Understanding China's Global Ambitions Part 2B: New Problems atop Old Ones

This was a long one, so I split it into two sections. This is part 2b. Enjoy!

Incomplete building projects like this one dot urban landscapes across China. With debts soaring and funds dwindling, there’s a high chance many will never see completion. Image source

The property market

What started as a means to create homes for the working masses has morphed into something that weighs heavily on the Chinese public today, especially amid credit defaults from some of the country's largest developers such as Evergrande and Country Garden. For decades, China's property developers constructed massive apartment blocks throughout the country with practically no limits on their access to credit. 

In a communist society that prioritizes social harmony and face, keeping people employed is a significant priority. For this reason, large firms that employ many people receive lavish loans at favorable rates from banks - their boards and management teams stacked with CCP members – with little regard for their financial performance. In this way, banks applied little to no scrutiny to loan applications from property developers, who simultaneously created upward mobility by building new homes for the middle class while employing millions of migrant workers in vast construction projects. This kind of lending is dangerous in a system with little oversight and accountability. 

For decades, the market for new homes seemed endless as millions of Chinese joined the middle class each year. Moreover, China lacks well-regulated and trustworthy investment opportunities in its stock markets, and this, combined with restrictions on international cash flows, left wealthy people with few options for worthwhile investments. For this reason, China's wealthy bought multiple homes – sometimes hundreds of units or more – driving up prices across the country, especially in major cities such as Shanghai, Beijing, and Shenzhen, where homes can cost more than 43 times the average worker's salary. These high prices eventually placed home ownership out of reach for most. 

What emerged was a vicious cycle. As China's number of affluent people grew, they bought more homes, making them increasingly unattainable for the growing middle class. Developers borrowed more money to finance projects and purchase land on which to build them, with the money from land sale auctions providing the vast majority of funding to local governments. Debts skyrocketed as the rich grew richer from ever-rising home prices, and local governments spent lavishly on grand infrastructure projects that also enriched building contractors. Bank lending and special purpose bonds (SPB) also funded much of this lavish spending by local governments, causing local debts to skyrocket. For years, top government officials warned that this was unsustainable. When Xi Jinping came to office, a consensus emerged that something must be done.

Xi primarily addressed the problem by immediately and dramatically limiting developers' access to credit in August, 2020. These measures sent precipitous shocks throughout the system. Money from land sale auctions dried up, and local governments could no longer maintain their budgets or even service their debts. With no means to default, local debts continue to add to the country's sovereign debt with no end in sight. Because opaque and unaccountable systems obscure much of this debt, experts believe that trillions of dollars of China's debts are 'hidden' and likely to re-emerge sometime in the future. 

Construction sites across the country remain dormant due to a lack of funding, and home buyers, forced to purchase years before a project's completion, must now pay mortgages on homes they may never inhabit or risk losing their investment. The contagion has already spread to the global market, with countries like Australia forced to deal with slumping demand for iron ore as China's demand for steel falls steadily. Offshore creditors are negotiating with China's property developers to restructure their debts.  

Home prices – the backbone of household wealth for China's middle class – continue to fall. According to Bloomberg, for every 5% Chinese home prices drop, they wipe out $2.7 trillion in personal wealth. One former Chinese official admitted that there are now more vacant homes than the combined demand of the country's 1.4 billion people can fill. By some estimates, China has enough vacant homes for 3 billion people. However, many of China's homes fall into the 'tofu dregs' category – cheaply constructed and essentially unusable buildings meant to present the image of a completed project, often as a means to attract investor money with no hope of anyone ever living there. For these reasons, home prices will almost certainly continue to fall, if not collapse, even despite government attempts to cap these downturns.

China's property market is the most significant component of its economy, comprising some 30% of its GDP. This figure is roughly double that of the U.S., even in the lead-up to the 2008 financial crisis. The ongoing collapse of China's housing market will likely shape the international calculus of its elites for years—something we will explore further in Part 3. 

Falling home prices threaten to eviscerate billions of dollars in personal net worth across China. Image source

Import reliance

China produces more manufactured goods than any other country, accounting for over 28% of the global output – nearly double that of the U.S., its closest competitor. However, unlike the U.S., China is not rich in natural resources and must import the vast majority of raw materials needed to maintain this output. Moreover, China's massive urban middle class relies heavily on imports for even basic necessities: the country has been a net importer of agricultural products since 2004 and relies heavily on imports for its fuel needs. 

China continues to push toward resource self-sufficiency, with some degree of success. For example, it has paradoxically increased its green and coal-powered energy output in recent years because it has both at home in abundance. China is also producing more of its food domestically. Still, with just 10% of the world's arable farmland and a fifth of the world's population, China will likely remain reliant on imported food for the foreseeable future. Moreover, the vehicles, heavy machinery, and massive petrochemicals sector needed to maintain China's modern economy rely extensively on oil and gas, which it primarily purchases from Russia and the Persian Gulf. China also sources much of the mineral resources it needs to sustain its electronics manufacturing sector – the world's largest – from Africa, Latin America, and Southeast Asia. 

