Articles:
China’s political contradictions

What is really happening in China? That is now one of the most important questions for global businesses, which especially includes Japanese exporters and the many Japanese companies that have opened factories in China. Firms operating in China will know precisely what is happening to their own order-books and in their own markets, but the situation in the wider economy is more of a mystery.

The most headline-grabbing sign of stress has been in the Shanghai stockmarket, where an extraordinary year of soaring share prices was followed by a slump of more than 30% since mid-June and by a series of rather clumsy and ineffective efforts by the government to intervene and stop shares from collapsing.

Yet stockmarket movements merely provide a drama for the media. They are not yet very important for the economy, since only 7% of China’s population is active in the equity markets. The main importance of the Shanghai stockmarket’s volatile performance is likely to be political, not economic.

For what is really happening in the Chinese economy is a huge test of the inter-action between economics and politics in a country still run by the Communist Party. In fact, it is even more than that: it is a test of the choices and priorities of the Communist Party leadership between different, and conflicting, political goals.

The basics of what is going on in the economy ought to be familiar to anyone who knows about Japanese economic history of the 1970s. In that decade, Japan made a big transformation, partly driven by market forces and partly by government policy. Before that decade, Japan’s economic growth had been led by heavy industry (steel, chemicals, shipbuilding), by high levels of investment in factories and in urban development, by exports, and frankly by a high toleration for environmental pollution.

The transformation was to cleaner growth, less dependent on investment and more on household consumption, and one that was led by higher technology and consumer industries. This transformation was helped by the fact that Japan was a democracy.

This is exactly the sort of transformation that China’s non-democratic leaders have been calling for over the past ten years, and which has finally started to happen. Or rather, part of it has started to happen: investment, both in housing and in factories, has slowed down, probably to zero annual growth once allowance for the depreciation of fixed investment assets is accounted for.

However the other part of the transformation, the replacement of investment-led, generally dirty growth, by more consumer spending and by cleaner, higher-technology production, has been slower to arrive.

For that reason, although official GDP figures continue to predict economic growth this year of close to the government’s target of 7%, many private-sector economists believe the true figure will be lower, at 5% or even less. And they forecast growth for 2016 of at best 6%.

This slowdown may prove to be temporary: Japan too, during its transformation in the 1970s passed through a tough period following the twin shocks of the oil-price rise of 1973 and the revaluation of the yen. It takes time for industry to adjust and for new sectors to emerge successfully.

This is where the politics comes in to play. The industrial transformation that Chinese leaders have been calling for over the past decade requires political interventions to reduce the dominant power of some state-owned enterprises, to raise the cost of polluting, and to allow private firms to expand in new sectors. Such interventions have been hard to do, ever since Prime Minister Wen Jiabao began calling China’s economy “unstable, unbalanced, un-coordinated and unsustainable” nearly a decade ago.

The global financial crisis also delayed the necessary adjustment, when in 2008-10 the Chinese government intervened to rescue its economic growth through a huge expansion in credit, much of which was spent on construction and heavy industry.

Now, those political interventions are needed more than ever. But they clash with another political goal, being led by President Xi Jinping: establishing tighter control for the Communist Party over corruption, the media and much private-sector activity. And the Party’s interventions during the recent Shanghai stockmarket crash have made it look heavy-handed, incompetent and not very interested in market solutions.

President Xi’s political priority is the long-term survival of Communist Party control. Reducing the power of state-owned enterprises, enforcing environmental laws and deregulating the private sector are all necessary for the long-term health of the Chinese economy. Are these goals compatible? That is what we are going to learn, over the coming months and years.