Major change is already underway in China, with potentially enormous implications for all of us.
- Corruption is being stamped out via a policy of ‘shock and awe’
- Similarly, wasteful lending is under attack in both the official and the so-called ‘shadow banking’ sectors
- Thirdly, pollution is being tackled by literally ‘sending in the bulldozers‘ to destroy polluting factories under the eyes of TV cameras, and introducing quotas on car sales in the major cities
It is impossible to underestimate the scale of the changes now underway. Just as under Deng and Jiang, they are being led from the top by a new leadership group headed by Xi himself. Its key focus is on the “economy and ecology“, highlighting the economic and political crisis that developed during the “lost decade“.
Today’s challenge is not to restore order after the chaos of the Gang of Four, or after Tiananmen Square. Instead it is to head off an existential crisis over pollution, coupled with demographic decline. The Party’s main think-tank, China’s Academy of Social Sciences, has thus headlined the “shrinking demographic dividend, overcapacity, choking pollution, risks from the property sector and local government debt“ as key threats to be tackled immediately.
Bankruptcy was the key economic challenge facing Deng in 1977. Whilst as the World Bank noted, the major risk in 1993 was that ”China could have lost economic control and landed in a Latin American-style inflationary spiral”.
This time, as a major World Bank report with China’s National Reform and Development Commission has warned:
“China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the ‘middle-income trap’.”
This comprehensive Report was issued to coincide with the 5-yearly Party conference in March 2012 and highlighted 5 key risks:
“The end of export market growth; wasteful infrastructure investment; the need to boost personal consumption via higher wages (which has the downside of reducing profit margins and job creation); managing the transition to a new economic model; and the threat of hitting ‘the middle income trap’ described by Nobel Prize winner Sir Arthur Lewis”
Xi and Li follow the Deng/Jiang model
In response, it is clear that the new leadership is closely following the successful strategies developed by Deng and Jiang in response to similar crises:
- The return of ‘the man who knows what to do’. Deng was brought back in 1977, having been purged 3 times, because he was the only person who could manage the situation. Similarly he returned a second time with his Southern Tour in Q4 1992 to build Jiang’s powerbase. This time it has been Jiang who returned. He ensured the removal of the corrupt Bo Xilai, and forced through the leadership changes in November 2012 that meant 6 of the 7 current Politburo members are his men
- The immediate assumption of control over the military. The Bo Xilai affair highlighted the risk of military unrest – there were well-reported rumours of tanks moving in Beijing in March 2012. Xi has followed Deng and Jiang in immediately taking control of the Central Military Commission by becoming its chairman
- The use of the World Bank to develop a policy framework. Again, Xi has followed Deng and Jiang in this, with no delay. In fact, the World Bank began work even before Xi formally took power - highlighting his early awareness of the depth of the crisis that China faces
- Focusing on the economic challenge immediately. Deng had premier Zhao Ziyang, and Jiang had premier Zhu Rongji, both entirely focused on the economic issues. Today, Li Keqiang is taking the same role. Equally important is that Xi has followed Deng and Jiang in taking personal leadership of the issue via chairmanship of the new “Leading Group for Overall Reform”. Without his active involvement, reform will inevitably be blocked by those who would lose out as a result
- Willingness to take tough measures. China’s new leadership have 10 years of power ahead of them. Thus they are already sending in the bulldozers to destroy polluting factories over the heads of local government officials. Whilst Xi’s appointee at the central bank, Zhou Xiaochuan, is taking power back from the regulators who have failed to control the shadow banking sector. All this has clear parallels with Deng and Jiang’s ‘no nonsense approach’, and their appreciation that a sense of urgency is critical for success
What does this mean for the outside world?
The years after 1977 and 1993 were stormy periods in China’s history. The period to 2020 is unlikely to be different, and there are no guarantees that the new leadership’s policies will succeed. But it is already possible to identify some of the likely major impacts on the global economy:
- Domino effect. US-centric observers have wrongly assumed that the Federal Reserve’s taper has somehow begun to destabilise Asian economies such as India and Indonesia. They will now have to rush to catch up, as it becomes clear that this is really early warning of China’s massive policy shift
- Double-digit growth. The imperative of political survival means the leadership have to continue to bulldoze polluting factories, and also clean up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth will never return
- Deflation. Premier Li made clear last year that maintaining employment was his key priority. We can therefore expect China to focus on maximising export sales during the transition, effectively exporting deflation – as volume rather than profit will be the priority.
- Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, relatively high-value chemicals and other products into Asian and developing country markets, based on its vast new capacity.
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- Domestic Demand. Similarly the focus of China’s domestic demand will change. Sales of western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings as it will have more use for the cash at home – putting pressure on Western interest rates
Readers will no doubt have their own insights into the impact of these changes on their own businesses and personal lives. But one thing is very clear. China not only has to go down this path, as we described in chapter 6 of ‘Boom, Gloom and the New Normal’ in November 2011. But its leaders now clearly recognise that they have to change policy with great urgency.
The blog always feared that the recent boom would turn out to be another of the ‘boom and bust’ cycles that have characterised the post-Mao period. No sane person would ever want to go back to the days of the Great Leap forward and the Cultural Revolution. It therefore hopes that Xi and Li will not only manage to overcome the current crisis, but also succeed in establishing a more sustainable future for the country.