Predicting Chinese economic performance is useless.  It’s really impossible to guess, since there are just countless variables.  Given the nature of the Chinese state, most of these variables are confidential, further adding to the hilarity/difficulty of trying to make an accurate prediction about the Chinese economy. Nonetheless, many academics, bankers, and policy wonks have made it their professional hobby to give their two cents.

The pessimist camp is probably the larger of the two.  They argue that China’s 65 million empty apartments, and 500:1 rent to buy ratio are surefire evidence of a housing bubble.  They want to believe an authoritarian political system isn’t sustainable, and that the amount of secret bad loans with national banks will eventually bring the whole house of cards down.

The optimist camp counters that there are still hundreds of millions of peasant Chinese who want to – but have not yet – moved to the cities.  So, it’s inevitable that all these houses will someday be occupied, instead of staying vacant as investment properties.  They also argue that despite high housing costs, most houses are paid for in cash instead of credit.  A housing crisis like that in the US would be much less likely.  Optimists will say that as long as growth continues, support of the government will also continue.  Any bad loans can certainly be absorbed, even if it means tapping into the $3 trillion of cash reserves.

I used to be a hardcore pessimist.  I’ve seen these empty housing plots firsthand, seen stadiums erected where there was no demand for them other than a one-off international sporting event, and seen the world’s largest mall look like some sort of post-apocalyptic movie set.  The idea of “market research” clearly is not an important element of doing business, in most cases.  I think now I am less pessimistic, but would still consider myself “seriously concerned” about a number of economic fundamentals.  Despite the futility of these predictions, here are some trouble areas I see based on observations I’ve made on the ground.  I think they follow the same themes as others have already pointed out, but with some different approaches:

  • Rising incomes: Chinese incomes are rising too fast, and it’s not as localized as it used to be. It may have taken 30 years for Shenzhen worker salaries to go from 500 RMB/month to 1000 RMB/month, but in other cities like Changsha, the 500-to-1000 gap is closing in only a couple of years. The result is that it is impossible to find labor at any reasonable cost in Shenzhen, and the goods produced in Changsha are only marginally cheaper than those in Shenzhen. China’s greatest strength has always been its huge labor force, but this emphasis on high-tech investment is completely diluting that advantage. By the time the far western reaches of China fully industrialize, their salaries will not be all that different from those in Shenzhen. I think the upgrade to value-added, low-labor industry is going to leave many unemployed in the coming years.
  • Capital flight and Brain Drain:  The vast majority of well-to-do Chinese hold foreign bank accounts.  This is not unheard of in the US by any means, but even middle class Chinese people often keep a large part of their savings with international banks.  The highest tier of wealthy Chinese are also buying up investment properties in Canada and Australia left and right.  I believe a solid majority of wealthy Chinese send their children to universities in the US, Canada, or Australia as well.  Given the allegedly robust Chinese economy, why wouldn’t they be sticking with where the action is?  It seems like in Shenzhen, everyone drives a BMW 7 series and has a villa by the sea.  Yet when you look at the numbers, China’s economy is about 2.5 times the size of India’s, but it’s emigration rate is over six times as high.  Maybe Indians have a harder time getting out, or maybe China’s businessmen know something that most people do not.  When they do emigrate, they take their expertise and capital with them.  This is damaging for large Chinese companies trying to recruit world class talent, and also for small innovative firms looking for venture capitalists.  Speaking of innovation…
  • Innovation: As long as financing remains tight, state firms will get cheap loans, while small private businesses will not.  State firms will then seek to buy out/ruin private competition. With no competition or “garage companies” like early Google or Microsoft, I don’t see Chinese innovation being a force anytime soon.  This will be painful in the long term.  Is there a state owned enterprise  anywhere in the world that is on the cutting edge of a specific industry?  The only I can think of is Areva, but even they have a pretty substantial investment from Siemens.
  • Political stability: The politics will give out before the Chinese get rich. I could probably name a dozen people, from middle class office workers to taxi cab drivers, who blame everything on the government. High house prices, poison food, and officials driving around in black Audi A6s are all despised.  I don’t think it will be some terrible violent revolution or a civil war, but I do predict some very significant devolution of powers from the Communist Party to other organizations within the next 5 to 10 years.
  • Housing: The demand will be nearly perpetual, so in the long term, someone will live in these empty houses someday. But issues like quality of the structures themselves, class of apartments (luxury apartments seem to be far more prevalent than “normal ones” in Shenzhen) and environmental issues could precipitate a crisis. Beijing might be on a crazy building spree, but if north China runs out of water (as is happening now), I don’t think anyone will want to live there.  Tianjin has enough office space for the next 25 years and is still building more.  Tianjin also has severe water shortage issues, and demand could evaporate (no pun intended) if environmental problems become severe.
I still don’t think China will have an economic “hard landing”.  The foreign reserves could withstand a very significant financial crash, and the savings rates of most people are quite high.  I think politics will be more of a threat to the economy than bad finances, as prevalent as they may be.