Beware China's Political Bubble: Business Class
Although China has been churning out its share of unpleasant news, many onlookers don't consider its problems as serious as those of other big economies.
They should think again. China’s biggest economic challenges are political in nature and daunting, and will almost certainly get worse. That is because its autocratic system, for all the stability it has provided, will struggle to handle the sustained economic slowdown the country is likely to confront during this decade.
With crucial leadership changes due next year, the jostling has already begun over the people and political postures that the ruling Communist Party will select to steer the country. Reports of rioting by migrant workers in the southern manufacturing province of Guangdong this week are a reminder of how much is at stake in the years ahead. The protests that break out routinely across China are tiny compared with the upheaval that could erupt if growth slows and the political system is unable to cope. And social unrest is only one of the risks China will face when it can no longer grow its way out of every problem.
For the moment, much of the news out of China tends to focus instead on shorter-term risks, or on manageable problems that seem unrelated to one another. Accounting issues, for example, have increased doubts about China’s listed firms. Meanwhile, the authorities’ latest efforts to rein in credit -- announced this week along with more news of rising inflation -- worry those who fear a hard landing for property construction.
The steady stream of moderate trouble, following strong growth year after year, doesn't seem that serious compared with the obvious -- and so far unaddressed -- difficulties facing the European Union, Japan and the U.S. Sure, the risk of a sharp property slowdown is worth watching; but because Chinese residents save up before buying their homes, rather than loading up on debt, it doesn't look like the sort of imbalance that has been so damaging elsewhere. And yes, when Chinese companies merge with foreign ones to gain listings on overseas exchanges -- the most recent worry for those buying shares in corporate China -- investors in those companies should stay alert; but this risk seems depressingly familiar when one considers the hazards of emerging-market investing.
Yet China does have a serious imbalance -- its own type of bubble -- and it doesn't involve property or shares. It stems instead from a political system that is poorly equipped to do what will be needed to sustain growth and allay social unrest in the coming decade. This mismatch, between weighty expectations of future success and a political structure that can't support them, is reminiscent of many other episodes of dashed dreams, from dot-com busts to housing-market collapses.
As with many other booms, China’s rapid growth stemmed initially from real and substantial changes, which powered a genuine transformation. In China’s case, the driver wasn't one breakthrough technology –- such as the Internet was in the U.S. in the 1990s -- but rather widespread structural change, beginning in 1978 with sustained reforms that gradually replaced central planning with reliance on market forces. Foreign direct investment and technology flowed in, and workers migrated from rural areas to the rapidly growing industrial cities. All of this contributed to a huge and sustained increase in China’s productivity.
These gains have been a boon for China. But the country’s rampant growth will nevertheless slow sharply at some point, and this is likely to start before this decade is out. As in so many booming economies in the past, some of the drivers of productivity growth -- such as that exodus of workers from farms to factories -- will begin producing diminishing returns. And the ability to grow rapidly by catching up to leading-edge economies will moderate as the gap between China and advanced countries narrows.
There is nothing unusual about this. One recent analysis, which examined fast-growing economies in the half-century after 1957, estimates that within five years China will reach the level of income at which, on average, other star economies began to fade.
The authors of that study – Barry Eichengreen of the University of California at Berkeley, Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University -- make clear that the average conceals a great deal of variation. The continuing development of China’s western regions may allow it to maintain high growth for longer than other fast-growing economies did. Conversely, its awkward demographics, a population that, as the saying goes, will get old before it gets rich, may make sustained growth even harder for China than those earlier economies. In any case, growth will slow sharply at some point, from 9 percent a year in real gross domestic product per person to perhaps 5 percent to 7 percent.
When that happens, many of the problems created by China’s autocratic and highly investment-driven approach will worsen and begin to feed on themselves. The Communist Party’s leaders have invested heavily in a narrow approach to growth, and have leveraged their credibility in the process.
In adopting this course, China's autocrats have sacrificed accountability in many important dimensions to deliver growth, which has occurred in a way that only weakly carries through to wages and consumption. The country is nearing a point, moreover, at which sustaining growth will require the gains to be more broad-based, from the way capital is allocated to the mix of non-manufacturing jobs created. A government that shuns accountability and fears information flows is unlikely to foster, or cope well with, such a shift.
(Brian Barry, a professor of economics and executive director of the Initiative on Global Markets at the University of Chicago Booth School of Business, is a contributor to Business Class. The opinions expressed are his own.)
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