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Four The Scenarios

In this chapter, we present the scenarios, the Great Reset and Slowing but Growing. However, many of the seeds of future developments were already shown by 2014, when we drafted the scenarios, so both scenarios, as well as the wild-card scenario, begin from the origins described in this chapter. As is customary in scenario writing, our vantage point is 2030, and we are looking backward to trace our steps over the past 15 years.1 For ease of comparing prices, all dollar figures are expressed in constant 2012 U.S. dollars so as to avoid making projections about inflation levels.

Background to All Scenarios

China has experienced extremely rapid and sustained economic development over the past several decades. Beginning with the Reform and Opening Up Policy in 1978,2 and the establishment of several Special Economic Zones in coastal cities in the early 1980s,3 the country's overall wealth and per capita GDP grew by double digits over several decades. Much of this growth began with reforms in agriculture, which included a shift from collective land ownership to a household-based system and removal of price controls (Organisation for Economic Co-operation and Development, 2010). This freed up rural laborers to migrate from their hometowns to coastal cities with huge demands for factory labor. The pace of urbanization was enormous. China went from 300 million people in urban areas in 1990 to almost 700 million in 2011, or from about one-quarter of its residents living in cities to about half. Living standards for many have greatly increased.

Yet, by 2014, some cracks had appeared in China's economic machine. Although problems had been simmering, the response to the global financial crisis in 2008 marked a defining moment. To avoid an economic downturn caused by slowing demand for exports, China adopted a roughly USD 585 billion stimulus package (Tsuruoka, 2014), which was largely fueled by borrowing.

Although the overall level of debt was not dangerously high by the standards of developed countries, three problems became apparent. First, the debt-to-GDP ratio grew very quickly over the ensuing five-year period, from 125 percent of GDP in 2008 to 200 percent in 2013 (Casey, 2013). Municipal and corporate debt levels increased rapidly (household debt was a far smaller issue). Such rapid growth in debt is seldom sustainable.

Second, most of the growth took place in the shadow-banking system, a set of financial entities that are not regulated the same way as the banks. Shadow banking was attractive to different groups for different reasons. Many affluent households kept money in shadow banks for lack of other types of liquid investments. The stock market was risky, and regular banks offered very low interest rates. Small- and medium-sized businesses borrowed money from shadow banks because they had a difficult time getting capital from the state-run banks. Even cities turned to off-the-books entities to borrow money and lease land because they did not have adequate revenues of their own.

Third, both the central government and many cities used stimulus funds to build large amounts of infrastructure. Although spending on roads, rail, and other important infrastructure is generally a good investment, some argued that infrastructure was overbuilt, and much of it has been awaiting the increases in demand that would justify them.

In China's case, the flip side of state overinvestment was private-sector underinvestment, meaning that private businesses could not access capital to grow, and underconsumption, meaning that most people saved their earnings rather than spending them. So, by the early 2010s, roughly half of the economy was driven by government-controlled spending,4 not private businesses or households (Szamosszegi and Kyle, 2011).

Another major set of problems was in the housing sector. First, local governments, lacking stable sources of revenue, had turned to long-term leases of developable land. They were in a shaky position if demand for housing stagnated or fell, and, as noted above, many local governments were heavily in debt. Second, in the largest first-tier cities, housing prices had inflated by the early 2010s to levels far beyond anything affordable to an average household. In Shenzhen, for example, the ratio of the average house price to average income was almost 18 to 1 (Yi and Tan, 2013), with any ratio over 5 to 1 considered unaffordable. Although the falling prices in 2014 (Shao and Yao, 2014) might have helped resolve the affordability issue, they also meant that property developers were losing money and at risk of defaulting on their loans.

Third, despite the affordability problems, more than 20 percent of homes in urban areas were vacant (Fung, 2014). In the first-tier cities, wealthy households purchased many of the vacant units as investments, with no intention of living in them or renting them out. Housing was a desirable investment because of low interest rates on bank savings, as well as volatility in the stock market. In second- and third-tier cities, housing production was driven largely by local governments, which encouraged housing production as a source of city revenue despite lack of demand. This resulted in "ghost cities" of vacant housing, vacant shopping malls, and vacant office towers.

In addition to these economic difficulties, long-term environmental problems had surfaced. Air and water pollution had reached dangerous levels. Air pollution contributed to 1.2 million premature deaths in 2010 (Goodell, 2014). Sixty percent of groundwater was too polluted to drink (Chang, 2014). Water reserves in the northeast were declining rapidly; the water table under the North China Plain (which includes Beijing) has dropped 1,000 ft. (about 300 m) since the 1970s ("All Dried Up," 2013), and the region might run out of groundwater within the next ten years, by 2040 (Yardley, 2007). Soil contamination remained a serious problem as well; a report released in spring 2014 found that nearly 20 percent of all farmland was contaminated

(Wong, 2014).

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