enterprises and many self-employed people have been hit hard by the epidemic. Many of them have gone bankrupt and closed their businesses. Some still have to service their mortgages and car loans. For them, it's not a question of whether they want to spend money, but they can't consume ...

Those who want to go to the bank and invest money are mostly older people. Do they do it because their incomes have become higher? Surely not. The reason is that their expectations for the future are gloomy and that's why they are putting more money aside.

To really solve the problem of domestic demand, people need security and confidence for the future. We need to raise real incomes. And we need to get serious about protecting people's modest wealth so that there's a positive, self-reinforcing cycle between economic growth and people's standard of living."

Sun is remarkably clear in addressing a contentious issue - even in China - that will not only continue to preoccupy Chinese policymakers, but is also on the global agenda because of its geopolitical implications. The issue is that the country has become the "factory of the world" over the past 30 years. In the heyday of globalization, China has developed capacities for many basic materials and end products far beyond the long-term needs of the large country, covering at least half (steel, cement ...) to 80-90% (solar panels, electronics ...) of world production in most industrial segments. This is neither desirable nor sustainable in the long run.

"China's production capacity cannot be absorbed by domestic demand alone. China's production capacity as the "factory of the world" in the era of globalization far exceeds our normal domestic demand. This means that production capacity can never be absorbed by domestic demand alone. Now globalization is being rolled back, now supply chains are being transformed. True, our supply chains are the most complex and complete, and the quality of our industrial workers is very high. But what are we going to do with all the products that our huge capacities churn out?

You can demonstrate this with products that are directly related to people's daily lives. Worldwide, 15 billion pairs of shoes are produced annually. Of these, China produces over 10 billion pairs, or nearly two-thirds. But China consumes only 2.4 billion pairs of shoes per year. So China produces 8 billion pairs of shoes for the world market. It is similar for home appliances: for refrigerators, air conditioners, and washing machines, China has 50% or more of the world's total production. But China has only 17% of the world's population.

We need to strengthen domestic demand. This is necessary. But we must also realize that the domestic market can never absorb our existing production capacity, even if domestic demand normalizes and increases. There are only two possible solutions: One is, we completely reorganize our economic structure. The other is that we continue the reform and opening-up policy and fully integrate into the world market."

Presumably, the Chinese government will do both - transform the country's economic structure in the long term AND stick to globalization in the sense of linking economies worldwide.

The new economic model of two cycles - an inner cycle of economic growth and expanded consumption, alongside trade exchange with the world - points to the intention to expand the domestic market and reduce the one-sided export orientation while being a partner in the global economy.

Nevertheless, the government continues to use monetary and fiscal policy levers. China's central bank has lowered interest rates, even though this is the first time in a long time that the Chinese currency has fallen below the level of 7 RMB to one U.S. dollar. Tax breaks for private companies are intended to boost industrial production and secure jobs. In addition, the government has presented a plan for the transportation infrastructure, according to which the central highway network is to be expanded by a further 11% to 130,000 km by 2027. By comparison, the interstate highway network in the U.S. is about 98,000 km long. China's rapid transit network, operated by the China State Railway Group, was 42,000 km long at the end of 2022 and is to be expanded to as much as 53,000 km by 2027. The minister in charge said these plans would boost the economy in the short term and provide more jobs (Nikkei Asia, 5/31/23). But not a word about the profitability of these investments and about the longer-term maintenance of this infrastructure, which is fantastic by international standards.

For many economists, such programs, encouraged by loose monetary and credit policies, are indeed an investment turbo. But at the same time, they reinforce the misalignments in China's economy and drive up the share of bad loans even further. A director of the research institute of the National Development and Reform Commission NDRC, which designs and guides China's state planning and industrial policy, described insufficient private demand as the main problem of China's national economy. But this problem cannot be corrected by short-term policy measures, he said. Far-reaching institutional reforms are needed. He identified significant problems in housing policy, unemployment insurance, the pension system and health insurance, especially for the middle and low-income groups, including migrant workers in urban areas. Addressing these problems would not only improve the living conditions of these groups and create more social equality. It would also increase private consumption (Caixin, 7.6.23).

