China’s economy is slowing. Here’s the case for and against freaking out.


A man gestures as he watches stock activity at a stock exchange in Huaibei, China. (STR/AFP/Getty Images)

China has just reported that its GDP growth rate, which measures how quickly the economy is growing, was just 7.5 percent for the second quarter of 2013. That's high by American standards, but low by Chinese standards. In fact, China's GDP growth rate has slowed in 11 out of the last 13 quarters. The Chinese slowdown long anticipated by economists appears to have arrived.

If the story seems confusing, that's because there are, broadly speaking, two very different ways to read what's happening. There's the optimistic case and the pessimistic case. Which one you believe depends on how much faith you have in the Chinese government and how good you think China is going to be at shifting its economy to be more like the United States's.

Here's what everyone agrees on: Something had to change

China's economic growth has come largely from exports and urbanization, something that foreign economists and Chinese leaders have long warned is ultimately unsustainable. In the long term, China needs to shift its economy away from making stuff for foreigners and toward making stuff for regular Chinese people.

In the short term, China needs to cool down its banking system, which right now looks an awful lot like the U.S. banking system just before the crash: over-invested in a real estate bubble, over-leveraged, lending and borrowing more than is safe or responsible. About three weeks ago, the Chinese banking system started to freeze up – just as they did in the United States right before Lehman collapsed.

The case for optimism: Beijing is in control

The collapse in the U.S. banking system and real estate market was uncontrolled: We didn't prepare for them and were taken by surprise. But Chinese leaders are popping their country's banking bubble deliberately, trying to do gently what would otherwise happen not-so-gently. They're also deliberately trying to slow down the country's overheated growth; this quarter's GDP slowdown is actually well within official projections. It's not a stall, it's a careful slowdown made to avoid a stall.

What we're seeing now might actually be the process of China forcing through some changes that will be painful in the short term so that it can both avert an unwanted crisis and make necessary long-term changes. China, economists agree, needs to stop growing its economy by exporting cheap products abroad while it builds vast housing developments and unnecessary infrastructure projects at home; stories of remote towns with two airports are way too common. The country has to make a very difficult, very important shift to an American-style economy, in which it focuses on selling stuff to Chinese consumers. For all sorts of reasons, this is easier if China's economy slows down a bit.

The case for pessimism: Beijing can't accomplish what it needs to do or waited too long for

China is not out of the woods: while it is trying to avert a credit crisis, which could be potentially disastrous, banks are still so heavily leveraged that it remains a risk. The timing of this is crucial, and it's possible that China put it off for too long.

Chinese leaders could lose their nerve. The country's social and political stability has, for the last 20 years, been premised on sustained economic growth. As that growth slows, regular Chinese people will feel the pain – particularly when it comes to housing, which is already barely affordable in first-tier cities – and they're likely to be vocal about it. And there's another group that may suffer: the massive industrial and construction firms that have made a fortune during the boom years. China's shift to a consumer-driven economy is probably bad news for those firms, which are politically influential and well-connected in Beijing. A 2011 Eurasia Group report, still relevant, warned that it won't be easy for Beijing to stand up to these groups.

So should I freak out?

Not yet. But you should definitely keep watching. If China endures a too-rapid slowdown or a bubble-burst, it would be very bad for the entire world, which relies heavily on the Chinese economy. But if it successfully transitions to the slower-but-healthier economy it's seeking, it would aid the rise of a Chinese middle class that could change the country from within. Either way, it's a big deal.

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Max Fisher · July 15, 2013