More than at any time in the history of modern China, 2016 will be a pivotal year for the economy. Indeed, the odds are not small that the county’s economic troubles — which, remarkably, seemed like genuine news to much of the world in 2015 — will only get worse.
Such a turn of events could well have a fundamental impact on the growth of the global economy, which is still inching forward in slow motion following the recent financial crisis. And for emerging markets in particular, a China in economic straits could slow down (or even potentially put on hold) the country’s newest initiatives — the Asian Infrastructure Investment Bank (AIIB) and the ‘One Belt One Road’ (OBOR) investment and trade network — about which there has been a tremendous amount of fanfare.
In the end, China’s timing for the launching of these may prove to be unfortunate.
Lying at the core of China’s economic headaches is that Beijing has painted itself into a corner. No economy can have its cake and eat it too. Yet the overarching objectives of China’s economic reform programme — launched in 1978 soon after the death of Mao Zedong and encapsulated in Deng Xiaoping’s 1992 pronouncement that country’s reform model would henceforth to be defined as a “socialist market economy” — have been always fraught with inherent inconsistencies.
As someone who has professionally focused on China’s economy since 1993, worked extensively in many regions of the country — some far, far off the beaten track — and been on the factory floor in more Chinese state-owned enterprises (SOEs) than have most Chinese (or so I’ve been told by friends in Beijing), Deng’s notion always struck me as a contradiction in terms.
The tremendous ingenuity, determination and patience of the Chinese leadership and society, coupled with the country’s sheer size — in geographic, population and resource endowment terms — have allowed China over the last three-and-a-half decades to largely paper over these inconsistencies and achieve a globally envied record of economic growth.
And this is true even if allowances are made for the well-known inadequacies and inaccuracies of Chinese official statistics, which even the leadership itself recently has come clean about. But as China’s growth becomes slower and slower, compounded by gyrations in the country’s stock “markets”, a fall in the value of the renminbi, and a huge overhang of vacant buildings throughout virtually every city, China’s chickens appear to be coming home to roost.
What are some of the more worrying contradictions? Perhaps the least understood is that while Beijing has been intent on trying to reorient the economy to be driven by consumption rather than the country’s long-standing compulsion for saving and investment, the fact is that the economic and political lifeblood of China remains highly dependent on continued, if not accelerated, investment.
Investment for what? To ensure the state remains front and Centre in the economic sphere by propping up SOEs and the four nationwide state-owned banks.
It is only a bit of an exaggeration to say that China’s state owned banks pretend to lend money to the SOEs, and the SOEs pretend to pay back the banks. As a result, debt among domestic non-financial firms keeps growing rapidly and is currently very high. Meanwhile China’s SOEs are operating with significant excess capacity, trade flows are declining, and deflation is becoming widespread.
This is due to the fact that the country’s traditional economic backbone, the lumbering SOEs — still championed by the Communist Party — continue to be induced to become larger and are doing so at the expense of the non-state, “private” sector, whose growth has actually been faster. This is not sustainable.
By the same token, the recent perturbations in China’s stock “markets” — less so the price gyrations themselves (which actually are not new) than the authorities’ as well as the population’s reactions to them — may well mean a fundamental tear in the country’s microeconomic fabric and a breakdown in Deng’s logic are in the offing.
Throughout the world effective stock exchanges are based on transparency of transactions, integrity of information flows, and stable and well-specified enforceable rules of the game. These are largely missing in China.
Yet the country’s leadership has been opening up access to the stock markets at a furious pace in order to pacify the population so it feels it is able to share in the economy’s growth in some fashion. Unsurprisingly the number of traders has exploded.
But many freely admit that they engage in transactions based simply on hearsay or from informal tips from friends and family members. This is why it has become so commonplace to refer to China’s stock “markets” as casinos.
Worse still, over the past number of months Beijing itself has become a big purchaser in the exchanges to prop up share values (which it has done in the past). When a government does this, why even pretend to call these stock markets? No doubt, this is the most glaring of China’s economic contradictions.
Most worrisome, however, is this is a loser’s game. At some point, resources will either be exhausted or they will be taken away, perhaps by the People’s Liberation Army (PLA).
That Beijing is treating the stock exchanges as ‘too big to fail’ and committing moral hazard, only creates stronger incentives for the Chinese people to continue to buy stocks. This is the real knife’s edge: while the leadership professes it wants the population to believe in markets, having the state jumping in and out of the marketplace in an attempt to strengthen this belief is tautological.
All this is not being lost on China’s citizenry, business community, government technocrats and the PLA. Notwithstanding the country’s strong nationalistic feelings, going forward the risk of loss of confidence in the leadership’s ability to manage — indeed perhaps even unwind — some of the more pronounced contradictions successfully may not be trivial.
There has long been a nagging feeling by some China observers that, all told, these contradictions may well reveal an economy built on a house of cards. An exaggeration to be sure, but not wholly out of the realm of possibility.
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Dr. Harry G. Broadman is a Senior Fellow at Johns Hopkins' Foreign Policy Institute. He is also CEO and Managing Partner of Proa Global Partners LLC, a boutique international business strategy consultancy, which focuses on investment transactions in emerging markets. Previously, he was Senior Managing Director at PricewaterhouseCoopers (PwC) and also served as PwC’s Chief Economist. Broadman is a faculty member at Johns Hopkins University and a monthly columnist for Forbes magazine.