Commentary on Political Economy

Friday, 27 November 2020


Ticking time bomb: why Xi is dragging down the dragon

In the midst of global pandemic gloom, Australia’s exporters were at first cheered by a glimmer of hope — China’s economic bounceback. But those hopes were swiftly dashed. China’s rulers no longer seem to want its citizens to buy our products.

And since the US election, a further worry: Joe Biden might make nice with counterpart Xi ­Jinping, leaving Canberra isolated in its concerns about Beijing’s aggressive behaviour, and American exporters will steal our Chinese markets. Online jokers are already anticipating Beijing’s great imperial palace being rebranded the For-Biden City.

This chain of angst about China underlines the disruptive success of Beijing’s wolf-warrior strategy. But beneath it all, an even more momentous time bomb is ticking away.

What if China’s recovery — which is being driven substantially by Western stimulus funding that has boosted demand for its tech gadgets and health gear — slowly slides downhill over the next few years? What if China’s economy starts to lose its mojo?

This has become almost unthinkable. All the more important, then, to consider it.

The Australian budget for 2021 is predicated on China’s economy growing by 8 per cent, and then going on, the Treasury hopes, to “strengthen further”.

Australia’s defence planning has become preoccupied with anxiety about the apparently inevitable day when China’s economy leaps over America’s.

Leading strategic thinker Hugh White says in his latest book that “China will challenge America’s position at the forefront of key emerging technologies”, with its economic rise “transforming its ambitions as an international player”.

ANZ chief economist Richard Yetsenga says the circumstances are changing, however, and that it will now be “very difficult for China to become the world’s largest economy (in market-economy terms) by 2030 — even reaching that milestone by 2050 seems ­ambitious”. The US average income per person today is 3.3 times or 6.4 times China’s, depending on the measure.

Bian Lichun, founder of the Liucundao Business School, teaches a home organising class in Beijing.
Bian Lichun, founder of the Liucundao Business School, teaches a home organising class in Beijing.

Meanwhile, Australians are becoming habituated — or resigned — to a commercially coercive Chinese state constricting their capacity to deliver some of the products and services, from barley to wine, cotton to tourism, for which Chinese firms and people had demonstrated an increasingly healthy appetite.

China’s economy grew by 4.9 per cent in the past quarter, its overworked steel mills sucking in vast shipments of iron ore from the Pilbara, so far unaffected by those bans on what Beijing views as more niche products.

Yet ratings agency Moody’s says that despite some bounce-back, overall in this COVID-19 era “China’s growth will significantly slow across the board this year”. And if China’s economy continues to slide over the next few years ­towards the global mean, as Yetsenga expects, Beijing’s capacity to continue weaponising its economic heft in order to expand its ­influence around the world will become steadily eroded.

China’s leader Xi Jinping might thus need to push more rapidly towards his goals of “the great rejuvenation of the Chinese nation” and of global leadership, while he still has waves of capital to deploy — or to threaten to withhold. In Beijing’s own terms, Xi has won two signal victories this year: as the People’s Leader of the People’s War with COVID-19, against which the capitalist West continues to struggle; and by following up his subjugation of Tibet and Xinjiang by also bringing Hong Kong to heel through imposing the new National Security Law, leaving only Taiwan untamed among China’s borderlands.

But his great new challenge is to be fought on territory in which Xi feels less comfortable — reconstructing China’s economy. For China’s economic ascendancy matters considerably more than its military might.

It is essential for Beijing that while political, diplomatic and ­security issues may rage to and fro, people at home and abroad remain convinced that China’s economy will continue to thrive as the threat of COVID-19 recedes there, driving world growth — including Australian growth — once more, as it did during the Asian and global financial crises.

But despite the recent sprouting of positive numbers, that’s unlikely to happen in the same way this time. First, because China’s economy is heading for some trouble internally. Second, because its global engagement as “the world’s factory” — while flourishing thanks to COVID-era demand, especially for tech gadgets and medical equipment — will start to flag.

Third, because the politics is getting in the way of good policy, both inside China and, to an extent, outside. Beijing’s economic sanctions, and threats of them, against Australia and other countries act like wrenches slung into the cogs of machines that make for mutually beneficial trade.

