More semiconductors, fewer homes: China’s new economic plan

China’s political leaders, under pressure to support the country’s fragile recovery, are slowly steering the economy on a new course. They are no longer able to rely on real estate and local debt to fuel growth, but instead invest more heavily in manufacturing and increase central government borrowing.

For the first time since 2005, when comparable data was kept in China, state-controlled banks have begun a sustained reduction in real estate lending, data released last week showed. Instead, huge amounts of money are being funneled to manufacturers, especially in fast-growing industries such as electric cars and semiconductors.

There are risks to the approach. China has a chronic oversupply of factories, well more than it needs for its domestic market. A greater emphasis on manufacturing will likely lead to more exports, an increase that could antagonize China’s trading partners. China’s additional lending also poses a challenge to the West, which is trying to promote additional investment in some of the same industries through legislation such as the Biden administration’s Inflation Reduction Act.

The shift to production lending underlines Beijing’s reluctance to bail out China’s debt-laden real estate market. Construction and housing account for about a quarter of the economy and are now suffering from sharp declines in prices, sales and investment.

China’s investment push could fuel more growth in the coming months, partially offsetting the housing sector’s woes. But more central government borrowing to replace local borrowing will do little to undo the long-term drag on growth caused by rising debt.

“I don’t think there is a problem for short-term development, but we should worry about medium- and long-term development,” Ding Shuang, chief China economist at Standard Chartered, said at a recent forum of Chinese economists and financial experts in Guangzhou. “It’s fair to say that real estate is not at a bottom.”

China’s housing crisis has its roots in four decades of debt-fueled speculation that pushed prices to levels far above what could normally be justified by rents or household incomes. Chinese policymakers caused the sector’s recent downturn by reining in lending several years ago, and are now reluctant to save the sector by unleashing a new wave of home loans.

The government believed China’s economy would bounce back in 2023 after the country’s leaders lifted most of the ‘zero Covid’ restrictions that devastated the economy last year. But after an initial burst of activity, growth slowed in the spring and summer. Vulnerabilities remain: industrial activity fell again last month, after growing in August and September.

Last week, at a conference chaired by Xi Jinping, China’s top leader, Communist Party and government officials met privately to discuss financial policy. According to an official statement afterwards, the conference ordered more financial resources to be sent to advanced manufacturing industries, as well as aid to local governments.

While the housing market is struggling, factory construction, fueled by government-backed financing, is in high gear.

China has already built enough solar panel factories to meet the needs of the entire world. It has built enough car factories to make every car sold in China, Europe and the United States. And by the end of 2024, China will have built as many petrochemical plants in just five years as all the plants now operating in Europe plus Japan and South Korea.

Economists at the recent meeting in Guangzhou held by the International Finance Forum, a Chinese think tank, acknowledged that the country was facing challenges not seen since the years immediately following Mao’s death in 1976. But they predicted that major investments in new production technologies would pay off. out.

“Today we have similar problems as in 1978, so the question now is: what will be the future of innovation-driven growth?” said Zhang Yansheng, a former senior official at the central government’s economic planning agency who is now with the China Center for International Economic Exchanges.

The Chinese banking system’s shift from real estate lending to manufacturing began several years ago, Bert Hofman, director of the East Asian Institute at the National University of Singapore, said at the event in Guangzhou.

Before the pandemic, Chinese banks were increasing their real estate lending by more than $700 billion a year. In the twelve months to September, total outstanding real estate loans fell slightly. Banks lent less to developers, and households paid off old mortgages and took out fewer new ones.

By comparison, net lending to industrial companies shot up from $63 billion in the first nine months of 2019 to $680 billion in the first nine months of this year. That money has been spent partly on building a semiconductor industry that could allow China to wean itself off imports and sidestep US export controls, but also on categories such as electric car production and shipbuilding.

Many economists have expressed concern that throwing more money at manufacturing might not save the broader economy. The real estate sector is still in decline and is so large that it will not be easy to compensate for its problems with growth in sectors such as the automotive industry, which represents 6 to 7 percent of economic output.

The factory-building spree threatens to antagonize other countries: much of the extra production is likely to be exported as many Chinese households have curtailed their spending.

But the United States and the European Union have become less willing to accept further increases in their trade deficits with China. The European Union is already investigating the Chinese electric car industry’s use of government subsidies, creating a new trade divide between Brussels and Beijing.

China is aware of these risks and is trying to woo developing countries. These countries still have sizable, but often aging, manufacturing sectors that provide an opening for exports from newly built, highly efficient factories in China. Many developing countries are struggling to renegotiate large debts to Beijing for infrastructure projects, leaving them in a weak position to raise tariffs on Chinese goods.

Chinese factories have been gaining a dominant position for decades. The country’s share of global output has increased almost fivefold to 31 percent since 2000, according to data from the United Nations Industrial Development Organization. The United States’ share has fallen to 16 percent, while the share of developing countries, excluding China, has remained at 19 percent.

Of course, one thing that won’t change in China’s approach is its reliance on loans to fuel growth.

Officials have tried repeatedly for years to tame the debt addiction. Liu He, vice premier, promised in a 2018 speech that this would happen within three years.

Instead, local government debt has soared since 2020, reaching nearly $8 trillion last year, and local government semi-independent lending units have collected trillions of dollars more in loans. China’s total debt burden has ballooned until, relative to the country’s economic output, it is significantly greater than the debts of the United States and many other developed countries.

Yao Yang, director of the National School for Development at Beijing University, said in September that efforts to control debt had not been successful.

“Between 2014 and 2018, which should have been a deleveraging period, debt skyrocketed; the situation became even worse after 2020,” he said in a speech. “This indicates that previous measures to deleverage were ineffective and in some cases counterproductive.”

Siyi Zhao research contributed.