A group of Chinese economists from Beijing have circulated a “top ten” list of the difficulties faced by the Chinese economy in 2018. This list has been removed from all media in China, but it has been released outside China (as far as I can tell, in Mandarin only). For obvious reasons, the economists who drafted this list have chosen to remain anonymous.

It is of interest to see what Chinese economists themselves see as the important issues for the Chinese economy. This is a list for 2018, but it sets the stage for 2019.

The top ten (per these Chinese economists) is as follows.

1. Trade war with the United States. China has consistently maintained a major trade imbalance with the United States. China sells but does not buy. The imbalance grew even more extreme in 2018. This is a core factor leading to the trade war. This is because the U.S. has shown it will not allow a major trade deficit to continue with any country. It is therefore clear that the trade war with the U.S. will not be resolved until the trade deficit issue is resolved. Since such a resolution does not seem to be imminent, the trade war will likely continue, exerting great pressure on the Chinese economy.

2. The disappearance of Made in China 2025. From 2015 to 2017, the Chinese government touted its Made in China 2025 program as its core policy for development of the Chinese economy. Due to pressure from the U.S., Europe and Japan, public discussion of the program has virtually ceased. Foreign opposition to this program has been based on the following two factors:

a. The advances in technical expertise outlined in the program do not rely on Chinese domestic innovation. Rather, the program relies on forced technology transfer and IP theft. Objection to this approach is at the core of the United State’s Section 301 complaint against China. You can read the United States Trade Representative’s most recent Section 301 report in full here.

b. The Made in China 2015 program is widely viewed outside China has having been implemented to position China to be able to use technology to project Chinese power.

Without resolution of a. and b., it will be difficult for China to openly revive the Made in China 2025 program and nothing has been proposed in its place.

3. Frozen domestic real estate market. The Chinese domestic real estate market has been used to help finance both the central and local governments. The constant rise in real estate prices has been treated as a “blood transfusion” for both the local and central governments. But the end in price appreciation has been reached and continued price inflation will lead to a bubble. But popping the bubble now would cut off necessary funds for the government and would cause social problems in a population that has never experienced a real estate crash. For that reason, China’s real estate policies are frozen in place.

4. RMB value is between a rock and a hard place. The RMB weakened during 2018 and is now approaching 7.0 Yuan to the Dollar. The RMB is a managed currency, so the central government has to decide: should it let its value rise or fall? The pressure is intense to devalue, but that leads to some unpleasant results. With a weakened RMB, China risks being branded a currency manipulator by the U.S. and others. A weakened currency further encourages capital flight, which is already a problem for the Chinese economy. A weak RMB also means higher prices for oil, coking coal and mineral ores. But maintaining the value of its currency would require China make use of its dwindling foreign exchange reserves to support the RMB value.

5. GDP, debt and failure to deleverage. China currently maintains strong GDP growth by infusing debt into the economy. Even with this pump priming, many Chinese and other economists believe China’s GDP is not growing at the stated rate of 6.5%. Some even believe its economy is not growing at all. This means its economy has stopped responding to the debt infusion and yet the government continues to pump debt into the economy. This will likely eventually lead to some form of debt-induced economic contraction. The alternative is to start the deleveraging process now. But the economy is so bloated, any government induced deleveraging will likely cause a recession, a result that will lead to social problems. So China is at a crossroads on the debt issue. There are two roads to take, and both will likely lead to dead ends.

6. Local government debt. Local governments in China are not permitted to impose taxes. They finance their infrastructure and investment programs by issuing debt. Much of this debt is “off the books” debt issued by special purpose financing entities ultimately owned by the local government. Though the official local debt is estimated at about 20% of GDP, most economists think real number is closer to 100% (or more) of GDP. The central government has proposed resolving this problem by allowing local financing entities to declare bankruptcy. With a debt level at 100% of GDP, the bankruptcy approach is not feasible because of the negative impact this would have on the banking system and the local economies. But a continuation of this debt is not sustainable, leaving local governments with no viable alternatives for funding.

7. Collapse of non-bank capital markets. Since private businesses and private citizens have little to no access to bank financing, a non-bank capital market has grown in China as an alternative. In 2018, the three main components of that market collapsed: a) P2P lending, b) private company corporate debt (bonds) and c) private equity funds. This collapse has already resulted in some social unrest. More important, no alternative to this type of funding has been proposed.

8. Collapse of public stock markets. The Shanghai stock exchange was created to help funds selected stated owned enterprises (SOEs). It later evolved into a system to extract money from private investors. Chinese stock prices have never really been based on market factors. Prices have been set and manipulated by the central government. Small private investors have remained in the system, treating the stock market as a casino that ultimately favored the bettors. In 2018 it became apparent that it is not true that the government would guarantee the stock market would always increase in value. When this became obvious, the “smart money” quickly left the market. This then left only the private, small time investors and the government controlled market makers. Again, when it became apparent that the market makers had lost their ability to prop up the market, even the small private investors began exiting the market. This led to a sharp decline in all public stock market indexes. Not only has this led to a decline in the market, the financing provided by this market is also drying up.

9. The decline of the private sector. Under the leadership of Zhu Rongji, the watchword for the Chinese economy at the turn of the millennium was that “the private sector advances while the state retreats.” Over the past decade, this policy has reversed. Under the current government, the watchword seems to be that “the state advances while the private sector retreats.” The goal is for SOEs to control most of the more important sectors of the Chinese economy. But Chinese SOEs are generally less profitable than private companies, this transformation brings with it a decrease in entity profitability.

10. Three engines of the economy become three horse carts. Investment, domestic consumption and exports have for the past two decades been the three engines of China’s economy and all suffered substantial decreases in 2018. The fall of one pillar would be a significant blow, but the fall of all three at the same time has had a significant impact. At the same time, the three burdens of the citizens have increased over the past decade: a) social security in old age, b) education in youth and c) health care in between. With the three “turning to horse carts” citizen unrest is starting to grow.

Please note again that this list of ten comes from Chinese economists and it was written in Mandarin for Chinese consumption. Though it is not my list, I (and the other China lawyers at my law firm) have noted pretty much all of these factors present in China in 2018. When China joined the WTO, in 2001, the plan was for China to transition from a planned economy to a market economy. This move to a market economy never occurred and this list shows that it is not likely to occur and the likely results of this.