China hits its ‘great wall’

Colliding mega trends have created a no good, very bad situation for Beijing.

This original image was created, in part, with the assistance of DALL-E

We’ve heard from a number of #NewRules subscribers who want to know more about the situation in China. They ask, “What’s actually going on?” and “How does this impact the U.S.?” These are big questions, for sure, and they are especially important for people in business. Understanding what’s happening in China is essential for navigating the coming years, building resilience, and readying for change.

Recently, for the ROAR Report, a business intelligence publication about the 50+ consumer and marketplace across multiple industries and topics, I noted that “This is the Year of the Dragon in the Chinese Zodiac, a period that portends strength, wisdom, good fortune, and good luck. But things aren’t going so well for China these days.” However, the situation in China extends far past their demographic challenges.

In recent years, the world's second-largest economy has encountered not only a series of demographic challenges but also economic ones that have raised domestic and international eyebrows. It has also been engaged in some significant saber-rattling towards its neighbors, most notably Taiwan. High youth unemployment, a collapsing property market, debt accumulation, and geopolitical instability pose significant risks to its economic stability and growth prospects.

While Americans and Europeans are worried about inflation, China is facing a period of potential deflation, which can lead to slowed economic growth and increased unemployment and exacerbate already worsening provincial government debt problems. According to RSM International, a global network of independent assurance, tax, and consulting firms, “Prices paid at the factory gates, as tracked by China's producer price index (PPI), have fallen into negative territory.”

There’s great potential for China’s woes to spill over to the rest of the world in the coming months and years. Here’s what you need to know.

Headwinds from every direction

It doesn’t seem like anything is going right for China, and most of it is tied to population growth or the lack thereof.

Since its accession to the World Trade Organization in 2001, China witnessed an extraordinary period of economic expansion, boasting an average annual GDP growth rate of 10.25% until 2012. However, with Xi Jinping's leadership commencing in the spring of 2013, this growth rate moderated to an average of 6.22% per annum, with a significant slowdown to just 3% in 2022. It went up to 5.2% last year.

China’s economic model, which has successfully propelled it to unprecedented growth over the past decades, is now under pressure. The country faces a precarious balancing act of managing its debt levels while fostering domestic consumption, technological innovation and addressing the structural imbalances in its economy. Moreover, its demographic dilemma, characterized by an aging population, sharply declining birth rates and outward migration, adds layers of complexity, threatening long-term sustainability and economic growth.

Susan Shirk, author of Overreach: How China Derailed its Peaceful Rise, contrasts the demographic situation between the U.S. and China and its impact on the economy. “China’s population decline and aging population … is a reminder of America’s great advantage in being open to talented, hardworking immigrants from around the world.”

Declining birthrates, which were supercharged during the “one-child policy,” mass urbanization and the pandemic, are now below one baby per woman, an unenviable feat only accomplished by a few nations, including South Korea. At the same time, China has become a victim of its own longevity success because it refuses to update its retirement systems and norms—life expectancy at birth is now higher than in the U.S.

Culturally, at 35, Chinese people hit the “Curse of 35,” meaning that businesses see them as too old to hire and, of course, they are too young to retire. This pushes way too many workers out of the labor market. As a result, China's working-age population (ages 15–64) is on a downward trajectory, with projections indicating a yearly decrease of about 1 percent by 2030.

Mass youth unemployment is also a challenge, with up to a quarter of 16-24 year olds out of work. The Economist Intelligence Unit, in a report released earlier this year, said that the post‑Covid recovery has not eased the slack in the youth labor market. “The surge in fresh graduates has not been met by a commensurate increase in new job opportunities. New hires are still being offered lower wages amid the labor oversupply.” The U.S. had “quiet quitting,” which ignited The Great Negotiation, but the Chinese have “let it rot,” a term used to actively embrace its deteriorating situation rather than trying to turn it around.

A sign of the challenges facing Chinese youth can be found at the Southern Border in the U.S. where, according to the U.S. Customs and Border Patrol, “More than 37,000 Chinese citizens were arrested for illegally crossing” last year—nearly 10 times as many as in 2022. These migrants are part of a growing group who have given up on the status quo and are looking for a way out—it’s been dubbed “run philosophy.”

Good money after bad

Significant capital investment is needed but isn’t coming.

While increased investment could potentially mitigate some of these demographic trends, it comes with significant uncertainties. The noticeable drop in private sector investment in 2022 and 2023—where state investments largely drove the increase in total fixed asset investment outside the property sector—reflects the private sector's hesitation to ramp up investments amid an economic and political climate they perceive as unfavorable. Public investments have been spotty, too.

