Tag: China

When will we see peak China?

Don’t bet against China. This has been sage advice ever since that country’s careful embrace of capitalism after the death of Mao Zedong in 1976. Failure has been predicted several times, but its growth has been rapid, both in economic and political power. Similar advice pertains to the US economy, at least for better-off Americans, even as its politics disappoints. But nothing is forever, and there will come a point when China’s growth runs out of steam.

Right now there is unmistakable hubris in China’s political class, which frequently touts the superiority of its political system over that of the West – with its response to the covid pandemic being the latest piece of evidence. And yet as 2022 progresses, that will look less convincing. The point here is not that the pandemic started in China and that the initial outbreak was fumbled. That could have happened anywhere, though it is interesting to note that in China the problem arose with weakness and denial at a junior official level, whereas elsewhere the weakness is more likely to be further up the chain. China’s policy is to stamp out the disease before it can get going through very strict lockdowns, and sealing the border. It shows a very impressive degree of political control and resolution from the centre, which other large polities have failed to match. But what next? The first problem is that China’s own vaccines are less effective than those developed in the West, and are not up to the job of being a first line of defence – but the leadership regards the use of vaccines developed elsewhere as a sign of failure. The next problem is that the virus is evolving so that it is becoming more infectious, and thus harder to contain – though less deadly. This means that as the West moves beyond the need for lockdowns and learns to live with the virus, China is faced with an awkward choice. Does it try to keep up its zero-covid strategy, with all the costs that that this brings? Or does it let the virus run its course in China, softened by vaccines and a less dangerous strain? That might make it look as if China’s leadership had made some wrong choices earlier on – even if that is unfair, given that death rates in China are likely to stay very low. We have a demonstration of the strengths and weaknesses of the different political systems. The open, chaotic system of democracy in the West, which includes some important countries in East Asia, is both better at technological development, and more adaptable and resilient when it comes to shaping public policy. Policy failure may be more likely in the West, but its consequences are not as serious – indeed it can be more readily used as a learning experience.

Behind this is the timeless conflict between centralised political control and localised decision-making. The genius of capitalism is that uses markets to facilitate efficient local choices, right down to the individual; markets have proved vastly more effective at processing information than any other system that humanity has devised. The attempts by socialist states to do without markets, and the free capital that is required to make them work properly, notably by the Soviet Union and Maoist China, proved a dismal failure. While these systems did have some notable achievements, they made little progress with the eradication of poverty. The Soviet Union’s attempt to reform and embrace some aspects of capitalist systems ended in complete collapse. China noted this failure and made sure that its own embrace of capitalism was more controlled. The Communist Party developed a hybrid system of central party control alongside highly competitive capitalist markets that has been astonishingly successful. It has been the world’s most striking political and economic success of the last fifty years, and has done more to move the world out of poverty than any other single thing. With economic success has come a stronger political standing, backed by military power, which the country has been increasingly ready to assert.

Now, as a good liberal I need to make an important point here. China’s rise has been good for the human race. A country of over a billion people deserves a high status in the world’s political system. American conservatives are inclined to see China’s rise as a political failure – but that is quite the wrong way to look at it. This is not just because it has benefited so many Chinese people, who can now adopt middle-class lifestyles – but China’s rise has contributed to a much more efficient world economy, whose benefits have been well beyond its borders, and not least in the USA and other countries in the West.

But there is a problem, both for China and the rest of the world. China’s hybrid system of authoritarian capitalism is not sustainable in the long run. China is far from the only country that has followed this path. In the first half of the 20th Century there were Germany and Japan. In both of these rapid economic success led to political tensions that in turn led to militarism and vastly destructive war. In the second half of the century several East Asian countries have followed the authoritarian capitalist path, which too has led to political tension. There seems to be a choice between allowing democracy to take hold, or moving deeper into totalitarianism. South Korea and Taiwan have decisively taken the democratic path. Indonesia, Malaysia and Thailand are struggling with this choice, though not yet on the totalitarian road. Vietnam has so far successfully avoided the crunch, but it is bound to come there. Singapore resists full democracy, while avoiding outright totalitarianism, and is further down the development path than others – but it is just a city-state.

