China needs to look for sources of growth beyond the real estate sector

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The writer is a senior fellow of the Institute of World Economy and Politics of the Chinese Academy of Social Sciences.

Since 2022, the real estate sector has been a drag on economic growth in China.

The crisis in the real estate sector has directly caused a weakening of investment in fixed assets; has had an impact on consumer spending through wealth and income effects; and has led to a market-driven contraction of the credit system, further exacerbating the overall lack of demand. All of which means that the old model of relying on the real estate sector as an economic engine is unsustainable.

What industry could replace it as the main engine of growth in China? Currently, the automobile industry stands out, with a market size of trillions of yuan, but it is still an order of magnitude smaller than real estate sales. Furthermore, it is not feasible to replace housing with manufacturing. China’s manufacturing sector is already large; exceeds domestic demand and the expansion of exports would encounter more trade frictions with other countries.

At the same time, there is still significant unmet demand in certain sectors, particularly education and healthcare. Housing, education and healthcare have long been the three great burdens on the shoulders of the Chinese people and are the most discussed topics in informal conversations.

In the last 20 years, the issue of housing has experienced significant improvements. However, in education and healthcare, due to systemic and institutional barriers, the Chinese people’s willingness to spend has not been fully unleashed. For the market, this represents an important business opportunity. And for the Chinese economy, it means substantial potential for growth. In 2023, the United States spent more than 20 percent of its GDP on education and health care, but China’s share is still far below that figure.

In 2022, the service sector accounted for about 47 percent of total employment in China, while the expected proportion for countries at similar stages of development is 62 percent, according to my analysis of World Bank data. If China could increase the service sector’s share of employment to that level, it would unlock considerable growth potential.

Of course, some insist on treating education and health care as consumption expenditures. Since China remains a developing country, some economists and authorities believe that the capital stock must continue to increase; hence the emphasis on increasing investment in fixed assets rather than consumption.

However, investment and consumption should not be considered mutually exclusive. Numerous studies have shown that education helps improve labor productivity and is also a process of human capital accumulation. Compared with many countries where 11 or 12 years of education are mandatory, China’s nine-year system has room for expansion.

Similarly, the healthcare industry helps extend the working life of the workforce. Japan, with its comprehensive healthcare system, supports a higher average life expectancy. As a result, the employment rate among people over 65 years of age in Japan is approximately 25 percent, a level that plays an important role in mitigating the effects of the country’s aging society. In China, the rate is 18 percent, according to a report by Bruegel.

On the supply side, China’s development model in the past has been based more on the accumulation of tangible physical capital. But future development will depend more on human capital and innovation. And on the demand side, the development of sectors such as education and health also helps expand domestic demand. This also contributes to reducing China’s external imbalances.

A large portion of spending on education and healthcare comes from the state. This requires the government to expand its borrowing for public services and social security expenses. Higher public debt can help offset the negative impact of a credit crunch caused by the housing crisis.

It is noteworthy that the Chinese government is increasingly emphasizing the importance of science and education for economic prosperity and the importance of talent or human capital for a strong economy. If the relationship between the manufacturing and service industries is well coordinated, and the service sector is harnessed as a new growth engine, then the Chinese economy will still have significant capacity to expand.

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