Why the Evergrande crisis is forcing China to rethink its growth model

This column was previously published in L’Express on 24th february 2022

As the collapse of the giant developer threatens to spread to the whole of the real estate sector, Beijing is banking more than ever on the export industry moving upmarket, to the detriment of the service sector.

The worst thing about the Omicron variant is that it is highly contagious, and China is finding out that the same goes for real estate crises. The collapse of the giant developer Evergrande — which even a command economy has been unable to contain — is spreading dangerously to the whole of the sector, and this will lead the Chinese authorities to completely rethink their growth model for the next decade.

This is because real estate does not only account for a good fourth of China’s GNP, but for over 20 years it has also been the main driving force behind domestic consumption, by means of the “wealth effect”. It has been the overvaluation of real estate, estimated today at twice as high as overvaluation seen in the West, that has enabled the Chinese population, with a debt level now similar to the USA, to use loans to finance mass consumption. This scenario is now automatically reaching its limits in the absence of any future appreciation in real estate value.

The new growth driver should have come from the digitization of services, but, last summer, the government stated that the pace of any future development of services would now echo that of political control of young people, who are more interested in discovering the metaverse than in any government propaganda.

The blueprint that has been drawn up seems to be close to that of Germany or South Korea

A risky choice. The blueprint that has been drawn up seems to be close to that of Germany or South Korea, whose per capita GNP is likely be greater than that of France in only a few years’ time. The export industry’s move upmarket should be in two priority areas: automation — by means of artificial intelligence relayed by semi-conductors — and decarbonization — carbon capture being the next main target, after success with the electric battery, and solar and wind energy.

This gives us a better understanding of what President Xi really meant by “common prosperity”. It’s less about the sum of each individual’s prosperity — which is the Western concept — than the promise of the whole country’s rise to economic power. This is a scenario that reminds one of the USA in the 1960s, when trust in technological progress — symbolized by the Moon landings — had galvanized the whole population.

We must remember that, right at the beginning of his second mandate in 2018, Xi Jinping had announced the agenda: from 2020 to 2035 China would first of all be “modern”, before becoming “prosperous” between 2035 and 2049. A way of putting a 15-year extension on the old Chinese saying, “Rich country, poor people.”

This choice of growth pattern, which aims at prioritizing investment in production over increasing domestic consumption, is the opposite of the “dual circulation” that figures in official propaganda. But it is not without certain risks, as shown in the notable slowdown of the economy over the past few months — worse that official statistics would lead us to believe. Over the longer term, a recent Natixis study was expecting China’s potential annual growth rate to be capped at only 2.5% as from 2030. This growth rate would bring China into line with the rest of the world, as a result of a poor increase in productivity and the annual population decline.

Europe must be ready to see China strengthening its world position in the industries of the future

We can therefore see that the plateau reached by Chinese real estate speculation will have consequences far beyond the Year of the Tiger alone. Europe must be ready to see China strengthening its world position in the pockets of excellence of the industries of the future and, on the other hand, being relatively disappointing with regard to mass consumption, as in the digitization of B2C services.

A lot of catching up to do in the service sector. And it is in that very area that the USA will want to win the battle: by buying up Activision for $65 billion — the largest acquisition in the history of global tech — Microsoft is anticipating the metaverse invading the video game world. But, above all, invading the world of corporate software, the main source of future productivity.

It is all very well for the Chinese tiger to get all its claws out, but it absolutely has to make up for lost time in the services sector, which accounts for 70% of the economies of the most developed countries. If it doesn’t, then the USA will be quite right in thinking that time is on its side.

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