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Tsinghua Professor’s Analysis of China’s Economy 

{Editor’s Notes: “The Qianhai Entrepreneurs Summit 2023” was held in Shenzhen City, Guangdong Province on April 20 and 21. Sun Liping, a Social Science professor at Tsinghua University, gave a speech, “Searching for Certainty in Uncertain Times.” {1}  He pointed out that China’s economy has a new dualistic structure, where the state-concerned sector has an ample money supply but the people’s livelihood sector is in a deflationary state. He also thought that China’s economy will be in a long period of contraction as the world is going through a “great disassembly” process to wean itself off of the Chinese supply chain. The following is the translation of an excerpt from his speech.}

The COVID period is basically over. People are all concerned with what to do next (with the economy). I want to talk about three topics.

The First Topic: Dismay about the Long-term Economic Perspective

The first topic is my view on the economic situation.

The Official data has shown that China’s Gross Domestic Product (GDP) in the first quarter of 2023 increased by 4.5 percent. I looked at the movement of capital to see people’s interpretation of the number. It shows clearly that there are two different expectations relative to China’s economy: an optimistic short-term view and a pessimistic long-term view.

First let’s talk about the short-term view.

The South China Morning Post reported that foreign investors had been buying China’s stocks at the quickest pace over the past five years, and at an unprecedented pace since November of last year. However, China’s real economic output has not matched those investment expectations.

My view consists of two sentences. The first sentence: the actual economic growth might be even better than 4.5 percent. The second sentence: People are feeling it is worse than 4.5 percent growth.

Why did I say the actual number might be more than 4.5 percent? Because the actual number of last year’s GDP was likely to be much lower than the (official) number.

China reported a GDP growth of 3 percent for 2022. My personal view is that the reality is far worse – that number was much more substantially inflated than the numbers in previous years. Take an example: Levdeo Auto in Shandong Province. It had a 2022 revenue of over 2 billion yuan (US$281 million). However, the government recorded a revenue of 6.7 billion yuan, three times of the actual number.

However, even if the economic growth beat 4.5 percent from last year, it was only because the base (last year’s GDP) was so low. Overall, people did not feel the economy had a true 4.5 percent growth, especially in the areas that are visibly accessible: people didn’t see as strong an economic rebound as expected.

From the long-term outlook, it is not optimistic at all.  The long-term investment behaviors indicate investor hesitation and worry.

I mainly look at Venture Capital (VC) investment for long-term capital trend. The VC investment has been dominated by the US dollar. Caijing Magazine had a report some time ago: A partner of an investment institute said that, in the past, he used to fly to the U.S. several times a year to raise money, but he didn’t go there at all in 2022. It was not because of the COVID, but because the American investors did not want to meet him – several U.S. dollar investors expressed that, though they were still doing business in China that was their last investment.  (The Overall trend in 2022: American investors and venture capital backed away from Chinese investment)

New Economic Dualistic Structure

Some friends asked for my view on this year’s consumer spending. I said: First, the demand for daily necessities would return to the normal levels; second, there would be a retaliatory rebound in consumer demand in the short term for the leisure and entertainment category; and third, demand for durable goods would likely remain low for a significant period of time.

Three months passed in this year and my predictions proved to be true.

What was the lost-30-years in Japan (from 1990s to now)? In essence it was that as the (housing) bubble burst, people ended up with huge debts, electing to focus primarily on paying down housing debt instead of consumer spending.

People, including officials and scholars, are debating on whether deflation has taken place in China. The supporting arguments include: the money supply has significantly increased but prices remain low. The reason is that the general public does not have money to spend. This reflects the current reality of China’s economy.

I can use a diagram, in the shape of “8,” to explain the underlying reason. The upper circle is the State Concerned economy () and the lower circle is the People’s Livelihood economy (民生).

The state concerned economy includes industries of key resources, key infrastructures, high-tech, advanced manufacturing, and military, as well as government fund-raising platforms. The State-Owned-Enterprises (SOE’s) are here, as well as some important private companies: the county’s main focus is on this sector. It enjoys the greatest monetary resources relative to the lowest labor headcount.