The new 15-nation Regional Comprehensive Economic Partnership that includes China and Australia but not the US or India — the latter withdrew — will smooth some trade processes but can’t guarantee that Beijing truly enters into, as Trade Minister Simon Birmingham has urged, the “spirit” of the agreement.

Chinese Foreign Ministry spokesman Wang Wenbin asked recently what seemed to him to be a rhetorical question: “Between China and Australia, which country is breaching the principles of a market economy and the bilateral free trade agreement … and taking discriminatory measures? The facts are all too clear.”

They are indeed. A new Beijing government circular calls for “strengthening the (communist) party’s comprehensive leadership over foreign trade”. And Australia is far from the only target.

China is brimful of confidence in its commercial aggression because it is still performing better than any other large economy. But it is in the medium to longer term, rather than immediately, that its underlying challenges will develop more troublingly.

Economic policy was pretty consistent under the leadership of Xi’s predecessors Jiang Zemin and Hu Jintao — cautious and steady opening, and modernisation of production.

Leading Chinese economists and central bankers produced with the World Bank in 2012 a powerful report laying out a reform agenda to complete Deng Xiaoping’s liberalising vision. This would have steered the economy towards a new and more sustainable direction — from being driven principally by investment, credit and exports, to one more ­reliant on services and domestic consumption, with the market playing a decisive role in allocating resources.

But Xi, who was then taking charge as party general secretary, was focused not on the economy but on his anti-corruption campaign to purge and purify the party, the key platform that had brought him the senior leaders’ endorsement.

Steadily, as he personalised, centralised and restructured China’s governance, he also rowed back the party to resume its centrality in the economy.

Xi’s Thought, now enshrined in state and party constitutions, is on “Socialism with Chinese Characteristics for a New Era,” emphatically not on Deng’s old reform-and-opening-up era.

Meanwhile, China’s three chief drivers of growth this century — credit, internal migration and exports — have become increasingly constrained. China’s capacity for further overseas investment has become diminished, its debt surpassing three times its GDP and buying decreasing increments in productivity.

A new report on economic risk in China for the Centre for Strategic and International Studies in Washington states: “Investors are now questioning Beijing’s guarantees for risky investment products, bonds, companies and even banks”, since the failure last year of Baoshang Bank in Inner Mongolia, followed by four other banks being forced to restructure.

It says that COVID-19 and the resulting economic slowdown “have compounded the credit risks within China’s financial system; more banks are being asked to roll over loans to highly indebted corporates that are short of cash, and thousands of small services sector businesses have closed their doors, perhaps permanently”.

And China is struggling to challenge the use of the US dollar as the world’s reserve currency. The yuan is used for only about 2 per cent of international payments, compared with the euro at more than 30 per cent and the US dollar at more than 40 per cent.

The widely respected 16-year governor of the People’s Bank of China, Zhao Xiaochuan, who retired in 2018, said recently that China could not promote the use of the yuan while maintaining rigid capital account controls. “It seems we have a kind of mistrust or even a fear of the market and prices, including the exchange rate,” he said.

Beijing has responded in part by instead becoming the great champion of digitalised currency and by using blockchain in trade accounting. China already controls two-thirds of the computing power to mine Bitcoin. But this cuts both ways. In 2019, more than $US70bn ($95bn) of cryptocurrency was shifted overseas from digital wallets in China — likely the elite shifting wealth elsewhere.

China is now directing its diminishing capital stock back home rather than abroad. So the Ministry of Industry and Information Technology is targeting 105 new projects for an average of $US1bn each, and the CDB a further $US60bn for 24 projects.

Shifting supply chains

One aim is to shift this stimulus from “old infrastructure” towards new technological infrastructure, including the 5G mobile network. But that move is encountering consumer resistance, with current 4G speeds — and almost ubiquitous reach — appearing sufficient for most Chinese people, primarily today concerned about their savings and their jobs.

Internal migration to the cities has slowed as the manufacturers that used to bring people from the countryside are rapidly robot-ising, and it is tough for rural folk to find alternative work in services.

