by John West, Asian Century Institute
When financial crisis struck the US in 2008, there was no-one more triumphalist than a Chinese Communist Party official. Today, the tide is turning, as it invariably does.
Although it has been a messy experience, the US economy is slowing coming back to life. And China, which was the world's star economy in 2009 and 2010, is now faced with a set of momentous challenges. What are they?
First, there is social policy, including health, education, the environment and so on. The new Chinese leadership needs to complete the unfinished "harmonious society" agenda of HU Jintao and WEN Jiaobao.
While the US is now facing a fiscal cliff, China has a demographic cliff to contend with, because of the rapid population ageing due to the one-child policy. This means rising health costs. The one-child policy has also caused a large gender imbalance because of the preference for sons. There is a great need to improve human capital (especially management skills) to maintain productivity growth, and reduce the yawning gap between rich and poor. Massive environmental damage is now affecting the quality of life.
The social agenda is challenging, especially for its execution, because it requires the cooperation of local governments and state-owned enterprises. But, of the four main challenges facing China, this is the easiest one for the new leadership to tackle.
Second, there is the management of regional and international relations, the second easiest area for reform. There has been and continues to be great tension between China and Japan regarding the Senkaku Islands. Rising nationalism is now at the center of life in both China and Japan. There is also great tension with Vietnam and the Philippines in the South China Sea. There is a significant risk that these disputes could escalate into open clashes and conflict. No-one would win.
There is also great strategic distrust between China and the US, and anti-americanism is a very serious problem. While there are faults on both sides, China still carries hurt national pride from what it regards as the "century of humiliation" from the mid-19th century to the mid-20th century. These feelings have been nurtured through the national education system and Communist Party discourse, and have become ingrained in the national psyche.
The new leadership needs to work to overcome these attitudes. But it will want to appear tough in the short-term, at least - especially since Chinese nationalism has been a key tool in promoting national solidarity.
Improving China's regional and international relations will be challenging, but it is very much in the country's interests, including its economic interests. Japanese companies in particular, are reconsidering their investment strategies following the recent anti-Japanese demonstrations and violence.
The third challenge is that of economic reform. Rebalancing away from export-driven growth is necessary, since China's biggest export market, Europe, is in the doldrums.
Investment has now become an even bigger driver of growth in recent years (around 50 per cent of GDP), and state-owned enterprises (SOEs) and banks are now playing a larger role. This is not however a sound strategy.
It is necessary to increase the labor share of national income (and reduce the share of SOEs) to enhance social justice and stability, and also to promote domestic demand driven growth. The monopoly markets of SOEs must be opened up to competition to improve efficiency and productivity. And SOEs and banks should be privatized and put on commercial footing. Too much of national savings is squandered in inefficient investment expenditure.
The economic reform agenda presents many challenges. Reform could lead to some dislocation in the short term, and future economic growth will be slower. Then there are the vested interests in SOEs and banks, who benefit greatly from the current situation, and who are closely linked to the Communist Party leadership.
The last and greatest challenge is political reform. A quick move to democracy may be unrealistic and perhaps not even desirable at this stage. But there are strongly growing demands for respect of the rule of law and improving the quality of governance.
The HU Jintao and WEN Jaobao leadership regime has closed in humiliation. The financial shenanigans of WEN's family were exposed by the New York Times. And HU's chief of staff covered up, even from the Communist Party, the death of his son in a car accident. Why? Because the car was a Ferrari, and there were two naked Tibetan girls in the back seat. A pretty symbol of Communist Party lifestyle!
At the local level, there is growing social unrest because of the expropriation of land, environmental problems, unpaid wages, the corrupt court system, etc. There is much frustration at the grotesque level of corruption. Cyberspace has become an important arena for airing grievances about the Communist Party.
As a first step, there is a great need for the leadership of the Communist Party to become more transparent and accountable. They should disclose its financial affairs and be squeaky clean. In other words, they need to be part of the solution, not part of the problem. But this represents an immense challenge for the Party.
Judges and courts should be given independence at the local level, and not be beholden to local Communist Party officials. The people have great expectations regarding the rule of law and governance, which will be hard to contain.
In analysing China, we must have great humility. The workings of the Communist Party and the leadership choices are very opaque - although former President Jiang Zemin clearly seems to have played a leading role in choosing the new Chinese leadership, placing several of his people on the Politburo.
But the key issue seems to be whether change is possible within the existing system. Radical reforms are necessary to maintain growing prosperity. Indeed, reforms in the areas of social policy, international relations, and corruption and governance, are critical for economic growth. It is becoming increasingly difficult to separate economic and political reform issues. Corruption is having a very corrosive effect on both society and the economy. And making a serious start on reform is necessary to improve the credibility of the Communist Party, which is at "rock-bottom".
Maintaining the status quo would ultimately represent an existential threat to the Party. But if stability deteriorates and the Party feels more threatened, you can count on it to ramp up the nationalist fever and provoke its neighbors and the US.