Less growth, but more jobs

It remains to be seen whether and to what extent this rather social-democratic program will be implemented in practice. After all, the Chinese Communist Party has taken up the cause of promoting "shared prosperity" since 2017. "Business as usual!" will not work. This is also clear from an article by Zhang Jun, dean of the Faculty of Economics at Fudan University in Shanghai.[5] He discusses the changes in China's growth targets over the past 30 years:

"Over the past three decades, growth targets have to some extent become a self-fulfilling prophecy. From 1993 to 2013, these targets were practically taken by the Chinese central government as an indication of its hopes. Therefore, the actual growth rate was far above the government's targets. Yes, structural forces worked to China's advantage during this period. Local governments faced political incentives to implement their growth strategies-including investment in fixed assets and industrial planning-in a way that matched the central government's priorities and expectations.

The slowdown in China's GDP growth over the past decade is not due to misguided policies, but to a new policy approach. From 1993 to about 2013, GDP growth was the central government's primary goal and determined the policy approach to macroeconomic management. This goal - which local governments were tasked with achieving - led to accelerated public capital formation, an improvement in the investment environment, crowding-in of private capital, and the creation of more productive capacity.

However, this approach faces its limitations, which are rapidly rising marginal costs. Although productive investment drives growth and development, excessive investment leads to diminishing returns and rising debt. The principle of making growth the top priority has also led to significant environmental damage in China, such as air and water pollution."

The immediate social costs associated with this approach eventually led the Chinese government to adopt a new strategy focused on job creation and macroeconomic stability. China has already achieved considerable success in the area of employment. In the last ten years, about twelve million jobs have been created annually in urban areas. This far exceeded the target of eleven million - which was much more binding than the GDP target.

China owes these gains primarily to rapid advances in high-tech sectors such as the platform economy and electric vehicles. New digital technologies have fueled rapid growth in the service sector and strengthened the resilience of the labor market in general.

If the economy can create enough jobs, ever-faster GDP growth is simply not necessary. Even when GDP growth fell to about half the annual average (10.2 percent) from 2002 to 2012, there was no significant social unrest in China. Similarly, despite the pandemic-related downturn, there was no financial crisis or economic contraction that would have wiped out past progress in living standards.

China will continue to benefit from the change in emphasis of its policies - namely, away from a growth orientation and toward a focus on jobs. This approach is more conducive to the implementation of structural reforms, which are needed to limit overinvestment and advance debt reduction. Moreover, this strategy is also likely to drive the introduction of new technologies, thus setting in motion a virtuous circle of job creation and productivity growth.

An unfavorable external environment is another reason for China to look beyond growth. The global economy as a whole is struggling with declining productivity growth and falling demand - trends that are not likely to reverse in the foreseeable future ... More broadly, geopolitically motivated economic policies - not least the restrictions imposed by the United States on trade with China - are creating significant uncertainty in global supply chains and financial markets.

In advanced economies, the era of high growth and low inflation is over and is being replaced by the "secular stagnation" long warned about by former U.S. Treasury Secretary Lawrence H. Summers. In this context, it is right for emerging economies like China to abandon the illusion that high growth can be sustained indefinitely. The more likely scenario is probably a long period - perhaps a decade - of slower growth ..."


Sources

[1] Report by Xi Jinping at the XXth Party Congress of the Communist Party of China (Oct. 16, 2022), quoted from the unofficial publication in German.

[2] Richard Herd: Estimating Capital Formation and Capital Stock by Economic Sector in China : The Implications for Productivity Growth, World Bank Working Paper No. 9317, Washington 2020, at: https://openknowledge.worldbank.org/handle/10986/34126

[3] For a brief overview of China's social systems, see my essay: China, the Coronavirus and the World Economy, in: Socialism 4/2020

[4] Sun Liping: Three Views of the Domestic Demand Question, published on Sun Liping's WeChat blog on 12/12/2022; translation into English by David Ownby and published in his newsletter "Reading the China Dream"

[5] The German translation of the essay "China's Abandoned Illusion of High Growth" by Zhang Jun is taken from the newsletter China.Table #606 on 6/20/2013.

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