In September 2023 Nio, a Chinese electric car manufacturer, unveiled its latest product. It wasn’t a car, however, but a mobile phone. The device had the usual capabilities of a smartphone, but it also had more than thirty car-specific functions, such as instructing the car to park itself or drive itself to the owner’s location—something permitted in China at low speeds and in restricted spaces. Nio’s internet-enabled augmented reality glasses let passengers in the car share a computer game or a video meeting. Almost a decade after it was founded in 2014, however, Nio has yet to make a profit from its main auto business. It almost ran out of cash five years after it began, but a state-controlled bank injected US $1.6 billion, and a local government pledged US $1 billion.i Government backing allowed it to absorb the losses and keep going.
Nio’s story offers insights into China’s path to global electric car dominance. The government offers cheaper car registration, preferential parking and tax rebates to electric car buyers. Between 2009 and 2021, it poured more than $130 billion in subsidies into the electric vehicle market—and that’s not counting cheap factory land, tax reductions and other forms of indirect support. Government Guidance Funds provide ‘patient capital’ for long-term investment in early-stage companies in sectors deemed to have national priority.ii Today, new-energy cars (both fully electric and plug-in hybrids) make up more than a quarter of China’s new car sales. The industry leader, BYD, tripled its profits in the first half of 2023 and is so successful that it recently ordered its own fleet of giant transoceanic car-carrying ships which carry more than 5000 cars at a time.
Now, however, China’s economy is slowing under the weight of a deflating real estate bubble, financial crises among large developers and weak domestic consumption spending. Losses in the construction and real estate sectors are a problem because the real estate industry makes up about a quarter of the Chinese economy. Australian Treasurer Jim Chalmers recently described slowing growth in China as one of the greatest risks to Australia’s economy. The concern is wider than Australia because in the five years before 2022, China’s economy accounted for almost one third of global economic growth.iii What does the slowdown mean? To answer this question, we need to understand how China grew so quickly in the first place.
How China grew
China’s economy was severely underinvested when the country began to open up in the 1980s. The government forced up savings, channelled them into a tightly controlled banking system and used them to subsidise infrastructure and the manufacturing sector. China eventually had the world’s most competitive manufacturers and the best transport and logistical infrastructure, but very low household disposable incomes. The government’s control of the banking sector made this possible: people had to deposit what they saved in a government-run bank, and they received interest payments on those deposits at very low rates of return relative to growth. This was a hidden transfer of income from households to the manufacturing and infrastructure sectors. Rural workers who came to the cities for work were also underpaid relative to what they produced, resulting in more such transfers. Under the direction of the government, household and worker savings were funnelled through the state-controlled banking system to fund huge investments in infrastructure and manufacturing capacity.
As Matthew Klein and Michael Pettis show in Trade Wars Are Class Wars, this was a form of ‘financial repression’ that ‘produced a massive and sustained transfer from the Chinese people to large manufacturers, infrastructure developers, real estate developers, and provincial and municipal governments’.iv One result of it was that China recorded the highest savings rate in history: 52 per cent of GDP at one point compared to the global savings rate of 25 per cent. Another, less appreciated result was that Chinese households consumed less than 40 per cent of the country’s output—a much lower ratio than every other major economy.v China’s manufacturing competitiveness came at the expense of its household disposable income.
Structural distortions of the Chinese economy
These structural distortions were recognised by China’s premier Wen Jiabao in March 2007, in what became known as the ‘Four Uns’ speech. He said, ‘the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable’.vi Had China then switched to a growth model that prioritised consumption over investment, the result would have been higher household income and a stronger social safety net. But that would have required an array of new businesses and legal, financial and political institutions – something the government didn’t want. Instead, it responded to the Global Financial Crisis by spending big on transport infrastructure, buildings and other urbanisation initiatives. Infrastructure for the 2008 Beijing Olympics was an important background motive. Time magazine named ‘The Chinese Worker’ as runner-up candidate for its Person of the Year in 2009 for helping the world avoid the worst effects of the meltdown.
Australia’s Treasurer knows that China needed Australian iron ore to make steel for these colossal projects, and that large resource exports to China were one reason for the strong performance of the Australian economy and financial system during the GFC (other reasons included the Labor government’s economic stimulus, the very small exposure of Australian banks to the collapsing US housing market and the Australian banking regulator’s lending standards that largely kept banks away from subprime and other high-risk loans). Little wonder, then, that Chalmers has recently said he shares ‘the pretty substantial concerns people have voiced about the Chinese economy … The weakness, the softness … has obvious implications for us in Australia’.vii The spot price of metals is one of the first things Australia’s Treasury officials look at every morning, and with good reason: the price of iron ore underpins the federal budget. The Budget Papers include a ‘sensitivity analysis’ showing that a US $10 per ton change in the price of iron ore would result in a $5 billion increase or decrease in the size of Australia’s economy.viii
To the joy of Australia’s resource exporters, in 2008 the Chinese government accelerated its high-savings high-investment drive, causing its household consumption to fall even faster as a percentage of GDP. That kept household incomes and domestic demand down, constraining the growth of private businesses, since their profitability requires that people spend more. In turn, the government kept expanding the public sector to maintain the level of growth it deemed politically necessary. The main beneficiaries in those high-investment years were powerful new groups in export-focused manufacturing and in real estate, especially at the province level. They amassed wealth and gained political connections as they embarked on a massive investment spree to accomplish the central government’s objectives. Growth was spectacular, undoubtedly, and drove China’s electric vehicle manufacturers to world dominance, but there were also asset bubbles, especially in real estate, and a sharp rise in debt.
