“China is facing major challenges that go beyond its real-estate crisis”

Why is the real-estate market so important to the Chinese economy?
Eichenauer: Many Chinese own one or more homes as a form of retirement pension. Most Chinese citizens’ savings are in the real-estate market. That’s why the middle class has been hit so hard by the real-estate crisis.

Are there any other reasons for the economic crisis in China?
Eichenauer: People’s trust in the government has collapsed. The strict COVID-19 restrictions and then the sudden discontinuation of these measures have contributed significantly to this attitude. The sudden and surprisingly intrusive regulation of tech companies in recent years has partly caused the loss of confidence in the future role of the private sector in the Chinese economy. And, finally, there is youth unemployment, which creates the lack of income available for consumption.

How does a psychological factor like the lack of trust affect the economy?
Mikosch: People only consume and invest when they have confidence. Investment in particular has been a very important factor in Chinese growth in recent decades.

How can trust be regained?
Eichenauer: You could support people living in poverty by giving them consumption vouchers. Or one could strengthen the state pension system, which is underdeveloped in China. However, such socio-political measures are not consistent with the ideas held by the current leadership of the Chinese government.

Mikosch: These political leaders have adopted a somewhat different mindset than their predecessors. Economic development for the population at large is no longer the top priority. The geopolitical rivalry with the United States is the main consideration.

Is the country’s authoritarian system of government perhaps also reaching its limits?
Eichenauer: Yes, possibly. The more a country develops economically, the more creativity and independence are needed. Once a certain stage of development has been reached, it is no longer simply enough to copy products from the West (reverse engineering) and manufacture them more cheaply. Rather, one has to develop one’s own products and engage in so-called forward engineering. The Chinese education system is not geared towards this, and entrepreneurs lack the confidence that they can reap the fruits of their labour.

Returning to the real-estate crisis: could we now simply trust market forces and hope to see a shake-out in the market?
Mikosch: In principle, yes, but market adjustments can take a decade or more and be very painful. We saw that in Spain, Iceland, Japan and Switzerland in the 1990s. I would advocate moderate state intervention. The government could offer indebted private and semi-public players in the real-estate market opportunities and incentives to reveal their debt and restructure it. This would get their debt out of the system partly by writing it off and partly by paying it out to state-run bad banks.

What does the economic crisis in China mean for the Swiss economy?
Eichenauer: Basically, the global economy – with the possible exception of the US – is faltering. China’s crisis is being exacerbated by this, instead of the country’s post-pandemic consumption potential boosting the global economy, as had been hoped. This is affecting the Swiss economy both directly, because it can export fewer goods to China, as well as indirectly, because other export-focused countries such as Germany are demanding fewer intermediate products from Switzerland.

Mikosch: China is no longer just the world’s workbench and has become an economic locomotive as a consumer. When the engine of this economic locomotive falters, Switzerland also feels the effects. The Swiss watch industry, for example, exports many luxury watches to China and is therefore affected by weak demand there. Fortunately, the Chinese financial sector is not internationalised, so China’s real-estate crisis will not trigger a global financial crisis. Evergrande is not a second Lehman Brothers.

Should Swiss exporters be looking more towards other Asian countries for diversification? India, for example, has replaced China this year as the world’s most populous country.
Eichenauer: Diversification of supply chains and foreign markets is definitely a good idea. This reduces dependencies and increases resilience in the event of local production problems. Other Asian countries will benefit from China’s weakness but will never be able to replace or displace China simply because of the country’s size. Vietnam, Malaysia and Indonesia are simply too small compared with China. Consequently, the European economy cannot completely decouple itself from China, and no one is currently attempting to do so. Economic integration is worthwhile on the whole. India has a lot of potential but is still wrestling with many internal problems such as ethnic tensions.

Some observers see China as facing an invisible growth ceiling, the so-called middle-income trap, which countries like Mexico and Argentina have already failed to overcome. Is there any truth in this theory?
Mikosch: The theory of the middle-income trap is essentially a statistical observation that developing countries no longer grow much beyond a certain level of development. A central tenet of this theory is that, above a certain level, very little growth can be generated from the adoption of foreign technology, and countries then fail to lay the foundations required for their own technological progress. In reality, however, there are many reasons why different countries grow at different speeds. In my view, the middle-income trap has not established itself as an evidence-based academic theory. I do not believe that China has hit a growth ceiling; on the contrary, it still has strong growth potential, especially if it manages to deal with its real-estate crisis. Although China will no longer be growing at 5 to 6 per cent annually, it can achieve 4 per cent GDP growth over the medium term.