The economic model that China followed during the last 40 years has created huge world-class infrastructure and generated tremendous wealth at the cost of escalating inequality, surging debt, and enormous investments that have turned bad. The slowing growth and increasing chaos that we see in China today are the results of unbalanced growth, whose effects we are seeing even in India. The German-American economist Albert Hirschman held that all rapid growth is essentially unbalanced growth.

Indeed, deliberate unbalancing of the economy may be a good strategy to achieve rapid growth in underdeveloped countries. “To create deliberate imbalances in the economy according to a pre-designed strategy is the best way to accelerate economic development”, Hirschman said. Hans Singer, a German-British economist, also said that “Unbalanced growth is a better development strategy to concentrate available resources on types of investment which help to make the economic system more elastic, more capable of expansion under the stimulus of expanded market and expanding.

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The strategy is often very effective to break the low-level equilibrium in which underdeveloped countries get trapped, with their production, consumption, savings and investment becoming so adjusted to each other at an extremely low level of income that this equilibrium itself becomes an obstacle to growth. To break this equilibrium, unbalanced growth can be deliberately planned by directing investments in selected sectors through a strong ecosystem of incentives and disincentives which create their own cycle of innovations and creative destruction. A development model in which such unbalanced growth can address and reverse the existing imbalances in the economy can be a very successful one; it will mitigate the adverse consequences while ensuring rapid growth.

Both China and India have witnessed such sector-specific high growth which propelled their economies into higher and rapid growth trajectories and lifted millions out of poverty, albeit creating huge inequality. After all, inequality is the price of growth. But then as the economy grows, the model becomes self-propelling and starts creating its own imbalances. As Hirschman said, “If the economy is to be kept moving ahead, the task of development policy is to maintain tensions, disproportions and disequilibria.” As the existing imbalances are reversed, the model becomes increasingly irrelevant to the original set of imbalances and creates a new equilibrium at a higher level, and Hirschman premise is then forgotten. The problem is that it is not easy to abandon a development model that had once brought success.

As Michael Pettis, a Professor of Peking University, observed, any successful model will “generate a set of deeply embedded political, business, financial, and cultural institutions based on the continuance of the model, and there is likely to be strong institutional and political opposition to any substantial reversal”, and that is the case with China today. China’s development was steered by high investment, which till the 1970s saw very little investment in infrastructure and capacity. Investment initially can come only from domestic savings ~ and high savings means low consumption. Since the household sector is the major consumer, through a deliberate strategy of limiting the growth of the household share of GDP and hence consumption, China propped up the domestic savings rate to around 50 per cent of GDP, the highest recorded in any country.

These savings were then channelled through the banking system to businesses, real estate developers and local governments at artificially low, governmentdetermined interest rates. The result was astoundingly rapid growth driven by high investment. China had one of the highest investment rates in the world between 40 and 50 per cent of GDP every year for a decade, while for a developing economy, it is typically around 25 per cent. India’s current investment rate peaked at around 39 per cent in 2012 and is now hovering above 30 per cent. When growth becomes so dependent on investment, and when a substantial part of the investment turns bad as has happened now, a sharp slowdown of overall economic activity inevitably follows.

The problem becomes grave when such investment is funded not by savings, but by debt. In every economy, there is a limit to which investments can be productively turned into capital stock at a given stage of development. Once that absorption capacity is breached, economy shifts to a different growth model in favour of consumption rather than investment, and then debt begins to rise. So long as the debt is productively utilised for further investment so that the resulting rise in growth exceeds the rise in debt, debt remains sustainable, provided the primary deficit is managed well. But when debtfunds go to unproductive investment, debt begins to rise faster than the GDP. After China gave a huge fiscal stimulus to overcome the economic meltdown of 2008, its debt began rising.

To maintain growth, China began diverting its huge trade surpluses and higher domestic borrowings to investment in property and infrastructure. Its debt rose steeply from around 150 per cent of GDP to 270 per cent by 2020. It is now clear that much of these investments were unproductive, with no returns. The first to fail under the weight of the staggering debt was the real estate sector, with gigantic apartment blocks remaining empty without buyers. Local governments likewise invested in excess infrastructure such as underutilized rail systems, roads and highways, stadiums, and convention centres. On top of these, cronyism and corruption exacted their tolls. Property and infrastructure were the twin growth drivers of China, and once accounted for half its GDP. The bubble had to burst some day, and it has now, and the distress is now gradually spreading to other sectors.

The options are limited, because trying to revive growth by creating more infrastructure will result in more unproductive investments and more debt. The other option is to boost consumer spending by increasing transfer payments like pension and welfare to be paid by the Central and local governments by sacrificing their share of the GDP. But as Pettis says, the distribution of political power in China, like elsewhere, is a function of the distribution of economic power, and “a major shift in the latter would almost certainly set off a commensurate shift in the former” which may be difficult to accomplish politically, recalling the Hirschman model. That leaves only one option ~ to let the growth fall to around 3 or 2 per cent over a period of slow-growth structural adjustment, so that the market cools while the government absorbs the cost of such decline in growth to spare households of its effects. After almost decades of high investment-driven growth, it is now clear that too much of that investment has gone to projects that did not add real economic value. One way or the other, investments and growth have to slow down. The era of high growth of China is now a thing of the past.

Other countries have faced it too, like Japan in the 1990s when it shifted to a low-growth model. But unlike Japan, or the USA, China is relatively poor with a per capita income that is one fifth of the USA. Chinese citizens are still waiting for a comfortable life. As the premier Li Keqiang said in 2020, “Their monthly income is barely 1,000 RMB. It’s not even enough to rent a room in a medium Chinese city.” But the problems emanating from the current malaise will weigh on China’s economy for years. The question is: given China’s share of global production, consumption and supply, what would be the consequences of slow growth for the CCP, China, and the world? The unfolding economic slowdown means the CCP’s credibility will be seriously dented.

As it is, the ill-conceived Covid-19 lockdown policy has caused immense economic and physical hardships to people while shielding them from immunity. With low growth, welfare expenditure will get further reduced to accentuate their suffering. Demography will also pose serious challenges to growth, as with fertility rate falling to only 1.16, China is sitting on the cusp of a demographic time bomb and there won’t be enough productive hands. Fewer workers, fewer future buyers for apartments, fewer consumers: these demographic fundamentals cannot change over the short term. Another impediment for growth would be restricted access of Chinese firms to foreign technology due to China’s increasing international isolation.

It will also mean less military spending. With less spending power, choices on public expenditure priorities will become difficult, and CCP will have much less maneuvering room. Social stability would continue to be a serious concern, and the imposing and all-pervading surveillance tools that stood the regime in good stead during the high growth years may not hold as strong. Globally, the repercussions from China’s slowdown will mean a huge disruption of supply in the international markets, and if the ongoing Russia-Ukraine war is any judge, all countries will continue to feel their impact.

Low inflation is likely to be a thing of the past and low growth will be the new normal for most countries. This will impact global growth for years together. The only way these can be smoothened is by dismantling the authoritarian command-control state, by conceding the mistakes and reorienting the policy back towards marketization that has delivered decades of doubledigit growth, while giving people room for debates and openness. But Xi Jinping is no Mikhail Gorbachev, and drunk in his ideological dystopia, he will be unlikely to yield.