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China- Is the dragon getting tired?

Over the last few years, it has become increasingly clear that the Chinese system is not as stable as it was at an earlier time. Starting in the 1980’s, China has grown to be the second largest economy in the world, with some even predicting that it will overtake the United States someday. However, there are several factors that make this unlikely.

Cooked Books

The first factor that makes overtaking the U.S. unlikely is that the GDP of China is very likely simply not as big as it is reporting to the world. Based on data from the World Bank, China’s average GDP growth rate from the 41 years ending in 2021 was 9.27%. During this time, Asia has gone through two massive financial crisis (1997 and 2008) and a global pandemic. Despite this, China has never had a recession over this time period; something that seems hard to believe. If the numbers are to be believed, the Chinese economy is nearly 38 times the size that it was in 1981. For comparison, the U.S. has had 5 recessions during this same period and is a little over 7 times as large as in 1981. While this by itself is not necessarily cause for skepticism, the fact is that China appears to have a system in which leaders at various levels are judged on the economic numbers that their regions produce. (1) This produces an incentive to get the “right” numbers and further incentivizes numbers falsification when the true numbers come in low. This virtually guarantees distortion of the final economic numbers in a positive direction. Even overstating the number by 1 percentage point annually over 30 years can have the effect of implying that the size of the Chinese economy is nearly a 46% larger than it actually is.

A few years ago , several academics (Wei Chen, Xilu Chen and Michael Song of the University of Hong Kong, and Chang-Tai Hsieh of the University of Chicago) looked into additional (aka, harder to fake) data such as tax receipts, nighttime light intensity from satellites, electricity generation, railway cargo and merchandise exports to name a few. They estimate that China has been overstating its GDP growth rate by 1.7 percentage point since 2008. (2) Even assuming that the 2008 GDP numbers were accurate, this would imply that China’s GDP is roughly 24 percent smaller than what the Chinese government is saying it is.

Whatever the true size of China’s economy, it is clearly smaller than what is being portrayed by the government and the popular press. For a system whose entire legitimacy depends on providing prosperity, high published growth rates can for a time satisfy a population that has been promised prosperity with the image of that prosperity being visible in the near future, even if it isn’t currently here in the present. However, that game can only go on so long. When the people lose faith, the legitimacy of the entire system can be called into question, with resulting civil unrest.

Bad Debt

Another concern is that credit allocation in China is more politically influenced than in the West. It is important to understand that the Chinese government views bank lending as a tool to attain the government’s political goals. To the extent that it cares about the economic rationality of lending at all, it is likely only in the context of the fact that economic rationality is necessary to promote economic growth; which is the main pillar of the Chinese social contract keeping the Chinese government in power. Historically, whenever political rationality and economic rationality collide, political rationality virtually always wins in the short run and virtually always loses in the long run. Although the banking sector can, in theory, give loans to anyone, in practice roughly 75 percent of the lending goes to State-Owned-Enterprises (SOEs). (3) These enterprises tend to run in line with the state’s political goals, rather than what business/economic rationality would perhaps dictate. This implies that economically inefficient loans (i.e., bad or troubled loans), are much higher than would be the case in a relatively free and efficient capital market system.

One example of this is in an effort to jump start their economies after the financial crisis, many regions in China turned to debt and started building infrastructure. There have been many stories in the West of “ghost cities” in China—vast urban areas that have been built up with no one living in them. This phenomenon has been somewhat over-hyped in that the Chinese have had a tendency to overbuild and then let the new “city” be inhabited over time. In some cases, a ghost city today may be a normal metropolis 10 or 20 years from now. That being said, some ghost cities are likely to remain that way, as a central planner doesn’t always get things right. In both cases, these developments represent loans that either won’t be repaid for many years or won’t be repaid ever. Consequently, these loans represent nonperforming assets that will act as a drag on bank balance sheets. At best, this can reduce lending capacity economy-wide, and at worst can cause the collapse of banks.

There is some indication that nonperforming loans may be reaching dangerous levels. While the government may downplay nonperforming loans as low, some of this this has to do with the differences in Chinese and Western accounting systems. Adjusting for this gives rates of nonperforming loans that can be three times (or more) as high as the official figures. (4) Some believe that the rates could be as high as 10 percent to 15 percent. If true, this would wipe out the capital base of the entire Chinese banking sector. Last year, the major Chinese property developer Evergrande (2nd largest property developer in China) announced that it could no longer support $300 billion in liabilities. A default of a player of this magnitude has knock on effects in which impacts sectors of the economy linked to it, such as banking, steel, etc. Put another way, the property sector in China accounts for roughly 24% of China’s total GDP (and a similar percentage of employment) (6). Financial stress of the entity is going to have a negative systemic impacts on the Chinese economy.