Under its current leader, Xi Jinping, China has opted for decisively for totalitarianism, and is taking Hong Kong with it. What do I mean by totalitarianism? It is a political system where a highly centralised elite, usually with a clear single leader, attempts to control all aspects of life. This includes non-political values and the editing, and rewriting, of history. The concept of objective truth is discarded so that pretty much any statement is valued purely on its political implications. The reach of public policy often takes in the private foibles of the senior leader – in China the government wants to stamp out effeminacy among men, for example. The Chinese Communist elite has decided that any admission that the Party is, or ever has been, mistaken is a political challenge that must be crushed. Hence its difficulties in confronting covid. A change of policy might in fact be a sensible response to new facts about the virus – but, especially given the hubris displayed so far, it also makes it look as if the earlier policy was a mistake. The argument that when the facts change so does the policy is not a comfortable one for authoritarians: when the facts change, so might your legitimacy.

We come to a basic problem with authoritarian systems. They rely heavily on an elite of no more than a few hundred people, personally known to each other. Beyond this it is impossible to trust people completely. And the further they follow the totalitarian path, the greater this reliance becomes. There is simply a limit to the amount of information that such a small elite can process. The public health authorities in Wuhan, where the covid outbreak started, were not able to take clear, independent decisions, but felt that their duty was to suppress information about anything that looked bad. China has worked hard to make its elite work efficiently, including by leveraging it with technology. The country is placing heavy hopes on the use of Artificial Intelligence (AI). Singapore’s ruling elite is doing much the same thing with some success – but it is one thing to manage a city state, and another a country of one billion people. For China’s ruling elite the problems are mounting. Here are a few of them.

The first problem is demographics. Thanks both to Mao’s one-child policy, and to the normal dynamics of economic development, the ratio of working-age people to older people is in the process of rapid decline. The overall population of the country is starting to fall. For all the country’s economic advances, a Western-style system of welfare has not been developed. This will require a radical reshaping of the Chinese economy with high economic productivity increasingly focused on domestic needs – and, surely, a greater dependence on imports.

Then there is financial management. China’s system of finance is many-layered and complex. The Western socialist idea of a centralised system of state finance with a large national debt has not been followed – doubtless because the economy too large and complex for that to work. Vast amounts of money have been invested, notably in property development, financed by a complex system of finance, involving public and private agencies. Restrictions on banks have led to complex work-arounds. There is a huge dependency on high property values, which reaches well into local government finance, where funds depend more on property development gains than taxes. The whole system bears a strong resemblance to the financial system in the West before the Great Financial Crisis of 2007-09. Western commentators are quite sanguine about this, assuming that the vast political power available to China’s central government will allow them to manage any fall-out better than Western governments did. Only up to a point.

Even in the area of global politics China faces a problem. Much as they crow at the retreat of the West in such places as Afghanistan, they have little ability to fill the vacuum. The West’s retreat is followed by collapse, vacuum and, in many places, war, and not by a beneficent China restoring order. China has nothing to match the West’s proclamation of liberal values and a rules-based order. It simply denigrates them, while boasting about its own political system, which is pretty much impossible for any other country to replicate, except Vietnam, perhaps. It is notably un-ideological in its international dealings. That is very attractive to regimes who tire of being lectured by Westerners – but it has a dark side. China has no compunction about bullying if it does not like what any country is doing – Canada, Australia, South Korea and, currently, Lithuania are all victims. Suddenly a rules-based order and a bit of lecturing start to look more attractive. China’s weak international position was especially conspicuous at the recent COP-26 climate conference. The country showed almost no leadership, in spite of the fact that most countries are becoming much more concerned about climate change. Those countries get a more constructive response from the West. And China is the world’s biggest producer of carbon emissions, so it should have something important so say.