Once the belle of the Chinese economy and home to most personal wealth, the real estate sector is now a source of serious vulnerability. Overleveraged firms are struggling to meet debt repayments, and new housing starts are markedly slowing. According to Bloomberg Economics, every 5% decline in home prices will wipe out 19 trillion yuan ($2.7 trillion) in housing wealth.

Additionally, the tech sector, a critical component of China's strategy to ascend the value chain, faces extraordinary pressures, with output growth hitting its lowest pace since records began. China’s stranglehold on the global rare earth mineral market, which powers everything from iPhones to satellites to children’s toys, is threatened, too, following the recent discovery of 2.34 billion metric tons in Wyoming.

Geopolitical threats

Just last week, China and Russia voted against the UN Security Council Resolution calling for a ceasefire in the Gaza Strip, rebuffing the U.S.-led resolution. They backed away from this position this week, and a resolution was passed on Monday.

U.S. Ambassador to the UN, Lynda Thomas-Greenfield, expressed her frustration with the diplomatic impasse. “For all the fiery rhetoric, we all know that Russia and China are not doing anything diplomatically to advance a lasting peace or to meaningfully contribute to the humanitarian response effort.” Radio Free Europe Radio Liberty noted that the chaos in the region may “offer China an opportunity to siphon U.S. attention away from the Indo-Pacific and showcase its diplomatic leadership, whose influence in the Middle East has grown extensively in the last decade.”

There’s also the question of Taiwan—it’s impossible to avoid it in a conversation about geopolitics and China today. The island nation, just 100 miles off the coast of China—roughly the distance from the U.S. to Cuba—has been in the sights of the Chinese Communist Party (CCP) since 1949. Xi Jinping has repeatedly said that China and Taiwan are "members of one and the same family."

But Taiwan isn’t the only prize China wants. Xi has made it clear that he wants to reunify all of the territory that was once under Chinese control. Beijing is currently engaged in disputes with 17 nations over land and sea borders. And, while there’s no official claim at this moment, Xi has his eyes on Outer Manchuria, which is home to Vladivostok and the Russian Pacific Fleet. His government changed the Russian city names on their maps last year to the historic Chinese ones.

China can’t grab it all, but just like Russia, they could try for a small territory like Taiwan first and then go for a bigger prize later. However, Russia’s folly in Ukraine and the West’s response may be enough to hold it at bay, at least for now.

Risks for the world

China's demographic and economic situation could have a ripple effect across the globe.

A deflationary spiral in China could lead to a substantial decrease in demand for U.S. exports. Given China’s role as a key market for American goods and services, in particular, reduced spending power and consumer demand in China could hurt U.S. businesses, leading to decreased revenues and potential job losses in sectors heavily reliant on Chinese demand. This would impact well-known consumer brands such as Starbucks, Nike, and Under Armour, which have significant consumer bases in China. Technology and automotive powerhouses, including Intel, Apple, Tesla, General Motors, and Ford, not only rely on the Chinese market for consumers but also have manufacturing operations throughout the nation. This could lead to eroding profitability for U.S.-based multinationals.  

Moreover, global supply chains, intricately woven into the fabric of U.S.-China economic relations, could experience disruptions, as well. Due to complications in sourcing products and components from a deflation-hit China, U.S. businesses might soon find themselves grappling with delays, increased costs, and reduced production efficiency. There is an upside here, at least in the short-term: U.S. demand for Chinese-made goods softened in the post-pandemic years, and the country is moving to be less reliant on Chinese imports.

Of course, there are also the issues of cybersecurity and the fight for artificial intelligence dominance. FBI Director Christopher Wray recently shared during a CNBC roundtable, “You can bet your bottom dollar that foreign adversaries, especially the Chinese, are actively targeting that innovation [artificial intelligence], that intellectual property.”

All of these issues could set off a domino effect, with financial markets becoming more reluctant to invest in China, further magnifying its problems. If deflation persists, China could potentially devalue its currency, further dampening business investment, economic growth, innovation, and job creation. The subsequent reverberations could be felt across the globe. 

And what about war? Is China preparing for a military conflict with the United States? All signs are pointing to ‘yes.’

Foreign Policy recently wrote that under Chinese President Xi Jinping, Beijing is readying for this prospect of war “by amassing ships, planes, and missiles as part of the largest military buildup by any country in decades.” Xi’s gone so far as to say that China must prepare for “worst-case and extreme scenarios” and be ready to withstand “high winds, choppy waters, and even dangerous storms.” Yet, according to the Center for Strategic International Studies, “60% of the U.S. public thinks a major U.S.-China military conflict is possible but not likely; 26% believe that conflict is likely; and 11% think it is inevitable.

Should the U.S. do the same? Perhaps. George Washington said, “If we are wise, let us prepare for the worst.” That might be the best advice for building resilience during these turbulent times.