Can China handle threats to growth and stability?

FT ^

[maui_hawaii]

Many analysts continue to tout China as the great investment opportunity of the new century. Yet, the long-term sustainability of its economic expansion remains uncertain. Can China’s explosive growth survive its corrupt and inefficient political system?

The economic record is, without question, impressive. Foreign direct investment levels jumped again in 2004 to a record $64bn. Between 1978, when its market-based economic reforms began, and the end of 2004, China has raked in an estimated $563.8bn – about 10 times the amount Japan has amassed since 1945. Wall Street analysts remain bullish on the People’s Republic, largely because these analysts tend to project growth rates for China’s next generation based on the performance of the last.

However, given China’s enormous and growing social and structural problems, there are few countries where past performance is less a guarantee of future results.

Over the next year, China’s economy should continue to fire on all cylinders. The PRC has sustained 9 per cent annual growth for a generation, and Communist party planners find no virtue in altering course. The party leadership does not accept the West’s view that China must manage a slowdown to growth of about 7 per cent to prevent the Chinese economy from overheating.

Party officials insist China’s economy is like a growing teenager that must be fully fed to be fully nourished. It is hard to say how much of that view is based on reasoned macroeconomic analysis and how much is based on the personal interests of Communist party cadres. It is a view held in Shanghai, however, where China’s entrepreneurship is at its most ambitious, and in Beijing, where national economic-planning decisions are made. Investors can expect more high-octane, near-term growth and investment in China.

China’s longer-term growth prospects are a lot murkier – mainly because China’s ability to sustain current growth rates with minimal political reform is in question. First, public demonstrations are increasing across the country. Beijing acknowledges that 20 years of reform of its inefficient state-run enterprises have produced unemployment, layoffs, and the withholding of wages, pensions, housing allowances, and health-care payments. Many analysts believe the financial troubles of the larger state-operated enterprises have already affected tens of millions of Chinese jobs.

The result is social unrest. Nationwide statistics measuring what Beijing calls “mass group incidents” have been unavailable since 2000, but, according to Murray Scot Tanner of the Rand Corporation, China admits to a 268 per cent increase in these incidents between 1993 and 1998. More recent provincial police reports offer an incomplete, but still revealing, portrait of the extent to which the unrest is increasing. The public security chief of Liaoning Province in China’s north-east, for example, claimed 9,559 protests, each involving at least 50 people, between January 2000 and September 2002. That’s an average of 10 large-scale protests every day for three years in one mid-sized Chinese province – and that’s only what local Party officials have reported. Nationwide, some have estimated the total number of protests in 2004 at 47,000. That stunning figure may be a conservative estimate.

More ominously for the government, the protests are becoming better organised. Cell phones, text messaging, the internet, and email have made an important difference in the ability of protest organisers to quickly turn out large numbers of people and to co-ordinate their actions. China has invested time, energy, and money in managing the growth of these new tools of communication. However, in a nation that marked the most recent New Year holiday with a record 11bn text messages, the Chinese Communist Party is fighting an uphill battle.

Local activists now work with Chinese NGOs to organise many of these demonstrations; their targets are corrupt local officials. Beijing, though often sympathetic to popular demands for better local government, remains steadfastly opposed to any political organisation outside the party’s direct control and has reverted to strong measures to restrain protesters – including armed force and arrest.

Beyond the growing unrest, longer-term growth in the manufacturing sector is in doubt, because, in a society with rising consumer expectations, fewer workers are now willing to accept minimal salaries without benefits. Adding to the list of structural deficiencies is a rapidly growing income gap and severe water shortages in China’s largest cities.

Another factor threatening China’s potential for sustained long-term growth: substantial environmental degradation. Nine of the world’s 10 most polluted cities are in China. Half of China’s rivers are polluted – perhaps irreversibly. The Chinese have demonstrated technical creativity for centuries, but central government interference stifles the spirit of free inquiry necessary for the innovation that drives a 21st century economy. China has no viable banking system. Big banks are insolvent. Borrowers default on anywhere from 40 per cent to 50 per cent of all bank loans, which are often awarded for non-commercial reasons.

Without question, China has an enormous wealth of labour and capital with which to address some of the most immediate of these structural challenges. Large-scale projects in 2004 to expand the capacity of China’s overstretched power grid and to upgrade its badly underdeveloped ports system proved remarkably effective quick fixes.

So the real question for China’s long-term growth prospects is a simple one: can China grow its way out of longer-term threats to the viability of its political and economic policies, or will Beijing’s unwillingness to reform its sclerotic political system ruin China’s economic prospects? The jury is still out, but the international significance of this question grows everyday. China’s political and economic choices will be the single most important influence on global markets over the next 10 years.

[only1percent]

What's happening in China is the gradual displacement of the state-controlled sector. Twenty years from now, China's GDP will be substantially more private than the United States. (While China may still have more government ownership of business, the U.S. government's share of GDP will be much higher due to massive outlays and taxes for Medicare and Social Security.)

Every year, millions of people change their employment, housing, or finances from the state-owned to the private sector. Start-up businesses don't even bother with mainland banking or securities markets -- everything is done directly with Hong Kong or Singapore institutions with those non-mainland courts or international-grade arbitration built into the deals.

The Communist Party is in its own transformation process, from a Marxist-Leninist club for ambitious (or established) bureaucrats into something more like a giant Chamber of Commerce with political powers. Whether it will in turn yield to democracy is not an ideological question at all, but, rather, depends upon whether Chinese businessmen can be persuaded that democracy is better for economic development than authoritarianism. So long as China depends upon a huge low-wage-labor force and heavily-polluting industries for a lot of its growth, I somehow don't see the business elite being too eager to open up governance to the masses.

[Sandreckoner]

"Twenty years from now, China's GDP will be substantially more private than the United States."

Perhaps, but if that's the case then in 21 years and out China will begin paying a crippling price for its failure to plan for a massive glut of aged citizens.

Regardless, I find it mind-boggling to read projections of Chinese future decades based on past decades. Invariably these seem to be made by commodities traders, fund managers and the like with something to sell, or who just lack the ability to truly look at future prospects. Most economists - and including the Chinese - project GDP growth to slow into the 7% range by 2010, to 5-6% by 2020, and into the 4-5% range not far beyond. Yet over and over China is projected to make incredible leaps and bounds by growing 9% a year (or even 7%) on out through the middle of the century, ensuring it overtakes the US as the largest economy in nominal terms. (Even the Chinese find nothing to chest-thump about in overtaking anyone in PPP terms.) It's patently ridiculous, but then I suppose as the Ted Fishman's over the world prove it can also be patently lucrative to foist such claims.

[maui_hawaii]

I read the first two lines of your post and figured you were smoking something.