Is China Facing A Balance Sheet Recession

Abstract

The COVID-19 pandemic since 2020 has pressed the pause button for the whole world for almost a full year. Starting from 2021, many countries have gradually resumed their economic activities and recovered from the pandemic. China, however, despite its economy showing signs of recovery, a slowdown in economic growth is also obvious and continuous. Before the pandemic, China’s economy maintained on average an annual GDP growth rate of 9%, with the lowest still exceeding 6%. But this growth rate dropped to an average of 4.9% since 2020, with only the year 2021 exceeding 6%. The slowdown in economic growth makes people wonder what has happened to China’s economy. Meanwhile, the concurrent China also shares some similarities with Japan in the 1990s. At their respective times, both economies were the countries with the second-largest GDP in the world after the United States, had bubbles in real estate, shared export-oriented models, faced challenges posed by ageing populations, and were subject to external pressures from the United States in trade and technology. Since 1990, Japan has entered a prolonged recession which was explained as being the balance sheet recession by an economist Richard C. Koo. The similarities and comparisons have raised the question of whether China, too, might enter a similar phase of balance sheet recession. However, some China-specific features have distinguished China from Japan and other Western countries where the balance sheet recession theory can explain their recessions well. For example, China is a socialist country, it has its socialist market economy. State-owned enterprises (SOEs) have dominated critical sectors and the state can have many interventions into the market through SOEs. The differences could obscure the typical symptoms of a balance sheet recession. The research gap remains in the applicability of the balance sheet recession theory in the context of China-specific features. Therefore, this research tries to study the applicability of the balance sheet recession theory to China’s current economic performance, and give policy recommendations to reverse its economic slowdown trend accordingly. To address the research gap, several steps are taken. First is to study the balance sheet recession theory, and try to summarise the typical patterns of a balance sheet recession. The patterns are summarised as having a deflationary spiral, decoupling between monetary base, money supply, and private credit, and liquidity trap. Then, the China-specific features that are most relevant to the balance sheet recession theory are studied. Through investigation, China has specific features of high saving rates and low consumption, large occurrences of SOEs compared to private firms, and a bank-based financial system. These features are likely to influence the typical patterns of a balance sheet recession…