Just as was the case for the Ming and Qing dynasties, China exerts little control over the systems that bring the goods it needs to and from its shores. Unlike the U.S., China possesses a limited ability to project military power outside its regional sphere of influence. Although China possesses more naval vessels than any other country, most of these cannot travel far from China's shores, making the force primarily defensive in nature. Although China continues to expand its blue water(long-range) naval capabilities, it remains far behind the U.S. Moreover, Japan continues to invest in its blue-water naval capabilities, and whether China's naval power exceeds Japan's is a matter of debate. For this reason, China relies more on foreign blue water navies, such as that of the U.S., to patrol the world's oceans and safeguard its trade routes than it does on its own naval force.

The confluence of geography and American power also limits China's ability to assert itself internationally. In Asia, a string of islands known as the first, second, and third island chains lock China in regionally. These chains include American military bases and increasingly hostile powers from Japan in the north to Taiwan and the Philippines in the south and Guam and Hawaii to their furthest extent. These island installations largely dictate whether vessels may enter or leave the waters surrounding China. Should China engage in hostile actions on the world stage, military forces on these island chains could move to limit China's ability to import and export goods severely. For example, the closure of just one strategic chokepoint – the Strait of Malacca – would practically eliminate China's ability to import oil from the Persian Gulf entirely and most of its current imports from Russia. 

Because China's modern economy relies extensively on imports, and because China is geographically strung in by external military power, it must adhere to the demands of the outside world to a large extent, lest it reap catastrophic results. Beijing's continued balking and chafing under this paradigm increasingly defines its role on the world stage in ways we will explore in greater depth in part 3. 

China’s blue-water naval ambitions put it at loggerheads with the military powers present in its first and second island chains. Image source

Demographics 

Demographics are China's third great strategic liability on the world stage. Although the Mao era produced a substantial demographic dividend that comprised China's massive labor force in the late 20th and early 21st centuries, more members of this generation age out of the workforce each year. Because Mao's successors feared overpopulation, they introduced a 'one-child policy' between 1980 and 2016. For decades, China's policymakers hindered births across the country. Factions often embarked on zealous campaigns to this end, such as the 1991 ‘100 Childless Days' campaign in Shandong's Guan and Shen counties that forced all women to undergo abortions, regardless of the stage of their pregnancy or if it was their first child. 

Although China abandoned its one-child policy in 2016, birth rates remain low, at 1.16 births per woman nationally and just 0.7 per woman among registered residents in Shanghai, the country's wealthiest city and largest financial center. These figures fall well short of the 2.1 births per woman needed to sustain a population. As in the West, this lack of fertility stems from economic issues amid high housing costs, stagnant wages, and rising unemployment among young people.

As a result of these trends, China's population continues to age faster than almost any other country. This aging demographic not only limits the workforce that built China into a modern global economy, but it will also steadily drains the system of resources. The impact of China's demographic crisis has already produced sweeping effects. For example, the military continues to struggle to reach its recruitment goals, in part due to the legacy of a one-child policy that keeps parents reluctant to put their only children in harm's way. Moreover, thousands of preschools and schools across the country continue to close due to a lack of enrollment, potentially leaving millions of teachers unemployed in the coming years.  

Whereas five workers supported every Chinese retiree in 2020, this figure will fall to 2.4 workers per retiree by 2035 and 1.6 workers by 2050. With a limited social safety net and laws requiring children to provide for their elderly parents financially, this burden will drain China of the cash needed to sustain consumer spending and investment moving forward, limiting growth opportunities. China's policymakers are acutely aware of this domestic challenge when engaging with the world today, and it also shapes their calculus toward it in ways we will explore in the next part.

By 2050, China’s demographic structure will require a dwindling workforce to care for a much larger, elderly population. Image source

Conclusion 

China's century of humiliation ensured its economic ascent was accompanied by rapid military expansionism. Now that China faces multiple and severe crises at home, its role on the world stage will likely be underpinned by an even greater degree of paranoia and insecurity. After all, its elites fully understand the consequences of foreign subjugation. Because China relies on the outside world to fuel its economy, it is inclined to use military expansion to safeguard its burgeoning regional and global interests. However, China is geographically strung in by foreign military power, putting it at loggerheads with the American-led international order. 

A growing sense of insecurity, exacerbated partly by a loss of face, is why China continues to close itself off from the world despite its profound reliance upon it. It is why China's surveillance state continues to expand rapidly over a populace that is both increasingly struggling economically and shrinking under extreme pressure. The public also stands to lose face, increasing the chances of revolt. These challenges and the cultural and systemic factors that will dictate the government's response to them are mainly why I left China two years ago. They also underpin China's contemporary foreign policy, which we will explore in greater depth in Part 3. 

We've covered a lot here, so here are some core takeaways: 

• China continues to close itself off from the world. Avoid spending time there if possible. If you must go, make it a short trip, and don't post anything about China online.

• The Chinese system is characterized by face, factionalism, money, and a kind of managed chaos. It lacks transparency and legal accountability and is highly prone to corruption. 

• China's modern society relies heavily on imports, yet it cannot safeguard its global interests militarily. Beijing continues to expand militarily yet remains hemmed in regionally. 

• China's property and local government debt bubble is vast, and we've likely only seen the beginning. This problem isn't going anywhere. 

• China's demographic challenges will hinder its growth and development, possibly for generations. 

Stay tuned for Part 3 next week!