Author of “Broken China”: China’s Economic Miracle Has Already Collapsed

Voice of America interviews Wright, author of the book "Broken China," to explore the end of China's investment-driven economic model, the real estate crisis, local fiscal distress, and the impact of China's economic weakness on global trade and U.S.-China relations.

Video link:

Full text:

Mr. Wright, thanks so much for making time for us. Let's start with the title of your new book, Broken China, How the Economic Miracle Shattered and what it means for the world. That's actually what caught my attention and made me reach out to you because it challenges the conventional wisdom. People are saying China is the world's second largest economy and it remains extraordinarily competitive in manufacturing and technology. But now you are arguing that China's economic model is broken. So my question, what is China's economic model by your definition and what made you think it is broken?

Sure, and thanks very much. I just preface my remarks by saying that the book, Broken China, and my remarks here are in my personal capacity, and they're not representative of Rhodium Group as a whole. The book is titled Broken China because this investment-led growth model that has depended upon credit has basically come to an end. The argument of the book is essentially that you can't really look at China's past economic, if you look at it through a financial system lens it looks entirely different. This is a country that has had a massive credit boom and now a massive credit bust and at the end of this unprecedented credit expansion one of the largest in the world in at least a century and perhaps longer and so if you factor in the implications on future growth that the financial system now constrains China's economic growth then the takeaway is that much of China's external messaging, much of their message to the rest of the world that Beijing has been successful and therefore their rise is inevitable is wrong. And it instead, China faces a much more constrained economic future and so the point of the title Broken China is not to say this is another bearish book about China, it is not a prediction, it is a diagnosis, or an explanation, of what has happened.

Sure. So for years, China basically was an investment-led economy and with more investment than household consumption because China had many years of catch-up growth. So it made sense to invest. And in order to invest, build infrastructure, build new factories, build new manufacturing capacity with the help of foreign capital, most of this was very profitable in the early years. Therefore it made sense for banks to aggregate that capital and to basically compel savers to direct resources toward state-directed companies and toward those investments, which it was generally very constructive for a while.

But any financial system can only expand as fast as the underlying economy that it is financing. And so when a financial system expands faster than that and is actually driving growth, either one of two things is happening. It is either deepening financial services making credit cards available to people who haven't had credit cards before and therefore offering new forms of financial services or it is adding credit risk such as making subprime mortgages available to people who couldn't necessarily afford to pay them and often these go hand in hand. When you're making new financial services available you're also probably taking on new credit risks in providing those.

And so the question in China is always how much of this new investment is actually productive of new economic activity. And for any individual bridge that you build across a river, it probably makes sense to build the first bridge across a river, right? No one's had one before, it unites a lot of economic activity, trucks and cars can go back and forth, all of a sudden even if this is expensive, it makes a lot of sense.

Does it make as much sense to build the second bridge? Well, sure, probably, but it's less important than the first. And when you get down to the tenth bridge, it's more and more questionable. In any individual project, you'll have to look at the project economics. But for an economy as a whole, we look at the credit to GDP ratio and the growth of aggregate credit relative to overall GDP.

And so in this period after the global financial crisis from 2008 to 2016, China added about a third of global GDP in new bank credit and roughly doubled their credit to GDP ratio. And frankly, we've never seen anything like this over such a limited period of time and many of the consequences that China is now facing is because the bill for all of that lending is now coming due.

You mentioned China's property sector, and you start your book with a protest in 2021. It has been five years, and those who protested are now in prison. So, how will the government handle the property market? Perhaps you feel they cannot do enough?

So, let's talk about the cake. Hmm, yeah, so the story in the book opens with this protest. That takes comparison. Eyes are extremely rare and cannot happen very often. Um, and look at a financial crisis. One wants to say, okay, I see bank deposits lined up outside the bank, like it's in a wonderful life. Everyone's wondering where their deposits are. Or I'm looking for sort of the Northern Rock or Lehman Brothers moments in this financial crisis in China, right? That happened basically not at a bank, but at property developers. And it happened largely in offices like Evergrande's. So, instead, this protest happens in the headquarters of Evergrande. Had borrowed was China's largest property developer. It had borrowed $310 billion at its peak, an amount that's roughly the GDP of Finland at the time. And so these are just massive, massive corporations with these enormous debts. And it became harder and harder to finance them as long as property, as long as sales weren't continuing to rise, as long as sales weren't continuing to rise at the same time.

So, as a result, since which China's largest company and its most important industry essentially cannot repay even its own employees in the loans that they have made to the company, it is suggestive that the broader economy has a larger problem as well. China's property sector was around 20-25% of GDP at its peak, maybe even a little bit larger. Since then, you've seen property new construction fall by almost 80%, and new sales fall by a bit more than 60%. It's taken roughly 10-12 percentage points of GDP off of the economy as a whole as that has slowed down.

And so the question is, you know, Beijing tried at various points to sort of stabilize the damage. And just over the last weekend, they've actually unveiled some new measures to sort of restructure the market at the same time. But largely this has been ineffective because you can't make people buy apartments that they don't necessarily want if they don't think that the prices are going to go up anymore. And what has fundamentally changed is that when everyone can see that there's way too many apartments, there's fundamentally no belief that property will continue to rise in value.

