This article was originally published at The Diplomat and is reposted here with permission.
In stark contrast to the fanfare that marked the 70th anniversary of the People’s Republic on October 1, 2019, China is wading into troubled waters as we head into 2020. The surest sign is the fact that Chinese Communist Party (CCP) leaders spare no efforts in cautioning the public about challenges ahead and pliant Chinese media outlets have been quick to spread the word: buckle up for turbulence. There’s nothing ambiguous in Premier Li Keqiang’s warning that the country “may encounter larger downward pressure and a more complex situation,” so “governments at all levels will face more difficult tasks and bigger responsibilities.” President Xi Jinping himself identifies “three tough battles” ahead: targeted poverty reduction, effective control of financial risks, and general improvement in the environment. There is an undisguised sense of urgency in his message: “We need to be prepared with contingency plans.” Jack Ma, Alibaba’s founder, weighs in to confirm that “the hardship of 2019 is probably just the start of difficulties.”
Tough Battles Ahead
The financial de-risking battle Xi referred to is necessitated by the toxic degree of indebtedness of the economy. China’s cumulative debt now tops 300 percent of GDP and IMF experts warned as early as January 2018 of the dangerous trajectory of the country’s credit growth. The biggest chunk of that is corporate debt, nearly twice the size of China’s GDP, which highlights the risks of overleveraging. The bulk of credit to businesses skyrocketed during the decade following the 2008 global financial crisis and in 2019 defaults in China’s corporate bond market rose significantly for a second year in a row. Outstanding household debt soared to $6.8 trillion in 2018 and accounted for 60.4 percent for GDP, according to the People’s Bank of China (PBoC). The level of government debt remains reasonable, at some 50 percent of GDP, but a mountain of risky payments has been placed on the shoulders of notoriously opaque local governments. Five regional banks have been bailed out due to management or liquidity problems this year alone and the number of salvage operations is expected to keep growing.
Poverty reduction is a top political priority for the CCP government, which has pledged to turn China into a “moderately prosperous society” by 2020. Figures matter a lot in the CCP’s rhetoric and they can be “revisited,” if need be. Thus, the country’s official GDP is regularly revised upwards – this has already happened four times after the censuses of 2004 (+16.8 percent), 2008 (+4.4 percent), 2013 (+3.4 percent), and 2018 (+2.1 percent). The latest adjustment by the National Bureau of Statistics comes in handy, in view of Beijing’s goal to double its- 2010 GDP by 2020, though to many this looks like of a case of massaging numbers to hit targets.
One of Xi’s personal bets is his much-trumpeted ecological civilization concept. Yet if China’s economy is running out of steam, it certainly is not running out of steel – nor cement or coal. As part of Beijing’s desperate effort to offset stuttering growth, the country’s rust-belt industries are picking up again and this is touted by Chinese media as a feat. The government’s response is a typical Keynesian approach, based on larger public investment, despite declining investment efficiency. The concern is that this may lead to backtracking on Beijing’s commitment to the Paris Accord on combating climate change.
Ensuring high levels of employment, through large-scale construction as a way of keeping people busy, is a matter of political legitimacy for the CCP. “Unemployment” is a dirty word in the country and is rarely uttered by state officials. While the National Bureau of Statistics publishes an overall rate slightly below 4 percent, unemployment may well be underreported. Crunching numbers announced by Li himself shows that some 3 million people joining the labor market in urban China every year are out of a job. The Chinese government is confident that it can live with lower growth rates, but it cannot tolerate increasing unemployment. Hence Beijing’s persistent message in recent months that the slowdown is gradual and this is okay as long as the labor market is functioning properly.
However, if the government really cares about employment, it needs to pay greater attention to private businesses, which are considerably more productive than state-owned enterprises (SOEs). The private sector is the driving engine of China’s economy, as it accounts for more than 50 percent of tax revenue, 60 percent of GDP, 70 percent of exports, and 80 percent of jobs, according to official figures. Yet many private firms are struggling to keep afloat: unlike SOEs, they are turned down by banks or are offered loans at high interest rates.