The other section, people’s livelihood sector, has most of the privately-owned, small or mid-sized companies. It has less monetary resources but employs the greatest labor headcount.

I call this the new dualistic structure of China’s economy.

The lower part of this structure (people’s livelihood economy) is in deflation. The upper part, however (the state concerned economy) has ample money supply. Using the term “cold” vs. “hot” to describe China’s economy, the lower part is cold, but the upper part is hot.

This dualistic structure explains the confusion of why there is a huge money supply, but people still don’t have money to spend. It is because most of the money only circulates within the upper circle.

For example, the government and companies had an additional 14 trillion yuan (including printing money) in the first quarter this year. The advanced manufacturing companies took about 70 percent of the money and the government took 12.6 percent to pay back its old debt. We saw a big increase in M2 money, but only within the upper circle.

We can learn three points from this:

One, the deflation that we feel is not the simple economic deflation of a normal economy, because we are in a dualistic economic structure.

Two, the traditional method to handle deflation, such as to increase money supply or lower the interest rate, may not work here. The real problem is that the money is in a closed loop in the upper circle and not coming down to the lower circle. I called it “a stagnant deflation.”

Three, if we focus too much on deflation (at the lower part), we might get into inflation or even stagflation (at the upper part).

Second Topic: A Not-Short-Lived Economic Contraction Period Going Forward

I prefer to use a term that is more vague  “economic contraction” instead of “deflation” to describe China’s economy due to the dualistic structure.

I think we will have an economic contracting period for quite a while in the next several years.

One reason is that, for China, the massive, unified consumption era is over.

China’s economic development can be separated into four phases.

The first phase (the early 1980’s) was to for people to buy daily necessities – China was in short supply of daily essential goods after the Cultural Revolution, so when the opening up policy started, there was a boom for people to catch up on daily essential goods.

The second phase (late 1980’s) was to buy the “three-big-items” – a color TV, refrigerator, and washer. This propelled a new round of economic development in China.

By the end of 1990’s (when the third phase started), most people had the “three-big-items” and manufacturing of those products dropped down to 30 percent of capacity. China started “three-big-mountains” reform – reforming on housing, education, and healthcare systems to make people spend their own money there (the government covered all in the past). China entered its fastest economic growth period, or the housing and car era, with double-digit annual growth, on average.

By now (the fourth phase), housing and car consumption has reached its limit. This time the massive, unified consumption era ends. What does it mean?

First, in the past there was always a dominant leading industry. In the future there can still be some hot industries but there won’t be dominating ones.

Second, in the past as long as a company caught the trend (to move into the right industry) it could make money. This won’t be this case anymore.

Someone said that Chinese like to save but not spend money; therefore, we need to come up with all kinds of measures to generate consumer desire and promote spending.

I do not agree with this notion. In the past, Chinese people would save for a year to buy a color TV or buy a house that was several dozen times of their annual income. Didn’t they spend a lot?

In the 1980’s, the growth of the government’s fiscal income was less than the GDP’s growth. It meant a bigger portion of the growth went to people’s pockets, which propelled consumption. Later on, the fiscal income growth surpassed economic growth. If (the government) had used the faster-increased fiscal income to build up a good social protection system, then people would still be willing to spend normally. However, though money was taken away (from the people), there was not enough social security built up, (so people would have to save money for their own safety).

Great Disassembly (大拆解) of the Global Industrial Chain

The second reason for a contracting economy in China is the increasingly tougher global environment.

All developed countries came from a poor state. If a country did not have war and did not have domestic infighting, it could grow to a relatively prosperous state in 30 years. However, it would reach a ceiling by then. I feel this is where China is.

If the international environment were friendlier (to China), such as more technological cooperation and more export orders, the problem China is facing would be less concerning. But the international environment has changed radically. I call it the Great Disassembly.

People often use the term “decoupling” (to describe the economy between China and the West). To me, “Decoupling” is a regional and technological concept; “Great Disassembly” is a better concept as it is at the strategic, global level.

We are facing a process of disassembly and re-construction after China has become a key player in the globalization of the world’s economy.

