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Brexit Is the Sum of China's Fears

Christopher Balding is an associate professor of business and economics at the HSBC Business School in Shenzhen and author of "Sovereign Wealth Funds: The New Intersection of Money and Power."
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In voting to leave the European Union, the U.K. has confirmed many of the Chinese Communist Party's worst fears about democracy. Now the question is whether Brexit will also impede its attempts at economic reform.

At least one major target of "Leave" campaigners in the U.K. -- an unaccountable bureaucracy in Brussels, enjoying the fruits of power -- will certainly resonate with Chinese citizens. Despite a recent corruption crackdown, dissatisfaction with officials is simmering in many parts of China -- over land grabs, unpaid wages, layoffs and more. For the Communist Party, a popular rejection of distant bureaucrats isn't to be taken lightly.

Brexit also confirms the party's fears about the capriciousness of the people. As an editorial in the Global Times, a state-run tabloid, put it, Brexit is a "Pandora's box," a "lose-lose situation" and a "major setback." The Chinese people, it went on, "will continue to watch the consequence of Britain's embracing of a `democratic' referendum." Such skepticism of the wisdom of crowds is widespread in Beijing's halls of power -- and it has real-world consequences for democracy advocates.

A deeper worry for the party is instability. The political and business classes in China are extremely risk-averse. Banks lend to state-owned enterprises in the belief that the government stands behind them, students from the best schools aspire to the civil service, and changes to policy flow from on high. Party technocrats tend to see political and financial instability as intimately linked. And as Premier Li Keqiang stressed repeatedly yesterday at the World Economic Forum, Brexit has increased both.

The immediate economic consequences for China are likely to be minimal. As Bloomberg economists Tom Orlik and Fielding Chen have pointed out, only 2.6 percent of Chinese exports head to the U.K.

But the indirect consequences could be substantial. After Britain voted out, the yuan suffered the biggest one-day drop since its devaluation last August. In the worst case, Brexit may act as a long-term drag on China's exports, increase its spare capacity, spur capital flight, impede foreign direct investment and generally weaken the forces that have sustained its growth over the past few decades.

Amid that kind of pressure, expect China's leadership to double down on economic and financial policies intended to keep growth humming and minimize any disruption, no matter what the price. That may mean a further weakening of the yuan and more credit-fueled investment. It may mean leaders will think twice about undertaking contentious bank reforms. And a much-needed overhaul of state-owned enterprises -- which risks turning laid-off workers into crowds of protesters -- could be placed on the backburner. A further tightening of dissent also can't be ruled out.

The Chinese Communist Party is a keen watcher of world events, and is quick to learn from the failures and successes of others. As it watches the British pound plummet and global markets go haywire, it will only see more evidence that the risks of major financial and political reforms simply aren't worth taking.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Christopher Balding at cbalding@phbs.pku.edu.cn

To contact the editor responsible for this story:
Timothy Lavin at tlavin1@bloomberg.net