China must look for sources of growth beyond real estate

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

Since 2022, the real estate sector has slowed economic growth in China.

The slowdown in real estate has directly caused a weakening of investment in fixed capital; it had an impact on consumer spending through wealth and income effects; and this caused a market-driven contraction of the credit system, further exacerbating the general lack of demand. All of this means that the old model of relying on real estate as an economic driver is unsustainable.

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

At the same time, there is still significant unmet demand in certain sectors, notably education and health. Housing, education and health care have long been the three main burdens on the shoulders of the Chinese people and are the most hotly debated topics in casual conversations.

Over the past 20 years, the housing issue has seen significant improvements. However, in the areas of education and health, due to systemic and institutional obstacles, Chinese people’s willingness to spend has not been fully unleashed. For the market, this represents a significant commercial opportunity. And for the Chinese economy, this means considerable growth potential. In 2023, the United States spent more than 20% of its GDP on education and health, but China’s share is still much lower.

In 2022, the services 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 were able to increase the share of employment represented by the services sector to this level, it would unlock considerable growth potential.

Of course, some insist on considering education and health care as consumption expenditures. Given that China is still a developing country, some economists and policymakers believe that the capital stock is expected to continue to rise – hence the emphasis on increasing investment in fixed assets rather than consumption .

However, investment and consumption should not be seen as mutually exclusive. Many studies have shown that education helps improve labor productivity and is also a process of human capital accumulation. Compared to many countries in which 11 or 12 years of education are mandatory, China’s nine-year system can be extended.

Similarly, the healthcare sector helps extend the working lifespan of the workforce. Japan, with its comprehensive healthcare system, promotes a higher average life expectancy. As a result, the employment rate of those over 65 in Japan is around 25 percent, a level that plays an important role in mitigating the effects of society’s aging in the country. In China, this rate is 18 percent, according to a report by Bruegel.

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

A large part of education and health spending comes from the state. This requires the government to increase its borrowing for public services and social security spending. Increased government borrowing can help offset the negative impact of a credit crunch caused by the housing downturn.

It is worth noting 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 manufacturing and service industries is well coordinated and the service sector is harnessed as a new growth engine, China’s economy will still have significant growth capacity.