There are three main threads of the disassembly: One, Europe’s reliance on Russia’s energy and resources. Two, the U.S.’ reliance on China’s manufacturing (supply chain). Three, China and Russia’s reliance on West’s high-tech, advanced equipment, and finance.

In the past few years, what the world did was to disassemble the reliance. Now the first disassembly of energy reliance is basically completed.

At the beginning of the Russia-Ukraine war, Russia said that Europe couldn’t live without Russian oil and gas. But now? Germany, the European country that most relied on Russian energy, announced on January 1, 2023 that it would stop importing Russian energy. The European economy was not bad last year and this year might be better.

The myth that the reliance cannot be disassembled has been broken. We must understand the seriousness of this. Now disassembly of the second reliance (on the supply chain) and the third reliance (on advanced technology) is happening.

The disassembly of the supply chain is most pertinent to manufacturing in China. There is a tipping point that would cause the supply chain to speed up on moving out of China. A company may find it hard to move out of China before that tipping point.

For example, let’s assume that manufacturing a cigarette lighter will need 25 components. If one could get all those 25 components within a half-hour drive (from the assembly plant), naturally it would make sense to keep the supply chain together (in China). But if one could find 20 of those components elsewhere (outside of China) and could pay a slightly higher price to get the other 5, and other countries offer more favorable polices on foreign investments, then this line of business has passed the tipping point and it is easy for a company to move out (of China).

There is another subjective reason. Many companies, especially the small ones, do not and are unable to do a thorough analysis on their own. So if there is a trend to move out of China, they will just follow.

In the past couple of years, each large company that has moved out of China was a pressure test for China. Didn’t you say that companies have to rely on established supply chains in China and cannot move out? They moved out, so what?

Nowadays some foreign companies are taking a tougher stance when talking to China, because they found that (the reliance on China) was not as indispensable as they had thought. When they move to another country, it might not be as good as (it was in China) initially, but they could survive and will be better off in the future.

The great disassembly presents different issues to different countries. Western countries grapple with the supply problem while  in China it is the demand problem.

The Russia-Ukraine War has shown this clearly. The West didn’t have enough stock nor production capacity for even some regular artillery, not to mention the high-tech weapons. They are willing to pay to buy from the international market. The medical masks and ventilators during the COVID pandemic tell the same story.

An analyst at Credit Suisse said that in the future (the West) will have to manufacture many things in their own countries. This is the supply problem that the West faces.

China, however, is on the opposite side – it faces the demand problem. The problem is not whether Chinese people have enough buying power, but that China’s manufacturing operations were built for the provision of the entire world.

For example, China produces 10.6 billion pairs of shoes in a year. On average a person replaces two pairs of shoes. China’s over 1 billion population can only consume over 2 billion pairs of shoes. It needs the whole world, with more than 7 billion people, to consume the 10+ billion pairs of shoes it currently manufactures.

So during the supply chain disassembly, the first issue China faces is excess production capacity.

Low Consumption Desire

A third reason for China’s contracting economy is the scarring effect of the COVID pandemic. The “scarring effect” was a concept brought up by an American economist. It means that the pandemic will have a lasting effect. It will, like a scar, stay and impact people’s minds, entrepreneurs, human resources, job markets, and corporations for a long while.

I observed netizens’ sharing that their idea of life and how it has changed their consumption behavior since the pandemic made them to rethink the meaning of life.

One person starts to think whether it is worth it to work intensely (from 10 am to 10 pm) without even time for a lunch or dinner break, to make a few dozen thousand yuan?

Another said that they will pay more attention to life itself.

Someone said that they will not buy something unless it is absolutely needed, not buy an expensive item if there is a cheaper one, and not buy a new item if the current one still works. Some people replace their mobile phones (for a newer model) every year, but now they will do it every other year.

A big change during the lost-30-years in Japan is people’s psychological change. To reduce the debt burden, people are willing to consume less. The whole society has entered a low desire state.

Therefore, I think we are going to face a not-short-lived economic contracting period.

Third Topic: China Can Further Develop Its Economy 

(This paragraph was omitted from the translation)


{1} Redian News, “Sun Liping: My Three Points on Current Situation,” May 25, 2023