Be afraid, China is about to hit the Great Wall
Yet the signs are now unmistakable: China is in big trouble. We're not talking about some minor setback along the way, but something more fundamental. The country's whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be.
Start with the data, unreliable as it may be. What immediately jumps out at you when you compare China with almost any other economy, aside from its rapid growth, is the lopsided balance between consumption and investment. All successful economies devote part of their current income to investment rather than consumption, so as to expand their future ability to consume. China, however, seems to invest only to expand its future ability to invest even more. America, admittedly on the high side, devotes 70 per cent of its gross domestic product to consumption; for China, the number is only half that high, while almost half of GDP is invested.
How is that even possible? What keeps consumption so low, and how have the Chinese been able to invest so much without (until now) running into sharply diminishing returns? The answers are the subject of intense controversy. The story that makes the most sense to me, however, rests on an old insight by the economist W. Arthur Lewis, who argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of "surplus labour" - underemployed peasants making at best a marginal contribution to overall economic output.
The existence of this surplus labour, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction and so on without running into diminishing returns, because they can keep drawing in new labour from the countryside. Second, competition from this reserve army of surplus labour keeps wages low even as the economy grows richer. Indeed, the main thing holding down Chinese consumption seems to be that Chinese families never see much of the income being generated by the country's economic growth. Some of that income flows to a politically connected elite; but much of it simply stays bottled up in businesses, many of them state-owned enterprises.
It's all very peculiar by our standards, but it worked for several decades. Now, however, China has hit the "Lewis point" - to put it crudely, it's running out of surplus peasants.
That should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic "rebalancing" - the jargon phrase of the moment. Investment is now running into sharply diminishing returns and is going to drop drastically no matter what the government does; consumer spending must rise dramatically to take its place. The question is whether this can happen fast enough to avoid a nasty slump.
And the answer, increasingly, seems to be no. The need for rebalancing has been obvious for years, but China just kept putting off the necessary changes, instead boosting the economy by keeping the currency undervalued and flooding it with cheap credit. (No, this bears very little resemblance to the Federal Reserve's policies in the US.) These measures postponed the day of reckoning but also ensured this day would be even harder when it finally came. And now it has arrived.
How big a deal is this for the rest of us? At market values - which is what matters for the global outlook - China's economy is still only modestly bigger than Japan's; it's around half the size of either the US or the European Union. So it's big but not huge, and, in ordinary times, the world could probably take China's troubles in stride.
Unfortunately, these aren't ordinary times: China is hitting its Lewis point at the same time that Western economies are going through their "Minsky moment," the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump. China's new woes are the last thing the rest of us needed.
No doubt many readers are feeling some intellectual whiplash. Just the other day we were afraid of the Chinese. Now we're afraid for them. But our situation has not improved.NEW YORK TIMES
Frequently Asked Questions about this Article…
The article argues China is in serious trouble: its decades‑long growth model has reached limits and faces a fundamental slowdown. That matters to everyday investors because China is a large part of the global economy, and a sharp Chinese slump—especially if it coincides with vulnerabilities in Western markets—could weigh on global growth and market returns.
Chinese data is described as unusually hard to trust because of a secretive government, a controlled press and the country’s vast size, which together make it more difficult than in other major economies to pin down what’s really happening beneath headline numbers.
China has long relied heavily on investment rather than household consumption—about half of GDP goes to investment while consumption is roughly half as large as in the US (the US devotes around 70% of GDP to consumption). That imbalance means China now needs a big rise in consumer spending to replace slowing investment, and failure to rebalance could trigger a sharp economic slump.
The ‘Lewis point’ refers to when an economy runs out of surplus rural labour that previously kept wages low and allowed heavy investment without diminishing returns. China appears to be hitting this point: wages are rising, investment is seeing diminishing returns, and the economy must shift toward higher consumption—an awkward and risky transition for growth.
Rebalancing means shifting the economy away from investment-driven growth toward stronger household consumption so rising wages and falling investment returns don’t cause a slump. It’s difficult because the change needs to be fast and broad, but past policy choices have postponed necessary adjustments and made the eventual transition harder.
The article explains China delayed rebalancing by keeping its currency undervalued and flooding the economy with cheap credit. Those measures propped up growth temporarily but postponed the day of reckoning and likely made the eventual downturn sharper.
By market values China is only modestly larger than Japan and about half the size of the US or EU, so in ordinary times the world might absorb a slowdown. But because China is hitting its structural limits at the same time Western economies face their own risks (a so‑called Minsky moment), the combined stress raises the chance of broader market pain.
Key signs from the article to monitor include persistent falls in return on investment, slowing or falling total investment, stagnant household income or consumption growth despite rising wages, continued reliance on cheap credit or currency intervention, and synchronized stress in Western credit markets—any combination could signal a deeper global downturn.
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