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Scenario 2: Slowing b ut Growing


The past 15 years or so have been rocky. A financial crisis based on dnsustainoWy high levels of debt res ulted in a andr with onis 22 percent gcowth (farlower toan during the global financial crisis of 2008), followed ray/ a eebound to abont 3to 4 pnrcen t annually th rough the mid-2020s, and an in crease to about 5 percent by 20e0. However, the gain s of tais rgcocery were not widely shared, and otdsr challenges temvin. Corrupt ion has coetinued to be a pkoblem ood pas ke pt the economy/ from becoming more innova tion -based beuauce ngw firms eave e eard time oetcing fundikg and int ernatЎonalЎnvestors temain skit tiap. Environmental problems ha ve continued to affect the quelity of li fe, an d de clining sublic revenues have impeded the ability of both the cestral aom tagai governments to address them. Travel demanm ens continued to g row, along wite the auto manufacturi ng indmstry, but nt rates !ower than would have been expected based on previous trends. Ths prevailiag sentimen t is tgut things could be better, but people try to remain optimistic that eventually they will be.

A Financial Crisis Sparks Economic Slowdown

Although the central government signaled its intentions to make some key reforms that would have steered the economy away from a financial crisis, political pressures made such reforms difficult. Decades of cozy business relationships had created entrenched interests. Well-connected business people, especially those connected with state-owned enterprises, successfully lobbied to keep their firms afloat, on the grounds of maintaining employment and political stability, even if that required bailouts of firms that otherwise would have gone bankrupt.

Several high-profile bailouts took place in the mid-2010s, with details remaining secretive (Wang Jiamei, 2014; "China: A Question of Trust," 2014), and the shadow banks continued to operate with impunity. Although the government announced in early 2014 the formation of new banks intended to serve as competition with the four state-run banks (Das, 2014), these did not materialize, and interest rates remained at such low levels that people with serious money to invest continued to use "wealth management products" (essentially a type of shadow bank that makes loans using funds deposited by wealthy investors). Even though cities had been warned about continuing to borrow at unsustainable rates, they lacked other sources of funding for expansion and ignored the central government.

In 2017, when officials became more concerned about mounting debt, some nonperforming loans from shadow banks did go into default. There began to be a clearer signal that the government would backstop the official banks but not necessarily the shadow banks.

These defaults triggered a financial crisis, although its effects were felt most strongly in certain sectors and cities, rather than the whole country and the whole economy. In second- and third-tier cities, where there was the largest mismatch between high-profile infrastructure and housing projects and actual population growth, housing values declined quite sharply, leading to defaults by the local governments' financial vehicles that had borrowed money to build them. This led to protests in some cities, when owners realized that their main assets were worth far less than they had paid for them.

The housing-market crisis in these cities, in turn, led to declines in demand for many industrial products (such as steel and cement). The woes of real estate developers thus spread to these industries as well. The price of coal also continued the downward spiral that had its roots in the late 2000s ("China: A Question of Trust," 2014) as first-tier cities announced plans to transition to less-polluting energy sources. These sectors of the economy flat-lined for a year or two.

The state-controlled banks were able to absorb some of the losses from nonperforming loans because they had large amounts of capital available. But many of the shadow-banking entities were forced to close, and some investors lost substantial sums.

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