These problems are clear. Another important issue is more ambiguous. Will the increasing control of the Communist elite mean the loss technical innovation? At the moment the Party is bearing down on privately-controlled businesses, which have been the source of much of this. But totalitarian regimes can be good at innovation, especially in highly focused areas, such as military technology. China has set some major priority areas, which will doubtless receive generous funding. All the same, innovation and creativity flourish more in a less directed environment. Much of China’s investment is sure to disappoint. AI, in particular, is a much much trickier thing than those with directive minds allow. Driverless cars have been around the corner for many years now, for example.

So, as China confronts these problems, what is likely to happen? The biggest fear is that, like Germany and Japan a century ago, it channels its frustration into military aggression, and starts off a war that it cannot stop. There are some signs of this, but the world is a very different place. The world trading system, which has China at its heart, is liable to weaken as China tries to become more self-sufficient, both for political reasons, and to manage its changing domestic priorities. How this plays out in the wider world is hard to judge. It could be a boon for other developing world countries, who may take China’s place as exporters. It could hurt the American economy, which has benefited so much China’s boom – but then again, betting against such a dynamic and adaptable system is not wise.

My guess is that China will be enveloped by a slow-moving financial crisis. Communist power will succeed in slowing it down, but that will prolong rather than solve it. This will impact investment, development and growth across the country, and undermine the Party’s prestige. Eventually Mr Xi will be replaced, perhaps as his next term ends in five years’ time, and this would be cue for another change in direction. The world will become a very different place.

2016 is nothing like 2008, but there’s trouble ahead for the world economy

In my New Year post I did not write much about finance, but made some rather throwaway comments that the economy could take a turn for the worse in 2016.  Having just read Martin Wolf’s rather sanguine piece in the FT, I hadn’t quite understood that my views were in line with conventional wisdom in the financial markets – and this not at all a position I like to be in. But pessimism is in, and reflected by lower share prices worldwide. This has filtered through to left wing commentators, like Will Hutton, who gleefully want to show that “austerity” or “neoliberalism” is leading to a repeat of the 2008 crash (though Mr Hutton is too good a writer to use those particular totems). This is definitely company I don’t want to keep. Time to dig a bit deeper.

It helps to think back to what happened in the last turndown, the crash of 2008 – as this is foremost on people’s minds. At the start of 2008 the banking system was in deep trouble, although on the surface things were quite calm, if gently sinking. “Holed below the waterline” was the description that I used at the time – alas I was not publicly blogging until three years later, or my reputation might have been made. Trust was breaking down because the banks were dealing a lot with each other, or off-balance sheet offshoots, rather than with the public or businesses. And things were starting to go wrong, beginning with US sub-prime mortgages. The huge tangle of interbank transactions and derivatives meant that nobody knew how the losses would play out or where – so everybody was tainted. Things kept superficially calm until quite late in 2008, when Lehman Brothers collapsed, threatening a chain reaction that would have brought much of the world’s banking system to a screeching halt. Since the banking system is at the centre of everyday life in developed economies the result could have been catastrophic.

That catastrophe was largely avoided, but only because governments bailed banks out to keep the whole system afloat. Even then the damage to the non-banking economy was severe, and government finances, especially here in the UK, were ruined. What was so alarming about the whole episode was that a fairly routine downturn in the business cycle infected part of the US mortgage market, which then completely disproportionately went on threaten the whole system. Defenders of Britain’s Labour government still can’t believe it was anything to do with them – though in fact ten years of complacent economic management had left the country highly vulnerable to such a chain reaction.