‘New Development’ under President Xi
China’s leaders appear to have recognised the severity of the problem. In a January 2021 speech to Communist Party officials, President Xi Jinping said, ‘we have changed the thinking that the GDP growth rate is the sole barometer of success’. Xi has called for a ‘new stage of development’ aimed at ‘pursuing genuine rather than inflated GDP growth’. Local governments should not ‘compete with each other to have higher growth rates … we cannot blindly pursue rapid growth without regard for objective laws and conditions’.ix
What policy forms would such rhetoric take? One example is a bankruptcy mechanism free from political intervention. This is easier said than done, given the political influence of successful groups who have long received artificially cheap credit. Other examples include faster wage growth, tax cuts, government-funded consumer vouchers and building a social safety net with higher pensions, unemployment benefits and better, more widely available public services. As The Financial Times’s Martin Wolf says, ‘This looks like a decisive moment in China’s modern economic history. If the government recognizes that the old high-saving, high-investment model is broken, it can generate reasonable growth with a more balanced consumer-led economy’.x
Clearly, this won’t be easy precisely because the business, legal, financial and political institutions of the current model have delivered China tremendous influence around the world, and have also created rich and powerful new groups at the provincial level. Other leaders before Xi talked about changing China’s model: in 2010, Vice Premier Li Keqiang lamented China’s ‘irrational economic structure’ and argued that ‘uncoordinated and unsustainable development is increasingly apparent’.xi But the model has created economic winners and great national pride, and China’s economy isn’t shrinking—it’s just growing less quickly than before. The best estimate is that China’s growth was 4.6 per cent in 2023 and will likely be 4.8 per cent in 2024. That means China is growing slower than the government target of 5 per cent, but still comfortably more than some advanced economies, and more than ten times faster than the Eurozone.xii
If the government can reset its path towards New Development, China will require fewer imports of industrial commodities like iron ore, cement and earth-moving equipment, but more imports of food and consumer products like wheat, beef and consumer goods. The adjustment would result in many years of lower growth, but growth of a more balanced kind. Australia’s own primary export-focused economy would have to adapt to these changes.
Military spending implications
One sector unlikely to see spending reductions anytime soon is the military. China is adding multiple warheads to its intercontinental-range ballistic missiles and deploying a new, longer-range missile on submarines.xiii Expert analysis by the Federation of American Scientists’ Nuclear Information Project estimates that China has a stockpile of approximately 410 nuclear warheads for delivery by land-based ballistic missiles, sea-based ballistic missiles, and bombers. It is expected to have about 1000 operational nuclear warheads by 2030, fielded on systems capable of reaching the continental United States.xiv Its aim is to possess a massive nuclear retaliatory capability, known as an ‘assured destruction capability’ in the language of nuclear strategy. Put simply, it wants to ensure it cannot be intimidated by other countries’ nuclear threats. Its nuclear program thus falls within the paradigm of the principles of deterrence.
Counterforce and countervalue
An underappreciated reason for this nuclear weapons program is that developments in target detection and weapons delivery systems are making nuclear arsenals around the world more vulnerable. Sometimes called the sensing and precision revolutions, these developments allow a tiny number of technologically advanced countries to find and destroy opposing nuclear forces—a strategy known as ‘counterforce’. Remotely piloted aircraft, small satellites and machine-learning algorithms are making it possible to deploy large networks of space-based radars to find other countries’ mobile missiles, fixed silos, strategic air bases, submarine ports, command-and-control systems and leadership bunkers. Synthetic aperture radars have tilted the hide-and-seek balance in favour of the seekers. They bathe the ground with radio waves at wavelengths much longer than the visible spectrum, allowing detection of targets at night and through clouds and camouflage netting. Recent advances in data processing enable the identification of truck-transported missiles even when they’re on the move, as well as their speed and direction of travel.xv Advances in navigation and guidance have improved the ability of submarines, bombers and mobile land-based missile launchers to precisely determine their own positions while on the move, and to render hardened targets vulnerable as never before. The United States is well in the lead in counterforce, and therefore doesn’t prioritise nuclear weapons targeting of an adversary’s cities, economic and industrial infrastructure, energy and communication systems, ports or transportation nodes, an approach known as ‘countervalue’.
