China: Can the CCP Lose its Monopoly?

Chinese Riot Police in Sichuan Province in 2008.  Source: AFP

Chinese Riot Police in Sichuan Province in 2008. Source: AFP

Most communist regimes (most dictatorships for that matter) have been swept away by history, usually when they failed to deliver the goods on economic growth and social welfare.  Democracies contain elaborate rules by which the people can “throw the rascals out” when their leaders fail to deliver.  True, when enough people blame the democratic system itself, rather than just the rascals, democracies have been overturned as well.  Weimar Germany comes to mind.  

In spite of the great sweep of communist regimes into history’s dustpan, the Chinese Communist Party (CCP) has hung on and even prospered.  It has delivered the goods, producing a mindboggling 10% annual growth in GDP on average over the last thirty years.  The Chinese people have acquiesced to the CCP’s continued monopoly of political power, because, well, business has been good.

Yet China’s leaders are nervous.  They are nervous about the global economic crisis.  They are nervous about rising unemployment.  They are nervous about popular protests.  They are nervous about the internet, that discontent can spread like wildfire with the click of a mouse.

Some China analysts have warned, since Deng Xiaoping began liberalizing the economy, of the inherent contradiction of a society with economic diversity and a political monopoly.  Yet years of economic success postponed a resolution of this conflict. 

This is not to say that the day of reckoning is near.  The situation in China right now is not that bad.  The economy is expected to grow between 5-6% this year, below the 8% some economists have argued is needed to absorb the growth in the labor force, but not bad for the middle of the worst global crisis in decades.  Foreign exchange reserves are nearly US$2 trillion and rising, providing plenty of room to stimulate the economy without balance of payments pressures. Likewise, with government debt at around 25% of GDP, there appears to be a lot of room to spend money.

Scratch below the surface and all is not well in the Forbidden City.  Reports indicate some 670,000 factories have closed.  Unemployment, while nationally at a low 4.5% by official reports, may be much higher in rural areas (estimated at 15%), among college graduates (estimated at 12%), and among the migrant workers who man the machines in China’s coastal manufacturing juggernaut (estimated at around 26 million jobless).  The latter two groups, China’s leadership worries, could foment social unrest.  This year, after all, is the twenty-year anniversary of Tiananmen Square. 

Substantial income disparity can exacerbate social tensions in China.  While the country’s per capita income exceeds US$3,000 overall (similar to Tunisia’s and Peru’s), wealthy Shanghai’s income per head is closer to what we find in Chile, Turkey or Malaysia, while the poorest provinces have income levels found in the poorest African nations.  At 46.9, China’s Gini index demonstrates poor income distribution.

The massive macroeconomic stimulus the Chinese are implementing may not durably replace the external demand lost due to the global crisis.  China’s economy is distorted.  Consumers save too much.  Production is directed for export due to the undervalued exchange rate, reducing the supply of low-cost goods for consumption at home.   Ironically, in the planet’s largest socialist nation, the government fails to provide an adequate social safety net, causing consumers to save for health care, housing, education and retirement, thereby postponing consumption.

The stimulus package focuses too much on infrastructure investment in a country where investment represents an excessive 43% of GDP and infrastructure in the coastal cities is already world-class.  With investment rates this high, one wonders if the marginal return on investment could be low or even negative, as some economists argued was the case in Korea as it over-invested in the run-up to the Asian crisis, and in the Soviet Union during its dying days.  The stimulus package contains elements to bolster consumption, but perhaps more should be directed here, providing an effective short-term boost to the economy and fostering the longer-term adjustment needed for a stable domestic source of aggregate demand.  It took an externally-driven crisis to convince China’s leaders to do what the West has counseled for years, namely, stimulate domestic demand.

James McCormack, Head of Asian Sovereign Ratings at Fitch Ratings, in a March 2009 report on China  (www.fitchratings.com), notes that the fiscal stimulus plan “may not adequately address the issue of large-scale unemployment in export-oriented manufacturing.”  He adds:  “Chinese fiscal stimulus and monetary easing can help offset some of the effects of the economic downturn, but they cannot change the course of the economy, especially one in which exports of goods and services were equivalent to 37% of GDP in 2008.”  If the downturn in advanced economies persists, the stimulus package would have to be redirected toward greater household income support.

Another problem with the stimulus package is that it is channeled through public institutions, such as ailing banks and state-owned enterprises, rather than directed toward the dynamic, privately-owned manufacturers.  Moreover, local governments are expected to foot part of the bill, yet they rely on land sales for a large portion of revenues, under pressure from falling real estate prices.  As for the banks, the good news is that they do not need to de-leverage as banks are doing in advanced economies.  According to McCormack’s report, Chinese banks have a modest loan-to-deposit ratio of 66%.  However, Chinese banks, long involved in questionable lending, are weak and sprawling, with assets representing a sizable 128% of GDP.  Although the government’s debt burden is low, it may have a bank cleanup to finance in the coming years.  On orders from the government, Chinese banks are engaged in rapid, indiscriminate lending.  The government, with a low tax intake, may have to expand the tax base in order to support its current policy stance.

Should stagnation persist in the advanced economies, which have been the engines of Chinese growth, then unemployment and social distress in China will increase and the Chinese people will want a change.

Elizabeth Economy, Director of Asia Studies at the Council on Foreign Relations, addressing a political salon in New York this week, following a week-long visit to China, said she was encouraged by the lively debate taking place in China today over economic policy.  She noted, however, that the leadership remains reluctant to discuss any substantive political opening.  Chinese leaders worry about rising unemployment, especially among migrant workers and college graduates, because they know that, lacking avenues of popular expression, the people could take to the streets.  Yet instead of building or broadening institutions to channel social action, China’s leaders reach reflexively for the tried and true answer, that is, to give the masses the opiate they desire:  economic growth.

John Thornton, Chair of the Board of the Brookings Institution and a professor in Beijing, discussed signs of democratization in China in an excellent article in Foreign Affairs last year.  He enumerated examples of competitive elections at the local level and greater competition within the CCP itself, as well as improvements in judicial independence and governmental oversight.  Notwithstanding these healthy developments, Elizabeth Economy suggested that democratization in China thus far is more anecdotal than systemic.  Should a sustained downturn produce popular dissatisfaction, one cannot rule out trouble for the CCP or even an up-ending of the regime in the manner we have seen in other communist countries and other dictatorships.

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