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Risks Ahead for Brittle Beijing

John Lee

When China overtook Japan as Asia’s largest economy back in 2010, the common assumption was that regional economic dominance inevitably was passing from one East Asian giant to another.

With China now struggling to deal with the consequences of a vastly overvalued stockmarket and the makings of a classic property bubble, a growing chorus of people is asking whether what Japan experienced in the 1980s and 90s will soon be China’s future.

If only that were so. Unfortunately for the Chinese Communist Party and the people, following in Japan’s economic footsteps will likely be far more traumatic.

Like Japan in the 70s and 80s, China is nearing the end of its reliance on exports and fixed investment (that is, building things) to drive growth and looking to shift towards policies that can enhance domestic consumption. To achieve this, it is seemingly blessed with an authoritarian government that can concentrate on policies that need not sacrifice the country’s long-term interests for short-term political expediency.

That is the myth. Now for the reality. China’s economic problems are occurring in large part because of too much involvement of the party rather than too little. Take the property bubble. It emerged largely as a government-driven response to the global financial crisis, which devastated China’s advanced economy export markets.

From 2009 onwards, Beijing responded with the largest fixed-investment stimulus in history, forcing state-owned banks to lend predominantly to state-owned enterprises to build more things for the sake of headline growth: for example, ghost cities and empty residential housing.

Whereas fixed investment contributed 20 per cent to 25 per cent of gross domestic product growth in the 90s, it was behind 90 per cent of growth in 2009. Flushed with cheap credit created from citizens’ savings in state banks, SOEs made a killing by lending money to the credit-starved private sector, with firms in turn using overvalued assets as collateral for more borrowing.

During 2008-13, new credit flooding the economy increased by more than $20 trillion, more than the size of the American commercial banking sector.

Or consider the current stockmarket roller-coaster turmoil in China. The source of the wild ride is similar. Capital controls designed to prevent capital flight and keep state-owned banks solvent mean Chinese private firms and households cannot easily take their savings out of the country.

They are prevented from accessing many of the best economic opportunities, which are reserved for SOEs, and the property boom is flatlining, so speculating on the stockmarket has become one of the few ways to make a decent return. Crazy stock prices will always come down when panic sets in. And the problem for the government is that most listed shares are state-controlled firms. This means government measures to flood the economy with even more money to stem share price losses is as much about protecting SOE valuations as it is about assisting private investors.

Back to lessons from Japan. By the time its economic malaise began, the country had built solid institutions — rule of law, real and intellectual property rights and protections, independent courts — positioning Japan seamlessly to take a seat alongside other advanced, innovative and fully industrialised economies.

It also had a political system not dependent on growth for stability. This was clearly evident when the Liberal Democratic Party, which had ruled nearly without interruption since 1955, lost power in 2009 and initiated a handover without turmoil.

Even though the Japanese model was frequently described as state-led, the private sector from the 70s received the lion’s share of national capital and opportunity. This meant prosperity was broadly distributed during the good years, unlike in China where SOEs and the politically connected have been the primary beneficiaries of growth.

In fact, within one generation, China has gone from the most to the least equal country in all of Asia with respect to distribution of income.

In contrast, and because institutions were strong and opportunity was spread, Japanese society became rich before it grew old.

China has no such political or economic buffers. Its hyper state-led model means the vast majority of households will grow old and never become rich. As the country’s GDP has increased, political and social stability has worsened sharply. There were more than 184,000 instances of mass unrest against the government in 2013, according to official figures. Beijing officially spends more on internal security than it does on national defence.

Whereas its authoritarian approach may have played a role in supercharging growth, the party now needs to step back economically, socially and even politically for the country to continue to thrive. That it has been strengthening its grip this century is not encouraging.

Finally, all of this is highly relevant to Australian debates about China. Last week, the secretary to the Department of Prime Minister and Cabinet, Michael Thawley, was widely caned for saying China was not ready or willing to offer regional and global leadership. Critics counter that it is a large country with an enormous economy. But one-third of its people live on less than $2 a day while its age demographics will resemble those of western Europe within two decades.

The stability of its political system is uncertain and vulnerable to even a modest economic slowdown. China does not seem to have the resilience of postwar Japan, or America’s strength and capacity for reinvention. Perhaps China is too big to follow; but it is also too brittle to lead.

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