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History of the development, distortions, and prospects of the Chinese economy, which has gone from centralization to market to world power status in less than four decades
Just 35 years ago, China was a nationalized economy, without a financial market and with banks driven by public purpose
Economically, China is turning 35 years old. It’s easy to forget, but the reforms of the great helmsman Deng Xiaoping began in the early 1990s. The lack of historical perspective risks causing us to assess China’s current situation in isolation from reality, as if the data were coming from the US or European economies. But we must not forget that 35 years ago China was a nationalized economy, without a financial market and with banks guided by public goals rather than a desire to achieve the best allocation of capital. China’s history over these 35 years represents the greatest experiment in what it means to move from a centralized to a decentralized economy. Let’s try to understand why.
History of the Chinese stock market: to understand today’s China and envision a future China, it is useful to start with the history of its stock market. Since the late 1980s, China’s economy has been dominated by state-owned enterprises. But under the leadership of President Deng Xiaoping, significant steps were taken with the establishment of two major stock exchanges in 1990 and 1991 and the first wave of Initial Public Offerings (IPOs) to raise capital, which initially weakened state ownership in Chinese companies. However, corporate control remained firmly in the hands of the state, largely because of the special structure of listed companies: in early 2005, about two-thirds of the Chinese stock market consisted of non-tradable shares (NTS), a special type of stock that gave holders the same rights as holders of ordinary shares, except for public trading. These shares were usually owned by the state or national financial institutions, ultimately owned by central or local governments. There was an implicit agreement between investors and the state that NTS shares would never be traded on the stock market.
In 2005, the Chinese authorities announced a reform to eliminate the NTS. The reform forced NTS holders to compensate holders of traded shares (TS) for the possibility of selling their shares in the future. Beyond compensation, the reform has had very limited direct impact on China’s stock market structure in the short term, but it has laid the groundwork for increased capitalization through a broader ownership structure, advancing the privatization process and improving corporate governance and liquidity.
Chinese stock market performance: the figure illustrates the performance of the Shanghai Composite index over time (source: Investing.com). From an initial value of 130 in 1991, it became 3391.88 at the beginning of December 2024 with an average annual (geometric) return of 10%. Subtracting the average inflation rate of 4% (source: World Bank) yields a real return of about 6% per year on average, which corresponds to the long-term returns of the US market, but lower than the returns of the US stock market over the period 1991-2024 and the risks associated with investing in an economy that is experiencing strong growth, but characterized by higher elements of risk than other countries. For nearly a decade, the market value has not changed in any significant way outside of a fairly limited range.
The goal of growing as fast as possible has led to development at 10% per year and the creation of numerous imbalances such as ghost towns and useless infrastructure
Chinese economy and overinvestment: China has been suffering from over-investment for years. Many of the investments were of high quality and had significant returns. The best example is the Pudong financial district in Shanghai, built in the early 1990s. I was fortunate enough to see firsthand the large construction site where the city within the city was being built, but even more enlightening were the conversations I had with Chinese government experts when we discussed the master plan for the area. The conversation was particularly interesting when I commented on their original proposal, which included the possibility of dedicating an agricultural area in downtown Pudong for food production needed by the city. Local experts were surprised when I told them that in an exchange mode it may be more economically feasible to import food from outside in order to devote the territory entirely to financial activities (an observation that can be pondered at length today in light of the problems that have arisen worldwide as a result of the segmented and concentrated development model, which in a sense is inferior to a diversified territorial organization that includes a mix of activities and can make development more sustainable). However, important for the purposes of the current discussion is the goal of growing as fast and as intensively as possible, a vocation that has led China to develop at 10% per year and to create numerous imbalances, such as the construction of ghost towns and useless infrastructure that now represent an uncomfortable legacy to manage and are at the root of local real estate instability problems.
Chinese economy and excess exports: the second problem that China faces economically is excess exports. According to Goldman Sachs Research, exports accounted for 70% of economic growth in 2024. What is even more reminiscent of the real situation is that, according to the World Bank, exports account for 20% of gross domestic product, which is about 18 trillion dollars. China thus contributes $3.6 trillion to the creation of products consumed in other countries, equivalent to about 3% of global GDP. A burdensome role for regions of the world such as Europe and the USA where the main challenge is not consumption but production in order to enable populations to be active and save resources for increasingly longer lives.
The problem for the Chinese economy is very simple: find sources of aggregate demand that can push companies to produce
Economic Maneuvering for 2024: it is in this context that we must evaluate the recent announcement of a maneuver that aims to bring growth back beyond the 5% threshold, which has already been missed in 2024 and, according to November 2024 consensus forecasts, will fall to 4.5% in 2025, with further declines driven by the prospect of tariffs that the incoming Trump administration says it wants to impose on the rest of the world. The stock market reacted positively to the announcement, but enthusiasm quickly faded, mainly due to the lack of details. The challenge for the Chinese economy is very simple: find sources of aggregate demand, which can push companies to produce and innovate processes and products that allow them to be more efficient.
Conclusions: attention to sustainable development is indeed an important element for China, but it may be more useful for improving the quality of life in the long term than for restarting the economy in the short term. The economic priority should be to permanently address the still existing imbalances in infrastructure and real estate, as evidenced by the trend in real estate prices, as well as measures to stimulate domestic consumption, which, however, are not easy to implement in a country of 1.4 billion people, many of whom still live in the hinterland. As is often the case, Europe may be the loser in this geopolitical scenario: where will the goods stopped at the Port of New York go?