For years, China depended upon property as a financial asset. And it was this enormous generator of wealth for the Chinese middle class. If you had bought an apartment in Beijing, Shanghai, Hangzhou, Nanjing, Shenzhen, Guangzhou sometime in the 2000s, by the mid to late 2010s, you were probably a US dollar millionaire, at least on paper. So this was enormous. This unlocked enormous wealth creation. And the question now is, if that is gone and it is actually trending in the other direction, what can really replace it? Because it is not obvious how you actually find those sorts of sources of upward mobility for middle-class families.

那么，你认为中国无法解决这个问题吗？我的意思是，如果你是习近平的经济顾问，你会告诉他，解决这个问题的最佳方法是什么？

I think, I think there are several formal methods to solve this problem. These are political problems. And I'm not doing political analysis. These problems are where the fiscal policy will be decided. So, China can easily replicate its fiscal system. The fiscal system is facing declining fiscal revenues because most of the fiscal revenues depend upon investment-led growth, which is weakening. So you need to restructure that. You need to start taxing, you know, household consumption. But it's hard to tax household consumption because consumers don't necessarily want to, you know, don't necessarily have the capacity to pay more tax. And so you want to be encouraging consumption at the same time as you're taxing it. So if you want to tax the wealthy, you can do that, and Beijing is trying to do that, but it's always difficult to tax the wealthy everywhere. The more difficult choices are state-owned enterprises and local government enterprises. You basically have to tell many of these enterprises that they no longer fit within the national plan. But that's sort of the opposite of what China is doing right now. They are doubling down on investment-led growth. They're focusing on advanced manufacturing. And the problem with advanced manufacturing, AI, robotics, the, you know, all of the new strategic industries that China is focused on is that they're very capital intensive rather than labor intensive. They don't employ very many people. And if the economy stays imbalanced between investment and consumption, then every, the marginal demand for everything that China produces is still more likely to be found outside of China rather than inside of China. So it's uncl

ear, you know, this may be doubling down on a model that is going to generate more trade tensions with the rest of the world precisely because China's, if China can't generate domestic demand, they have to continue to rely upon exports to maintain growth. So, I mean, my advice would be some version of, you have to accept slower. I mean, obviously there are political trade-offs all involved, but that this capital-intensive, advanced industries focused manufacturing-led.

So, what does broken China mean for the world?

So, What does broken China mean for the world? And, Can China export its way out? So, This is the question. At some point, Everyone is happy to have cheaper goods for their consumers, but it comes at the cost of domestic producers. And as China's surplus is increased, It's also increased increasingly because of lower prices at which exports have been distributed. And that all sounds fine up to a point until that is ending up reducing investment incentives for these industries around the world as a whole. So countries do want to maintain a certain level of production within their own borders or within among friendly countries. And ceding manufacturing value-added to China over a longer period of time seems like a pretty bad bet if China is also weaponizing supply chains and threatening to withhold critical exports from the rest of the world. So there's a natural push to sort of rebalance, as Secretary Besson said, the global economy away from, toward more investment in the rest of the world, toward investment in sort of non-Chinese supply chains, and Beijing is resisting that. So the challenge for Beijing is this, if they cannot generate domestic demand within their own economy then trade tensions are inevitable because you're the world's largest investor so you can only grow relative to the rest of the world by basically displacing investment from your trading partners but if imports aren't growing it's less attractive to actually trade with China overall and so instead you see Beijing starting to use more sticks than carrots in trying to encourage.

of just how far Chinese exports can grow. And there's limits when most of the marginal growth in China's exports is in developing economies at this point rather than even the US, EU and Southeast Asia. So let's talk about the upcoming summit between President Trump and President Xi Jinping. Do you think China's economical weakness will give President Trump more leverage than what he had a few years ago? It looks very bad. I think that a few years later, the US had much more support over the years. I don't think whether the Chinese Communist Party (CCP) uses it in this resolution. They might have different tactics. But I would say that in 2020, in 2021, there was a practical issue that China could take to get from the US emnbi terms as a proportion of the global economy. That is really no longer a realistic possibility. The US economy could always crash, you can't forecast the future, but the US has outgrown China over the last five years in nominal dollar terms, in renminbi, in nominal dollar versus nominal renminbi terms, at the same time. Yes, US inflation is higher, but the problem is that deflationary pressure in China is.

and non-tariff barriers as well then that is likely to be a more effective form of leverage than controls over supply even including something as vital as rare earth minerals so there will likely be ongoing negotiations about trading off leverage over demand versus leverage over supply and the point I make in my piece is that the US has far more powerful tools over time Because if US agents are all unified, China cannot generate popular consumption, and based on China's power and energy, it naturally cannot lose the global export market, so the power of interest comes not only from the US, but from the US as well, and there is even more power. I wish we had more time, but time is up. Thank you once again, you all together.