Global supply chains are shifting, due to rising costs in China and to a desire to diversify sources from China to reduce political risk, with China having pursued economic sanctions against so many countries in recent years.

Germany is China’s most important market in Europe, and the Federation of German Industries, the BDI, has complained that China “provides extensive subsidies, above all to state-owned companies, along with other measures not in line with a fair and open market order”. Canada decided in October that a free-trade agreement with China, for which talks began four years ago, is no longer worth pursuing.

While China is expected to continue to dominate supply chains for a long time, trade patterns are changing. Moody’s wrote in a recent report: “The pandemic will accelerate the diversification of global supply chains and more manufacturing may move away from China.”

Young Liu, chairman of Taiwanese company Foxconn, which makes many of the world’s top tech consumables, including the iPhone, and employs about a million people in China, agreed, saying that “the past model where manufacturing is concentrated in just a few countries like a world’s factory will no longer exist”.

The pandemic has intensified such longer-term trends, rather than triggering them. The boom in demand for Chinese products this year, driving its present recovery, is substantially the result of the massive government funding programs in Western countries. In comparison, little financial help has been directed to households in China which, as Gavekal’s Andrew Batson and Thomas Gatley say, “focused instead on supply-side ­efforts to control the virus and get companies operating again”.

The world is changing, and China — which has in recent years grown used to driving development — now needs to change too.

The revived socialism of Xi’s new era partially worked at first. China’s continuing investment in upgrading infrastructure and in education, and its ready access to the world’s top innovatory technologies by attracting global tech leaders to operate there, helped ensure that rapid growth continued in the post-GFC era of the first half dozen Xi years.

Xi’s tough challenge

But the perfect storm of Donald Trump’s “trade wars” coinciding with COVID-19 has pushed Xi to take on his toughest challenge yet: steering China towards a new economic template, which he introduced at a Politburo meeting in mid-year. It is called “dual-­circulation” and it will take centre stage in the 14th Five-Year Plan, whose details will be launched formally at next March’s National People’s Congress session.

The core inner circuit comprises the domestic economy; the outer circuit comprises China’s international connections. The aim, Xi said, is to “fully bring out the advantage of China’s super-large market scale and the potential of domestic demand to establish a new development pattern featuring domestic and international dual-circulations that complement each other”.

Xi said this does not mean lessening or closing the open nature of China’s economy. But he wants jobs to rely on Chinese more than foreign markets, and more food to be grown at home not imported.

The consumption share of China’s economy is low today — only 39 per cent of GDP — compared with 66 per cent in the US, and it is well below the 45 per cent reached in China itself at the start of the 2000s.


Another Gavekal researcher, Gilliam Hamilton, says: “It is very difficult to significantly change households’ propensity to change, and China’s government has no track record of reliably being able to do so. A new government slogan is unable to make a big difference.”

Demand has not been driving the economy as it should. That’s understandable, since household debt as a share of disposable income is now higher than in the US. And investment by private firms, another important driver of consumption, is constrained by state banks’ reluctance to lend to them.

Long postponed finance system and fiscal reforms will also need to be implemented for dual-circulation to work fully. And upgrading the services sector requires greater foreign involvement, as happened a generation ago in manufacturing, while boosting consumption means putting more money in workers’ pockets and less in enforced savings, including to keep bloated government corporations afloat.

Michael Pettis, a finance professor at Peking University, said: “Economic recovery in China requires a recovery in demand that pulls along with it a recovery in supply, but that isn’t what’s happening; China’s ‘recovery’ is largely an exacerbation of the problems that have long been recognised by Beijing … which it has found politically very hard to manage”, since rebalancing involves a massive shift of wealth — and with it, political power — to ordinary people.

This will not be easy for a party whose absolute power has grown under Xi. Not renowned for his flexibility or pragmatism, can he now accommodate that modernising program he had originally inherited as he came into office?

Ubiquitous party guidance and a strong dose of protectionism, both a more natural fit with Xi’s core ethos, loom large as barriers to such overdue reforms. China’s private sector is already struggling under the weight of “party first” policy. Guidelines on Strengthening United Front Work of the Private Economy in the New Era, released by the CCP in September, say that it aims “to build a backbone team of private businesspeople that is dependable and usable in key moments”.