The US nuclear warfighting strategy has been explicitly focused on counterforce for the past decade. In 2013, the Pentagon officially stated that the United States would ‘maintain significant counterforce capabilities against potential adversaries’.xvi Among other things, that means pre-emptively striking an adversary’s command-and-control infrastructure and its nuclear forces before they can be launched. China’s military strategists understand all this, which is why China is expanding its missile silo fields. Its nuclear buildup can thus be understood as a defensive approach that reduces the pressure to escalate out of fear that it may be suddenly disarmed by a ‘bolt from the blue’ counterforce attack. North Korea, which lacks China’s wealth and therefore cannot take similar measures, has good reason to be worried.
A new playbook for new priorities
Forty years after Deng Xiaoping’s reforms, China is home to the second largest number of billionaires in the world. Recognising the sharp differences in wealth and opportunity as income inequality has grown, the government has adopted the concept of ‘common prosperity’. This was Deng Xiaoping’s original aim. He wanted China to harness the productive forces of capitalism and decided that some people would have to be allowed to become rich first. But the aim was to eventually create broad-based prosperity. This is now President Xi’s signature political goal, in addition to ensuring the country has enough military power to defend itself. Common prosperity means, as Keyu Jin says in The New China Playbook, that ‘it fervently wishes to avoid’ what it sees in the West—a ‘vast divide between rich and poor’ that ‘has stoked divisiveness, distrust, toxicity, and extremism’. It wants the political leadership ‘calling the tune that corporations dance to, rather than the other way around’. xvii
China’s outreach to the developing world—in infrastructure development, capital, technology and know-how—reflects its ambition to reshape global rules and norms by building economic linkages where they are welcomed. And they are welcomed in many parts of the developing world, partly because these countries also recognise the need for a democratic, equitable international order. They recognise, too, that China doesn’t proselytise, let alone seek to impose, its governance model. Even before the Industrial Revolution, when it was one of the richest countries in the world, ‘China did not export its ideas but let others come to seek them’, as Henry Kissinger wrote in On China.xviii
China’s government values stability over hegemony. Its military posture and its actions in dealing with the economic slowdown will continue to reflect this priority.
i Gerard DiPippo, Ilaria Mazzocco, Scott Kennedy, Red Ink: Estimating Chinese Industrial Policy Spending in Comparative Perspective, Center for Strategic and International Studies, 2022.
ii UN Conference on Trade and Development, Trade and Development Report, 2023, p. 11.
iii Over the past decade, the global economy grew by 35%. China made up 31.5% of this growth in Purchasing Power Parity terms with added estimates for the informal economy and allowances made for base year age. (https://www.worldeconomics.com/Global-Growth-Comparisons/China.aspx) See also https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
iv Nuclear Notebook https://thebulletin.org/premium/2023-03/nuclear-notebook-chinese-nuclear-weapons-2023/; US Department of Defense 2022a, 97.
vi IMF Survey: China’s Difficult Rebalancing Act, 12 September 2007 https://www.imf.org/en/News/Articles/2015/09/28/04/53/socar0912a
vii Keyu Jin, The new China playbook: beyond socialism and capitalism (Viking, 2023).
viii Klein and Pettis, Trade Wars Are Class Wars, p. 113.
ix Matthew Klein and Michael Pettis, Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace (Yale University Press, 2020), p. 112.
xi Joseph Post and Michael Bennett, Alternatives for Military Space Radar (Congressional Budget Office, January 2007); Thomas L. Lillesand, Ralph W. Kiefer, and Jonathan W. Chipman, Remote Sensing and Image Interpretation, 7th ed. (Wiley, 2015). Keir Lieber and Daryl Press, The Myth of the Nuclear Revolution (Cornell University Press, 2020).
xii Report on the Nuclear Employment Strategy of the United States (2013) https://uploads.fas.org/2013/06/NukeEmploymentGuidance_DODbrief061213.pdf
xiii Martin Wolf, How China can avoid the Japan trap, Financial Times, 27 September 2023.
xiv Henry Kissinger, On China (Penguin, 2010), p. 17.
xv Keith Bradsher, In China, an Electric Car Maker Loses Money but Thinks Big, New York Times, 25 February 2021.
xvi Bloomberg News, China Seen Robbing Consumers With Low Interest Rates, 6 August 2010.
xvii Charles L. Glaser, James M. Acton, and Steve Fetter, The U.S. Nuclear Arsenal Can Deter Both China and Russia, Foreign Affairs, 5 October 2023
xviii Interview, Sky News Australia, 27 August 2023. https://headtopics.com/ca/australian-treasurer-warns-of-economic-risk-from-china-slowdown-42993275