Beijing’s policy on reforming SOEs, many of which are loss-makers living on subsidies and cheap loans, seems to be caught up between competing priorities. The CCP’s instinct has always been to protect the privileged status of SOEs, while trying to make the state-owned sector more competitive and influential. However, there is mounting evidence that SOEs will no longer be out of the fray: from now on not all SOEs will be protected from defaults. The questionable competitiveness of China’s sacred cows is further dented by a decision of the government to transfer 10 percent of their assets, worth $157 billion, to a national social security fund.
Put the Blame on Trump!
It is true that the trade war with the United States has put enormous pressure on China and Beijing is not hiding it. Still, putting all the blame for economic woes on Trump is a lame excuse. Alongside the implications of the drawn-out dispute with Washington, the CCP top brass need to have a sincere debate about key structural challenges deriving from the very complexion of the Chinese economy and its development model.
In accordance with the World Economic Forum (WEF) methodology, China is an “efficiency-driven” economy, its competitive advantage being ensured mainly through some improvement in the delivery of standard goods and services. Xi’s administration has rightly prioritized the shift to high-tech manufacturing and services, and lifting China to a stage of development that would render its economy “innovation-driven.” But is this happening? For six years in a row, between 2012 and 2018, China has remained stagnant (28th or 29th in the WEF ranking system) and stuck with an “efficiency-driven economy” status. Moreover, China’s total factor productivity (TFP) rate has been sliding downwards ever since 2010, in parallel to the country’s decelerating growth rate, thus illustrating a close correlation between the two indicators.
Rapid aging under way in the country is not helpful either – in fact, the situation will only deteriorate in the years to come. And, in conjunction with the economy’s slowdown, this will bring China closer to the danger of growing old before becoming rich. Ironically, the one-child policy served as an accelerator and contributed to the country’s spectacular growth over the past four decades, but it is now turning into a brake. And the stand-off with the United States has nothing to do with it.
Will 2020 Be a Bridge to Safety?
But the trade war will remain an issue of paramount importance. Apart from the recent Phase One deal, a grand bargain between Beijing and Washington does not seem to be on the cards. And, regardless of the outcome of the U.S. presidential race next November, the current cross-party consensus in the United States on viewing China as a threat is unlikely to fizzle out in the foreseeable future.
Will 2020 take China into a more comfortable and prosperous third decade of the 21st century? Not very likely, as the biggest challenges the economy is up against lie beyond the 2020 bridge. Long gone are the double-digit growth rates that bred Chinese confidence until recently. While all forecasts point to an annual pace below the 6 percent bar over the next decade, there are projections of growth rates as low as 4 percent, even if this is a minority view in China’s elite and out of tune with the official songsheet.
Despite calls for a stimulus, the People’s Bank of China is not budging for the time being – instead, the authorities are looking at more rational allocation of resources and indirect incentives, such as injecting extra liquidity by loosening banks’ reserve requirements and offering tax cuts, at the expense of government revenue. De-coupling from the United States will accelerate the development of indigenous technologies and consumer spending, a pivotal element of Beijing’s blueprint, will pick up down the road, but it’ll take China quite some time before the country becomes self-sufficient. Not least of all, the expectations of increasingly demanding Chinese citizens will have to be properly managed: a “moderately prosperous society” will hope for a decent quality of life, which is not yet the case in China’s heavily congested and polluted cities.
Alongside its glaring weaknesses, China boasts some extraordinary technological achievements. Huawei, to pick an obvious example, is the biggest provider of telecommunications equipment and consumer electronics in the world, and one of the global leaders in 5G, despite the controversy surrounding it. In January 2019, the Chinese spacecraft Chang’e 4 made the first-ever landing on the far side of the moon. And China’s definitely making inroads in the domain of artificial intelligence. For all that, these pockets of excellence are unlikely to help lift China’s economy in its entirety to the coveted stage of “innovation” any time soon. The country’s “sweaty” development model, marked by perspiration rather than inspiration and quantity rather than quality, has been around much too long to be replaced within a few years.
A prosperous China would be good news for the world. An increasingly panting China, which is the likeliest outlook at present, is bad news – not just for Beijing, but for the global economy, too. And 2020, as well as the decade after it, will be fraught with difficulties for China. Xi’s administration will have to brace up for tough political choices and painful economic reforms that will leave little room for fanfare.