While some of this is pure speculation, the fact is that the structure of the Chinese political-economy is geared toward high levels of political lending. Some of the SOEs, well known for inefficiency, are kept afloat by loans that are likely to never be repaid. Because of the political incentive of keeping bad news hidden, the amount of bad lending currently in the Chinese financial systems is almost certainly much higher than the official numbers indicate. While the Chinese have been engaged in a deleveraging campaign for a few years by reigning in the shadow banking system, overall leverage is still likely too high. A collapse of the Chinese banking system would have global financial implications and would most certainly result in social unrest and the likely overthrow of the CCP. While this may not be the most likely scenario as the government would likely guarantee the loans and print money to repay them if the guarantee was ever put to the test, a scenario of bank contagion and collapse is at least more likely at some point than the government would like to admit.

Demographic Decline

No analysis of China would be complete without highlighting the demographic challenge that China is facing due to its decades long one-child policy. While the policy did accomplish its aim of slowing China’s population growth, it also artificially created a “baby bust”. This has resulted in an aging population due to the increased life-expectancy over the last 40 years. The effect of not having enough workers to fund the retirement system of the aging population, so well-documented in Western countries, is even more acute in China. Fertility rates in the U.S., Germany, and France (three examples often cited to illustrate the challenges of an aging population) are 1.88, 1.43 and 1.98 per woman, respectively. China effectively had a fertility rate of 1.0 for 35-plus years. Furthermore, the U.S., France, and Germany have at least some experience with migration that augments the population; an experience that China doesn’t share. In other words, as disruptive as aging populations are/will be to Western countries, it will be even more challenging to China.

In addition, the cultural preference for male children has, and will continue to have, socially destabilizing effects. The first is that women born in the years immediately following the imposition of the one-child policy in 1979 are now reaching or have passed peak fertility years. This has means that any effort to boost the birth rate to offset demographic consequences are not likely to have the desired effect as there are simply not enough women to counteract it. Even China’s shift to a two-child policy in 2015 hasn’t significantly boosted the birth rate, and it remains well below the population replacement rate of 2.1 children per woman. In any case, Chinese society, culture, and economy have shifted to the expectation and reality of one child over the last generation and a half. Societies, cultures, and economies don’t shift suddenly simply because the government flipped a switch to a two-child policy. While a two-child policy could eventually significantly raise the birth-rate, it will never reach the replacement rate, even if every woman of childbearing years has two children. The Chinese population is doomed to decline (starting in this decade), and Chinese power will start to ebb with it over the coming decades.


The most recent and unexpected shock to the Chinese system has come from the COVID pandemic. While Western countries have since abandoned most pandemic restrictions and accepted that some variant(s) of COVID-19 are here to stay and have started to live with it, China is opting to strive for a zero-COVID policy that has resulted in locking down over 300 million people in major cities around China, including Shanghai. Zero-COVID is a policy that has been personally championed by President Xi, and so is not likely to change anytime soon, as an admission of failure on this front would undermine the legitimacy of the entire regime. In addition, Chinese media will continue to promote the necessity of these lockdowns, as well try to promote narratives that absolve the Chinese Communist Party (CCP) and President Xi of culpability for the COVID pandemic.

The COVID lockdowns are going to have a negative impact on the economic growth of China. The only question is how long the Chinese government will continue with this doomed-to-fail zero-COVID policy (airborne infectious diseases don’t obey the dictates of governments). At first glance, these COVID lockdowns appear designed to undermine the legitimacy of the Chinese government due to the fact that they cause massive economic damage. Economic growth is central to the implicit Chinese social contract which offers prosperity in exchange for submitting to an autocratic form of government. However, if the economy was due for a contraction anyway, and if it is going to be a pronounced and long-lasting contraction, the reaction to COVID may be politically designed as a way for the Chinese government to blame the disease and the life-saving policies that it was forced to undertake for the economic pain, rather than being forced to admit that it was poor government economic policy that caused the economic downturn.

