China needs to look beyond real estate for sources of growth

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The writer is senior fellow at the Institute of World Economics and Politics at the Chinese Academy of Social Sciences

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

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

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

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

Over the past 20 years, the housing issue has seen significant improvements. However, in education and healthcare, due to systemic and institutional barriers, Chinese people’s willingness to spend has not been fully unleashed. For the market, this represents a significant business opportunity. And for the Chinese economy, it means substantial potential for growth. In 2023, the US spent more than 20 per cent of its GDP on education and healthcare but China’s share is still far below that.

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

Of course, some insist on treating education and healthcare as consumer spending. Given that China is still a developing country, there is a belief among some economists and policymakers that the capital stock should continue to be increased — hence the emphasis on increasing investment in fixed assets rather than consumption. 

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

Similarly, the healthcare industry helps extend the working life of the labour force. Japan, with its comprehensive healthcare system, supports a higher average life expectancy. As a consequence, the employment rate among over-65s in Japan is roughly 25 per cent, a level that plays a significant role in mitigating the effects of an ageing society in the country. In China, the rate is 18 per cent, according to a report by Bruegel.

On the supply side, China’s development model has in the past relied 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 healthcare helps expand domestic demand too. This also contributes to reducing China’s external imbalances.

A large portion of education and healthcare spending comes from the state. This requires the government to expand its borrowing for public services and social security expenditure. Increased government borrowing can help to offset the negative impact of a credit contraction caused by the real estate downturn.

It is noteworthy that the Chinese government is increasingly emphasising 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 co-ordinated, and the service sector is leveraged as a new growth engine, then the Chinese economy will still have significant capacity to expand.