Why are people worried now? Well one thing that helped the ameliorate the disaster in 2008 was that emerging markets, especially China, were less badly affected, and in China’s case, government stimulus helped keep things afloat. Now that side of things is unravelling. The Chinese economy is slowing, and in the process it is undermining world markets for commodities such as oil, which presents the threat of widespread damage in the developing world. The Chinese situation arises partly because the country has hit an awkward point in the evolution of its development, and partly because their stimulus package after 2008 was largely wasted and bad debts are threatening its banking system. Indeed the whole soundness of China’s growth strategy is coming into question (its second, state-directed phase , rather than Deng Xiaoping’s original liberalisation from 1978).

This is serious, and no mistake. The role China has played in the world economy in the last quarter century is hard to exaggerate. What is happening there is much bigger than the US subprime crisis that was at the heart of the 2008 debacle. But it doesn’t have the same destabilising features that caused such a fierce chain reaction – which were in plain view as 2008 started. China is not at the heart of a cat’s cradle of complex derivatives sitting in off-balance sheet funds, with almost every international bank taking part. And the huge power of the Chinese state, and the depth of its financial reserves, means that the country’s financial system will collapse slowly rather than suddenly. The western banking system is a much soberer thing than it was in 2008 too, even if many left wing commentators would have you believe that nothing has changed. For these reasons 2016 does not look like 2008. A meltdown, or near meltdown, does not look likely.

But there could be a slower moving form of trouble. Secular stagnation, the affliction of the world economy I referred to recently, is here to stay. Western economies will slow. Worse things may be in store in the developing world. Share prices may well fall badly – many markets have been overpriced for some time.

And in Britain? In my New Year post I suggested that 2016 might be the year the economy here started to turn sour. That comment wasn’t based on any deep thinking. Britain is unusually dependent on the international economy, as is evident from persistent trade and current account deficits, and a value for Sterling that is hard to justify based on its “real” economy. So, with things going awry in the world economy, Britain might be vulnerable. The Pound could come under pressure; foreign investors could desert London’s property market causing a chain reaction; or a downturn in the City’s finance sector could do the same thing. On the other hand, capital flight from the developing world could benefit London in particular, allowing the country to weather the storm. Some left wing commentators have been trying to stoke alarm about the level of personal debt – but that doesn’t stand up to close scrutiny. Neither should we pay much heed to Labour’s economic adviser, David Blanchflower, who on the radio this morning suggested that Britain was less ready to deal with a crisis than in 2008, because interest rates were already rock bottom. That vastly inflates the effects of interest rate policy on crisis management. David Cameron’s and George Osborne’s luck could hold. I struggle to understand the alarmism on the political left – it will merely undermine its already shaky reputation for economic grasp.

it seems to me that 2016 will be the start of a good old-fashioned cyclical downturn for the world economy, with no more than the usual localised financial crises. Personally I think this will morph into a period of more prolonged secular stagnation that will put paid to economists’ lazy assumption that 1-2% rates of growth are a law of nature.

And that should pose some very challenging questions for the art of economics. But that’s a topic for another day. Meanwhile government bonds are a better bet than shares; cash is not a bad bet either; don’t mortgage up to your eyeballs in property; and interest rates aren’t going up.

 

The Chinese test the limits of a state managed economy

Political commentary on economic growth operates between two poles. On the one side the right argues that the state should get out of the way, and allow entrepreneurial businesses full scope to do their thing. On the other, the left says that growth is driven by investment, much of which must be directed by the state to be effective. Both are right, of course, and the balance depends on the circumstances. But China offers a fascinating case study in this discourse.

Until the rise of Deng Xiaoping in 1978, China offered a good example of a failed, state-led economy, alongside the Soviet Bloc amongst others. The economy was made up of state owned enterprises (SOEs) and state directed cooperatives, operating according to production quotas, all part of a state plan. But the economy took off as the shackles of state control were released.

This seems to follow the right’s playbook, but what happened was in fact much more subtle. The state quotas and SOEs remained in being, but a private sector economy was allowed to flourish alongside it. This contrasts with what happened in Russia after the collapse of the Soviet Union in 1990. There, following the advice of right-wing US economists, the state system was dismantled, with SOEs sold off and production quotas abolished. You can’t be half-pregnant, these advisers suggested. That was disastrous, of course. The SOEs were acquired by well connected crooks, who formed a governing oligarchy. Essential state support systems collapsed. A flourishing economy did not emerge until a natural resources boom saved things.

