End of the Miracle? China Stands at a Crossroads

In-DepthEnd of the Miracle? China Stands at a Crossroads

End of the Miracle? China Stands at a Crossroads

Hambantota is unlikely to register with many in China. But the tiny Indian Ocean town thousands of miles away has become a potent symbol of unease about the nation’s miraculous economic growth.
Perched on the southern Sri Lankan coast, the town of about 11,000 hoped it would become a shipping powerhouse when it permitted China Merchants Group to establish a state-of-the-art port to capture some of the billions of dollars of value that’s shipped across the Indian Ocean every year.
Eight years after it was opened, however, Hambantota port lies almost dormant. Instead of teeming with containerships and port workers, reports say its busiest visitors include wild elephants that often trample through its collapsed perimeter fences.

A Chinese engineer looks over the construction site for the deep water shipping port in Hambantota. 2010. REUTERS/Andrew Caballero-Reynolds
A Chinese engineer looks over the construction site for the deep water shipping port in Hambantota. 2010. REUTERS/Andrew Caballero-Reynolds

Sri Lankan politicians borrowed heavily from Chinese banks to build the port but when they were unable to pay back the loans, the Chinese backers took control of the facility. With little prospect of profiting from commercial shipping, Hambantota may now become a Chinese naval site.

Chinese Influence

Hambantotans aren’t alone in feeling cheated. From Colombia to Malaysia and the Congo, there is growing concern that a surge of overseas investment launched five years ago to cement China’s wider influence is failing. More worrying still is the possibility that the problems facing the so-called One Belt, One Road initiative are symptomatic of a deeper malaise among China’s economic planners.
With a slowing economy, corporate debt running close to record levels, bubbles showing in multiple sectors and a tariffs dispute with the US that threatens to oust China position as the world’s largest trader, economists are recalibrating their outlooks for the country, and with it, their forecasts for the global economy.
“No one knows what’s going to happen to China, but if it does dip and go through turbulence then we’ve all got a problem,” said Professor Kerry Brown, Director of the China Institute at King’s College in London. “This is no longer a Chinese problem. It’s a global problem.”
To understand how China, history’s greatest wealth-creating project, got to this stage, look no further than Wu Xiaohui.
The chairman of Anbang Insurance was arrested earlier this year on suspicion of fraud. Anbang had been one of China’s largest privately owned insurers. But when Wu was arrested, the company was taken into state ownership. While he languishes in prison, accused of making questionable and risky overseas acquisitions, many believe the only difference between him and the tens of thousands of other high-flying financiers is that he was singled out for arrest.

Chinese Spending Spree

In the years after the 2008 financial crisis, Wu and China’s army of investors went on a spending spree as the government offered generous incentives to grow the economy out of the global recession.
It was an expedient that was as much political as economic. In the absence of any popular representation in the country, China’s Communist Party legitimises its rule by guaranteeing growth and prosperity for its 1.4 billion people.
To prevent civil unrest in the country, the leadership of President Xi Jinping reckoned it needed to keep GDP surging at around 8% annually. To do that, the government pump-primed the economy.
Between 2008 and last year, state-owned banks lent in the order of 12.5% of GDP for investment. In that time, it’s estimated that China’s total debt burden doubled to three time GDP, surging to almost $30 trillion last year from $6 trillion at the time of the crisis.
Much of that money went into speculative investments, particularly in the property sector, inflating dangerous bubbles. At the same time, China began refocusing its economy from outward-looking, export-oriented activities to developing its home-grown industries, particularly technology. The upshot was a fall in foreign revenue as exports fell to a fifth of GDP last year from about a third in 2016.
As the risk of corporate default rose and bubbles threatened to burst and throw the economy into a tailspin, Xi embarked on a policy of debt reduction in 2016. The state began cracking down on speculative activity, so-called shadow banking activities were shut and homes became harder for ordinary Chinese to buy. Foreign ownership limits were raised and trading of cryptocurrencies was abolished.

Damage Limitation

The damage limitation exercise is still in the works, but it’s already taking a toll. Borrowing costs have risen, consumer confidence has dipped and household spending has correspondingly declined. Growth has certainly slowed, to around a “new normal” of 6%-7%, and the expectation is that it will decrease further; Fitch Ratings estimates business investment will have to be cut 5% just to stabilise the debt-to-GDP ratio.
“The fast growth is over, but do we think China has reached a tipping point?” asked Kent Deng, Professor of Economic History at the London School of Economics. “I really doubt it because the state sector controls the economy.”
A notable outcome of Xi’s reforms has been an expansion of state control over China’s companies. The process of managed decline has meant the government has bailed out thousands of private companies. Instead of recapitalising them, it has assumed control of them through equity buyouts. State-controlled companies now account for about 50% of the economy and a third of profits, according to Deng. The government’s encouragement of nationalisation is reflected in the profitability disparity between state firms and private companies, which stands at 24% versus 16%.
Many economists see this is a bad sign: private companies generally perform better than nationalised ones. But the switch to government control, especially in the heavy industries, poses another concern for them – and little Hambantota.

Too Big to Fail

Few believe China’s economy will actually collapse. Arguably, it’s too big to fail; it’s so closely integrated into the global trading system that the international community is almost certain to act at the first sign of a serious decline.
Broad international integration acts like armour cladding on China’s economy, suggests Alicia Garcia-Herrero, chief economists for the Asia Pacific at French investment bank Natixis. That’s become apparent in the trade row that erupted when the US imposed tariffs on more than $260 billion of Chinese imports over the summer. When American firms cancelled Chinese imports, Beijing tapped its other trading partners to fill the gaps. Brazil, for instance, doubled its exports of soyabeans to China after Beijing imposed retaliatory measures against US shippers.
“A trade war with the US won’t wound China because it has enough other markets – only 40% of exports go to the US,” Garcia-Herrero said. “If all the developed-world countries were to follow America we would be in a different situation, but I don’t think they will – they can’t afford to.”
Brown agrees. “Despite the tensions, were we really to come to the brink I suspect somebody will stop the game and decide we should sit down together,” he said.
Of deeper concern to many analysts, however, is the future direction China will take under the increasingly authoritarian rule of its president. Xi cemented his hold on the governing party earlier this year with the scrapping of term limits that had underpinned a continuation of China’s open-market policy.

