This won’t be the first time we got it so wrong, and as in every previous case—most obviously that of the Soviet Union in the 1960s and Japan in the 1980s—it will probably take many years for American perceptions to change. But in whatever way events actually unfold, the China of the near future will no longer be the aggressively rising China of American fears, and the sooner we recognize this change, the less likely we are to engage in useless and costly confrontation.
Today, China urgently needs institutional reforms that both rechannel bank lending and change its legal and other institutions in ways that raise the productivity of Chinese businesses and workers. China must, in other words, begin the fourth stage of its growth period. It must rein in credit growth and, with it, investment growth, but if it is to prevent growth from collapsing, consumption must take up the slack. This requires redistributing large amounts of wealth from local elites and local governments to ordinary Chinese households.
The historical precedents for such a transformation are grim. The only countries that have succeeded in redistributing wealth and power and rechanneling the financial system to such an extent without suffering political chaos have either been robust democracies, like the U.S. in the 1930s, or highly centralized autocracies, like China itself in the 1980s, and in both cases it took a crisis to force the change.
Will China pull it off? There are broadly three ways that China can manage its adjustment. The best way is if President Xi Jinping has been able temporarily to consolidate enough power to force through the necessary wealth transfers that raise household wealth quickly enough so that consumption can power growth as nonproductive investment is forced down. In this case, China’s share of global GDP—currently around 15% to 16%—will probably continue to rise, albeit more slowly than in the past, and the Chinese economy will end up with a much larger and more powerful household sector, more stable growth, and eventually a weaker government sector.
The sheer extent of the needed reforms make this an unlikely outcome. Still, it is not impossible: China managed an equally difficult transformation with Deng’s reforms in the 1980s.
The second way is if Beijing is able to stabilize the debt burden with smaller but more-manageable wealth transfers to Chinese households. In that case, Chinese GDP growth will drop to well below half of current levels, although household income growth by a lot less. China’s share of global GDP would probably drop, even if not as precipitously as its predecessors, but it runs the risk, like Japan, of failing to resolve its debt burden and so suffering many years of stagnation.
The third way is if Beijing is unable to gain control of credit growth in time and the economy runs up against debt-capacity limits, either in the form of a financial crisis, or by effectively monetizing new debt as it comes due. A crisis is very unlikely as long as the Chinese banking system remains closed and the regulators powerful, but either way Chinese GDP growth would drop sharply, to zero or even negative. [Source]
"The sheer extent of the needed reforms make this an unlikely outcome." I'd say impossible. The Chinese people would do what with all this transferred money? Right now, all they seem to be able to do with it is buy empty real estate and junk bonds. Try democracy instead. I don't think 1980s China is nearly similar enough to the China entering the 2020s that a totalitarian dictator can manage the entire economy. Let the People themselves decide collectively and democratically at the local level what they want and need. That's where they can put the money. It will be vastly more productive.