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It is safe to say that attitudes towards the Chinese economy have changed significantly over the past few years. In 2021, if you got your news solely from YouTube, which no sane person should do, the prevailing view was that China's entire economy was collapsing from within and was just days away from total collapse. Today, on the other hand, the commentary zeitgeist has largely shifted towards how China is outright dominating the global economy, with all the usual trappings of strong-willed world leaders and an unwavering amount of fire. Of course, videos from those days were more than just pointless clickbait. It's been over 1,200 days since China was 12 days from collapse, and as far as we can tell, it's still standing. But the current wave of
overly positive coverage of the Chinese economy could potentially be just as misleading. In those years when people predicted China's imminent collapse, the economy actually experienced the most intense year of economic growth in history. But today it has actually been stagnant for the last 5 years, yet people continue to talk about its economic miracle. It's possible that this is simply a case of economists and commentators getting it almost perfectly wrong, but there's something more going on here. It is true that overall economic growth in China has been much slower than usual, and slower than obvious competitors like the US, but what is actually supporting this growth is much more important and sustainable. Their spectacular
real estate crash should, all else being equal, have pushed them into a serious recession, but it didn't because other industries came to the rescue in time. Moreover, these new businesses would probably never have had this opportunity if real estate had remained the center of the Chinese economy. So, was economic stagnation on paper the best thing that ever happened to the Chinese economy? How did the real estate market crash lead to the emergence of these other, arguably better, industries? And finally, has this external success translated into a real improvement in the quality of life of ordinary Chinese citizens?
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qualified financial professional before making any investment decision. Check out the full details in our description. So, on paper, a lot has gone wrong in China's economy over the past few years. The biggest problem was obviously the collapse of the real estate sector, which started with Evergrande in 2021 and then spread to almost all other heavily leveraged developers in the country. This has become a serious problem for several reasons. The first is that real estate was one of the main ways in which Chinese households invested their money. The stock market in China was much more volatile and significantly less profitable than markets in the West. And investing outside the country is strictly
limited by exchange controls. So, if you were a Chinese family with some savings, your options would be a low- interest bank deposit, the volatile stock market, or real estate. So most people chose real estate. At its peak, the entire construction, building materials, financial services, property management- all accounted for about a quarter of China's GDP, so the state of this sector effectively determined the state of the entire economy. Real estate was also a way for many governments to pay their bills without having to worry about the tedious business of collecting taxes from the population. They could simply lease plots of land to developers for 70 years and make a small profit. Around 2020
and 2021, land sales provided approximately 40% of local budget revenues in some provinces. So if the real estate market caught a cold, local authorities also caught the disease. And on top of everything, construction provided work for a huge number of people. This is an extremely labor-intensive process, and unlike factory work, it is almost impossible to automate, as each site is unique in some way. So when the housing market collapsed, it was a triple whammy, hitting household welfare, government revenues and jobs all at once. This is the main cause of the economic stagnation, which has also been exacerbated by the long and strict COVID lockdowns in China, as well as the questionable profitability of large infrastructure projects at home
and abroad, such as the Belt and Road Initiative. None of this could have instantly brought down the economy, despite what was written on the cover, but all of it together should have caused much more damage than actually happened. So why didn't it happen? Well, while all this was happening, the country was shifting dramatically towards high-tech manufacturing, including solar panels, batteries, and electric vehicles, in addition to all the electronics and equipment it was already producing. China's exports of new energy vehicles, which include both fully electric cars and hybrids, have increased about 20-fold since 2019. This has made China the world's largest car exporter, even though it was a fairly small player just a decade ago. So is
this just a lucky coincidence? Did a shiny new industry just happen to emerge just as the old one collapsed? Not quite. In fact, there is a fairly strong causal relationship between the housing market crash and the manufacturing boom, especially in these export- oriented industries. To see this, we have to go back to what really caused the real estate crisis, namely excessive lending. Almost everyone involved borrowed too much, but developers were the worst at it. It worked like this: developers would take deposits from homebuyers, often for apartments that had n't even been built yet. After that, they took out large loans to buy up land leases and construct buildings, which they tried to sell at a profit. This works great while prices are rising, but it's much
worse when speculation slows down and buyers disappear. In response, the Chinese government imposed strict restrictions on lending to developers and even reduced lending to individual homebuyers. The volume of new mortgage loans fell by more than two-thirds between 2021 and 2023, a huge decline by any standard. And remember, many of China's big banks are state-owned. Therefore, such directive restrictions on lending were much easier to implement than in the Western financial system. When the government owns a bank, changing policy doesn't require much persuasion, but this created a new problem. Chinese households are really good at saving.