Made in China

Xi’s power grab was widely seen as a consolidation of an economic outlook that had been growing increasingly insular. The official “Made in China 2025” policy document published in 2015 sets out a vision of transformation from an export-led economy to one that places more emphasis on developing domestic markets.
While its general thrust of advancing Chinese manufacturing higher up the value chain was greeted as a logical progression, the document hasn’t been universally welcomed. In the US, particularly at the Council on Foreign Relations, it’s viewed as a direct challenge to American technological hegemony. More broadly, however, it’s regarded as a retreat from the liberalism of the past.
“This is, in some sense, a reversal of policies that we saw during the first, and certainly during the second and third decades [of China’s economic awakening],” said Loren Brandt, a professor of international trade and economics at the University of Toronto. “Opening up to the world was extremely critical to China’s success and rapid growth.”

China 2030

Observers are worried that the publication’s contradiction of an earlier policy declaration, “China 2030: Building a Modern, Harmonious, and Creative High-Income Society” points to a potentially destabilising debate raging between rival liberal and nationalist factions within the Communist Party. Reports that leading scholars and other influential bodies have taken the unprecedented step of criticising the new direction indicate the party does not think as one on plans for its economic future.
“The Chinese elite are not completely misinformed. Some have been trained in the West and know Western market economics,” said Deng. “China has two options – to go back to the planned economy, controlled by the state with no personal market initiatives and where everybody is poor but everyone survives. Or it integrates with international markets.”
Hambantota, and thousands of other towns throughout the Eruasian and African regions, has found themselves at the sharp end of Xi’s nationalistic zeal.
They were recipients of some of that tsunami of investment that fuelled China’s debt accumulation – an estimated $500 billion of it. Driven by a vision of China overtaking the West, Xi embarked on his One Belt, One Road to open new markets and project Chinese economic might to the world. Cynics that initially condemned it as a funnel to offload surplus domestic production now increasingly condemn it as neo-colonial exploitation. As project after project is accused of poor planning and misguided management, so grows distrust of the initiative’s motives.
China's loans to Africa. Source: Reuters

Catastrophic Floods

In Colombia, thousands of people in villages downstream of the China-funded Ituango Dam are living in fear of catastrophic floods after critical construction problems were found in the huge power project. In the Democratic Republic of the Congo, a deal permitting Chinese developers to open copper mines in pristine wilderness is running over budget and over schedule and unlikely to recoup its $2bn investment because the area’s mineral wealth potential was over estimated.
Most damning, recently re-elected Malaysian Prime Minister Mahathir Mohamad scrapped billions of dollars of Chinese projects and raised the spectre of a new imperialist force in Asia. These setbacks have obviously had an effect: investment in OBOR projects fell 36% last year.
The West’s increasingly jaundiced view of OBOR has been buffered by growing wariness about Xi’s motives. He’s ruled China with an increasingly iron fist since assuming power in 2012, ratcheting up nationalistic fervour, launching purges against critics at home and adopting a more aggressive militaristic tone externally. In the waters of the South China Sea, where Beijing lays disputed claim to swathes of mineral-rich islands, the People’s Liberation Army has been busily building up military bases, to the chagrin of the international community.
Arguably, the West’s recent lurch away from a liberal, globalised economy visible in Trump’s economic nationalism has given Xi a free pass. Even so, as Garcia-Ferrero notes, there’s too much at stake economically for the West to challenge China in its own backyard.

Waiting Game

And so, China’s fate remains a waiting game. According to Deng, even if the private sector collapsed tomorrow, the state sector is so large and its momentum so great that China’s economy could keep running at a fair clip for 20 years and still preside over a GDP that’s among the world’s 20 largest.
On an optimistic note, it’s signalled a renewed focus on internationalisation as a counter to Trump’s tariffs. Tax cuts have been promised and there are indications more investment will go into OBOR.
Brandt argues China has faced off crises before, arguing that it still has room to grow. A disconnect between output and the country’s gigantic labour force means productivity trails that of much smaller economies. Brandt estimates the chasm is so wide that Chinese workers produce less than a third of their American counterparts. That may weigh on the economy now, but it represents unused capacity that can be utilised to absorb future economic pressures.
“China has by no means exhausted the ability to continue to leverage this gap, to narrow it,” said Brandt.

Market Inefficiencies

That view is echoed by Giacomo Santangelo, an economics lecturer at Fordham University in the US, who says China’s sheer size has enabled its economy to expand despite huge market inefficiencies. He argues that the problems it faces today are simply the result of the economy’s increased sophistication finally running up against that wastefulness.
“China still has a third of its workforce in agriculture and while much of the rice it produces is for export it still imports huge amounts of rice from the US,” he said. “That begs the question: Is China wasting its labour force on things that are not productive?”
Analysts agree that the Chinese leadership also has much at stake in maintaining growth. But that’s no guarantee it will succeed.
“The social contract between the people and the Communist Party is a pragmatic one, very strongly based on the idea of building a powerful rich country that ensures people are happy and secure and never victims again,” said Brown.
“At the moment that works but when it stops working, someone had better think of some sharp solutions pretty quickly. China has gone through moments of harmonious placidity that have suddenly exploded. That history doesn’t go away.”