Meanwhile, China’s pragmatic approach delivered spectacular growth, which led to a rapid diminution of poverty. After a first phase in which private enterprise transformed agriculture, a growing private sector flourished in producing manufactured goods for export. It was one of the most brilliant acts of economic government the world has ever seen. They took no advice from westerners. But the Chinese governing elite was left with some difficult questions. Sooner or later the SOEs and political structures would present limits to growth, and would have to be reformed. Commentators, inside and outside the country, confidently predicted that the Communist Party would have to release its grip. But that is not how things have played out.  The Party did reform SOEs to make them more responsive to market economics, but they did nothing that would threaten its own monopoly of political power.

Instead, as the 21st Century has progressed, a new model of growth has emerged. Alongside a vigorously competitive private sector, a massive programme of state-directed investment has sustained growth. That meant growth rates of 10% or so, even through the world recession of 2008/09. Something like 35% of Chinese national income is directed towards investment, much of it through SOEs. This has now swung towards the left-wing model, and those suspicious of capitalism and democracy have taken inspiration. A wise government, unconstrained by the petty-corruptions of democracy, has led the way to continued spectacular advance – and throwing out all that austerity nonsense too.

But, as Martin Wolf writes in the FT this is all coming into question.  The Chinese economy is slowing down. To an outsider this might look like an orderly transition. Growth rates of 7% are still high by almost anybody’s standards; the government’s aim of moving to an economy led by consumption rather than investment looks natural enough – this will improve the wellbeing of the Chinese people. And yet deep flaws in the Chinese model are being exposed. China has rather little to show for years of massive investment – at least in terms of economic returns, rather than monuments in steel and concrete. And behind the investment lurks piles of debt – representing the savings Chinese people. Chinese productivity has been static.

And slowing the growth rate from 10% to 7% may sound easy, but it creates real strains on financial systems, with all the time lags built into it. It implies a much larger dislocation. But with a stock of useless investments, SOEs who are not used to making themselves more efficient and effective, and a financial system threatened by excessive debt, doubts are growing about how feasible even 7% is as a growth figure. And since China plays such a big part in the world economy, it is no wonder that financiers across the globe are getting jittery.

This has some resonance in domestic politics in the developed world. The left’s criticism of austerity policies since 2008 has been virulent, and joined by many respectable macro-economists. Surely, they suggest, the state should have shored up demand with a programme of investment. Labour leadership frontrunner Jeremy Corbyn’s economic proposals are thick with this sort of thinking. But this only works in two circumstances. First is that the pre-crash economy was sustainable, and can be revived quickly, so all that is needed is to cover a temporary lapse in demand. In this event it hardly matters if the investment itself is useless (digging holes and then filling them in, and so on). But in Britain at least there was good reason to question the sustainability of the pre-crash economy: a large current account deficit, a structural deficit on state finances, a bloated finance sector, a declining oil and gas sector. Besides it is all now a bit late.

The second way in which investment can shore up an economy is if that investment produces decent economic returns in due course, allowing debts to be repaid. The unfolding problems in China are showing what happens if investment is badly directed. There are plenty of other examples (Japan is another good one). The trouble is that the more you try and turn investment on and off like a tap, to regulate the macro-economy or in an explicit drive for growth, the more likely investment is to be wasted. The money is directed according to political imperatives, not economic ones. This is something that macro-economists, who don’t like to look behind their beloved aggregated and averaged statistics, often miss. In the UK the criticism that the government did not invest enough after the crisis remains a valid one – but it would not have been easy to pump in the sort of funds that the wider economy needed to keep on an even keel.

Time will tell on China. Its leaders are not to be underestimated. But they are demonstrating that you can have too much state direction for a healthy economy.