The level of household savings has remained stable at 30-35% of income, which is four to five times higher than the indicators observed, for example, in the USA in recent years. So, if all that money was no longer going into real estate, where was it supposed to go? Well, the "safety valve ", if you will, was massive new lending to businesses in the areas of high-tech production. New medium- and long-term lending to manufacturing companies grew about tenfold between 2019 and 2023, absorbing most of the loans that previously went into real estate. And this is where it gets interesting, because this is perhaps a lesson for any other economy. We are usually taught that the job of a bank is to take money from people who have savings but don't know what
to do with them, and lend it to those who have productive ideas but don't have the capital to implement them. Depositors get rewarded in the form of interest, founders get their companies, and the bank takes a nice margin in the middle. Everyone wins. Of course, in most countries it has become much safer and more predictable for banks to simply lend to established businesses and people buying homes. There is always a demand for such loans, and they are much less likely to fail than some new startup with an untested idea. But by closing the safe option, the Chinese financial system was effectively forced to do what banks are supposed to do according to economics textbooks. Of course, it wasn't painless, but the good news is that the country is now
much more focused on creating valuable things than on reselling homes at ever-higher prices. The bad news is that over 400 electric vehicle brands and manufacturers have gone bankrupt or gone out of business, which gives an idea of how many companies have been fighting for a share of these new industries. To be fair, many of them were start-up manufacturers with tiny production bases, but it's still a pretty clear demonstration of the economic game plan. Give money to anything that looks even remotely worthy and let them compete until there are a few winners. This is industrial Darwinism, and it is much easier to implement when you have a lot of capital from households that save a third of their income and public lenders that are
much more resistant to financing unprofitable projects than others. But whatever you think about this method, it clearly worked. China now has the largest goods trade surplus in history. It exports so many high-tech industrial goods that even its huge imports of raw materials and food are completely offset. To give you an idea of the scale, China's trade surplus in 2024 is approaching a trillion dollars, more than double the 2019 figure. Of course, this success was offset by real problems due to the prolonged crisis in the real estate sector, but without the turnaround in industrial production, the situation would have been much worse. And as the global energy transition is likely to continue to drive demand for batteries, solar panels, and
electric vehicles, these industries are likely to only grow as export categories, even as the real estate market slowly recovers. But that's just the economy as a whole. GDP is a useful indicator, but on its own it tells a very simplified story about what is really happening. For while the industrial boom was able to save the overall figure, it proved less successful in saving people. It is this gap between official data and the real state of affairs that we built the Economics Explained newsletter around. Once a week, we send out one economic story-the very thing that shapes the world but is rarely explained properly. It's completely free and you can subscribe via the link in the description or via the QR code on the screen now. In any case,
let's get back to China. Without resorting to "at what cost " rhetoric, it is worth noting a few important caveats here. Remember, real estate construction was a huge employer, as building apartments, even those that look like they were copied, is almost impossible to automate. The modern factories that power this industrial boom, by contrast, are highly automated. These are isolated cases, but some car factories allegedly work with the lights off because there is simply no one to look at them in the workshops . So while manufacturing output may have offset the economic losses from real estate, it did not replace the lost jobs. Youth unemployment is of particular concern, as its level is significantly higher than the national average.
The government even stopped publishing this data for a time in 2023 before bringing it back with a revised methodology. And this comes at a time when many households have already seen their main financial " airbag"-their real estate- take a serious hit. Even those who were lucky enough not to invest in unfinished projects still own housing that has lost significantly in value. Or, at least, housing, the price of which has stopped rising as everyone expected. So in practice, many Chinese families are afraid to spend money on anything. They are afraid to invest and afraid of losing their jobs. Which leaves us in a strange situation. The macroeconomic story looks impressive on paper: record exports, growing industrial capacity, and the
largest trade surplus in modern history. But the macroeconomic reality for individual households is much harsher. And this can be seen in the prices. While the rest of the world has been struggling with inflation in recent years, China has been dealing with something quite the opposite. Consumer prices have remained stable or fallen since around mid-2023. And while Western central banks were aggressively raising rates to fight inflation, China was lowering them in an attempt to get people to borrow and spend again. It would seem that falling prices are a good thing, but in this case it is a symptom of the country producing a record number of goods that no one inside the country wants to buy. That's why exports have grown rapidly. If no
one is buying domestically, the goods have to go somewhere. Falling prices and high levels of exports may seem like a victory, but they can cause serious problems, especially when other countries start erecting barriers, such as tariffs. And these barriers are becoming higher not only in the US, but also in Europe. Because they also want to protect their local industry from the flood of cheap Chinese goods. This is real vulnerability. If exports are now the main engine of China's growth, and its largest trading partners are increasingly resisting, then the strategy of saving from the real estate collapse through manufacturing becomes
much more fragile. So is there a way out of this situation? Well, theoretically, yes. Domestic demand can be restored if part of industrial income is redistributed to households and people are persuaded to spend their earned money again. But if unemployment remains high and the government doesn't step in to make up the difference, there's no guarantee how long it might take. Meanwhile, China may accidentally become a perfect example of what happens when automation replaces so many workers that there is no one left to buy goods. For the economy as a mechanism, stagnation was probably the best thing that ever happened to the Chinese economy. The loss of real estate as a center of gravity forced funds to be directed into industries that actually produce
things. And this is almost certainly a healthier foundation than constant apartment trading. But for the people living in this economy, it has n't yet yielded results. And until that happens, the miracle exists mostly on paper, which is why both of these YouTube narratives were wrong. China wasn't 12 days away from collapse in 2021, and it doesn't just dominate the world today. This is an economy that has changed its engine on the fly and is still trying to figure out how to distribute the benefits among all passengers. Of course, the first step in distributing these revenues is collecting them, which China has historically been pretty bad at. We recently made a whole video about their new tax initiatives, so you can click on it on your
screen now. Thanks for watching, friend. Goodbye.
