Going into the third year at the helm of the world’s second biggest economy, Chinese leader Xi Jinping faces perhaps the most daunting task of any world leader, aggravated by the recent downturn in the economy.
Markets and many foreign observers have been extraordinarily slow in picking up the fact that the world’s second biggest economy is slowing down. That has been the policy of the Bejing leadership for at least a year. The drop in growth so far does not betoken a crisis. But it does raise the basic question of whether the leadership of the second largest economy on earth can manage the need for change on a huge scale, which could jeopardise some of its basic political criteria.
Forget Fed interest rate raising or EU QE; this is the most important single question for the global economy for the foreseeable future. The gamble of the Xi administration is that it can, as a reform document from late 2013 put it, “harness the dynamism of the market” to strengthen the dominance of the Party State that has run the Peoples’ Republic since 1948.
The need for change is evident. The old equation of cheap labour, cheap capital and strong export markets that drove spectacular growth from the 1980s no longer works. Wages have risen. Capital costs more. As for exports, things ain’t what they used to be. Three years of deflation has been fuelled by huge excess capacity. Consumers are not increasing their spending to rebalance the economy away from dependence on fixed asset investment in infrastructure and construction. The big anti-corruption campaign has sapped initiative. China has a debt mountain and multiple quality of life issues in pollution, food safety and lack of rule of law.
But recent events have hardly burnished the credentials of the reformers round Prime Minister Li Keqiang (very much second to Xi in the Beijing pecking order with the leader having heightened his status at this month’s big military parade in the capital). The convulsions on China’s stock exchange and heavy-handed official measures to check falling prices have curtailed Li’s policy of encouraging companies to raise funds through equity rather than by more borrowing. The supposed liberalisation of the currency was quickly stopped by central bank intervention. A cut in interest rates after bad August data ran counter to the government’s wish to reduce corporate and local government debt levels.
State companies have not been opened up to competition. The reform programme has done nothing to help private firms, which produce more growth and jobs than their state counterparts. Moral hazard still rules – companies that get into trouble are inevitably bailed out by the state.
Growth has been lacklustre so far this year. The government will be hard put to it to reach its target of 7 per cent for 2015. Manufacturing indexes have dropped. Chinese imports have benefitted from falling commodity prices but exports have been up and down with problems in emerging markets and soggy demand in rich nations.
All this is sapping the trust in official management of the economy among China’s households, the key supplier of funding to the system from their savings. Many international investors have been scared off by the official stock market manipulation. Big global companies are reviewing their involvement in the slowing economy.
The monthly numbers matter, of course, but, given the questionable nature of the data, it would be a mistake to put too much weight on them. The fundamental question involves the politics of the economy. Xi thinks he can reconcile market reform and the dominance of the Communist Party; he does not want to see reform sapping political power as happened in the Soviet Union.
If he is right, a new China Model will amaze the world; if not, the country will be stuck in what I would call a Middle Development Trap. The evidence so far points to the second, not the first – no great crisis given China’s resources and remaining catch-up potential but a steady slowing down, with global implications for countries and companies which rode on the back of its rise.