Business people must “maintain high consistency” with the party, its guidelines say, reinforcing a recent speech in which Xi said “patriotism is the glorious tradition of excellent entrepreneurs in China.” All key sectors remain firmly in party-state control. No one talks anymore of privatisation.

Beijing underlined this earlier this month by axing, just two days out, what was to have been the world’s largest ever float, of the $US35bn Alibaba finance sector spin-off, ANT. Alibaba founder Jack Ma branded the state banks as “pawnshops,” and said about governance agencies: “We should not use the way to manage a train station to regulate an airport.”

The party stepped in, with the People’s Daily stating: “There is no so-called Era of Jack Ma; he is only part of the era.” Which, the float kybosh underlined in spades, is Xi’s New Era.

Besides elevating Leninism to levels of previously undreamt-of control and surveillance, Xi has turned into a modern Marxist. He no longer believes the state must own the means of production to control a sector. But every organisation, every company, in China must contain a party branch to guide policy and choose its leaders.

Li Youwei, a former party secretary of Shenzhen, wrote recently that Xi’s program for such fusion between China’s private and state companies is causing widespread concern among businesspeople, stating: “We are standing at a crossroads.”

Employees in the workshop of a lithium battery manufacturing company in Huaibei, eastern China's Anhui province. Picture: AFP
Employees in the workshop of a lithium battery manufacturing company in Huaibei, eastern China's Anhui province. Picture: AFP

Ageing population

The country is also at a demographic crossroads, with the ending of the one-child policy failing to reset population growth, and with a quarter of the rural population, about 124 million people, expected by the Chinese Academy of Social Sciences to be older than 60 by 2025, coping with a state pension of less than $100 a month — raising further problems for this attempted shift towards a consumption-led economy.

China also stands at cultural and educational crossroads. It has depended crucially for its rapid growth to date on appropriating or building on technologies developed elsewhere.

For instance, today it spends more on importing semiconductors than it does oil. So Xi’s “Made in China 2025” scheme is intended to provide the domestic dual-­circulation sector with the innovatory grunt to supply the sophisticated parts required by giant tech companies such as Huawei that were previously imported.

But Beijing-based Wang Xiangwei, editorial adviser to the South China Morning Post, wrote recently that while “a free flow of ideas and opinions is vital to drive innovation … unfortunately the opposite is happening in China: the government is cracking down hard on dissent and tightening the muzzle on the media. Academic freedom is also suffering as researchers and professors have to strictly toe the party line or face stern punishment. Without freeing the mind first, innovation is hard to achieve.”

Unlike the old USSR, China’s economy is internationally enmeshed and irreplaceable, will remain huge, and will continue to offer immense opportunities for Australian businesses.

But Australia’s reticence to invest there, or to appoint to senior executive or board roles Australians who have experience of living and working in China, or in Asia generally, limit the country’s China-savviness. This is also being diminished by the success of Beijing’s clever wedge that we must choose between preferencing our economy or our security.

In the grander and longer game, Xi’s own Chinese Dream is at stake. If Xi — who steadfastly declines to elevate a successor — fails to meet his greatest challenge, to transform the economy, his other achievements will come into play, and the party may struggle to keep control.

And in that process, Australia’s own political, strategic and economic dreams — and nightmares — will need to be reshaped.

One of Xi’s favourite films is The Godfather, who made offers people couldn’t refuse. In 2021, he will make many offers, or threats disguised as offers, such as commercial deals in return for UN votes, for friendly rhetoric, and for refusing to “contain” China.

Australia and other partners are likely to refuse such offers, and instead to intensify efforts to diversify economic opportunities.

And some in the party’s own middle ranks are starting to murmur that Godfather Xi has done well so far, but instead of endless struggle, surveillance and stoushes it is now time to consolidate, to chill, to enjoy at last the fruits of their hard-won prosperity while it is within their grasp.

Rowan Callick, twice a China correspondent for The Australian, is an industry fellow at Griffith University’s Asia Institute.

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