Strong-Man Rule Indicates a Weak System:

Since Xi Jinping was elected to the post of General Secretary of the Communist Party and Chairman of the Central Military Commission in 2012, he has gradually been consolidating more and more authority in himself. Perhaps the most consequential of these was the elimination of the two-term limit for president, which would allow Xi to be president for the rest of his life. Other concerning actions include building a personality cult around himself in the manner of Vladimir Putin, Kim Jong Un and other dictators from history. Although no one would confuse China with having been a Western-style democracy before Xi, many in the West have assumed over the last 40 years that economic growth, prosperity, and engagement with the international trading system would make China more politically liberal. This has not happened. And now, it appears that China is becoming more repressive, with an expanded surveillance state using facial recognition software and the building out of a social credit system. According to one source, there are 415.8 million security cameras in China, or 54% of the world’s total (7). Xi’s complete hold on the Chinese government was confirmed in the last Chinese Communist Party Congress in October. His power was put on display when he humiliated former Chinese President Hu Jintao and had him led out of the meeting. Taken together, many analysts view Xi as a leader more in line with Mao Zedong than what has been seen in China over the last 45 years.

Although apparently strong on the outside, strong-man-rule systems tend to be much more unstable than they appear. In many ways, all decisions tend to flow up to the leader, thereby creating a single point of failure. In an autocratic system in which a Politburo with multiple independent members have a say, policies will be debated from multiple points of view. In a strong-man system, everyone will be trying to align their positions with what they think the strong-man wants. This means that the strong-man will be told what he wants to hear, meaning that the chance for optimal policies to be implemented becomes rather low.

Witness the disastrous Russian invasion of Ukraine. It is clear that Putin did not understand either the weakness of his military, nor the political situation in eastern Ukraine. In February of 2022, it was clear that Putin was determined to go to war. With a broader based decision making apparatus that required consensus among multiple individuals, it is more likely that Russian leadership would have had a better understanding of the situation in Ukraine and their own capabilities and not made the mistake of going to war.

In the case of China, they are continuing the damaging COVID lockdowns because that’s what Xi wants, just to take one example. And even if this policy makes short-term/long-term political sense, China is far too complex to be ruled by a single individual. Trying to do so virtually guarantees a large policy error that will be massively destabilizing (economically and politically) for China, and by extension, the world.


In seeking to understand China, one must understand that it is facing some short and long-term structural issues that are likely to weaken it over the next decade. From an aging/shrinking population to a large level of bad debt in the economy, China faces some intractable challenges. The fact that they have been overstating their economic growth numbers has helped to mask the economic challenges that China has had, but people (at least outside of China) are catching on to this fact and will modify their interactions with China accordingly.

In analyzing China, it is important to remember that the overarching goal of the Chinese government in general, and President Xi in particular, is to stay in power at all costs. Unlike Western governments and societies that see business & economic growth as something worth pursuing for its own sake, the Chinese government sees growth exclusively as a source of political legitimacy and national power. In other words, if engineering an economic recession would somehow strengthen the hold of the regime, then this is what it would do. And having state control of the media means that they might be able to sell an “economic recession is the road to prosperity” narrative to the population, if it became necessary. This is why the COVID lockdowns, while seemingly undermining growth and the legitimacy of the CCP, might actually strengthen the regime in the sense that they can point to COVID and the life-saving lockdowns that they were forced to undertake as having caused the recession (that was going to happen anyway), rather that government economic mismanagement. While I am not in the habit of attending Chinese Politburo meetings and don’t actually know if this is the reason for the lockdowns, it would explain why they might make sense from the point-of-view of the CCP.

Over the last decade, it is clear that the level of social and economic freedom in China has been reduced. From surveillance cameras, control of the internet, and a social credit system being instituted that can determine one’s chances in life, the government has been exerting increasing levels of control. This, and President Xi’s concentration of power in himself, indicates a government that is not feeling secure in its position. The underlying stresses in Chinese society are not going away, and the concentration of political power in one individual makes it less likely, rather than more, that Chinese policymakers are going to get things right. It should finally be noted that the Chinese system is now 73 years old. Many of the ways of operating were put in place at an earlier time; and while they might have been appropriate at that time, the world is changing. This will increase the pressures within society. And while a concentration of power may be briefly stabilizing of the system in the short-run, it is likely to become much more unstable in the long run.

In the next 10 to 20 years, look for China to become much more unstable, likely to the point that the CCP loses its monopoly on power.

Chris Angle, 13 November 2022


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