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China: Balancing Political Ideology and Economic Pragmatism

Written by Jillian Friesen, GEI Associate, and John Lounsbury

Last week the new Politburo Standing Committee of the Communist Party of China was introduced to the world. All of those who were elected are new members to the committee, including the new party leader Xi Jinping (pictured, Source). Also, they represent a rainbow of conservative positions and ideologies. Hu Jintao, the former party leader recently stepped down from his post as head of the CPC Central Military Commission, a position usually held for outgoing Party Leaders. Political and economic corruption have plagued China for decades. In his outgoing report, which was watered down with political language and overtones, Hu Jintao appeared to be stern on his position of ending corruption in his country. This desire was obvious:

“If we fail to handle this issue well, it could prove fatal to the Party and even lead to the collapse of the Party and the fall of the State.

Hu’s departure from his post at the Central Military Commission raises a few questions. Hu Jintao’s predecessor, Jiang Zemin, had held the position as head of Central Military Commission. Until Hu took the reigns after leaving his post as CPC Party Leader. Hu’s immediate departure as head of the military commission has led many to conclude Hu only wished to end Zemin’s reign. In a November 11th meeting of high ranking party officials, rules were enacted to prevent retired party leaders from meddling in new affairs of the government. This would strike out one more politician in the homogeneously aligned Chinese government and force Zemin into political obscurity.

The new Party Leader of the CPC, Xi Jinping had only kind words for Hu’s decision to depart. According to Xinhua, Xi said, in a recent meeting:1

[Hu’s] “important decision fully embodies his profound thinking of the overall development of the Party, country, and military” [and] “the decision also embodies his exemplary conduct and nobility of character.”

Hu’s actions have cleared the way for Xi Jinping to rule without the interference of old Party Leaders. Whether this decision made for the sake of political reform or just another power move is yet to be known. A more pressing issue is the state of the Chinese economy. There are those who tout the great Chinese “bubble” and those who believe China will slowly deflate back to economic reality.

China’s new leaders no doubt wish for China to continue on its path of economic boom and prosperity. However this is becoming more and more unreasonable as time goes on. The Chinese public are becoming better educated and better informed about their government and world issues. They are demanding a higher standard of living and higher wages. The psychological campaign of ingraining Chinese “nationalism” into the minds of its people is losing steam as well.

The structure of the Chinese economy needs to be rearranged. More credit needs to be made available to small businesses. Over 70% of China’s banking sector is controlled by four big entities. These banks tend only to lend credit to government sponsored businesses (SOE – state owned enterprises) and those lucky enough to be in the political loop. This in turn only fuels China’s “shadow banking” industry.

The depressed Purchasing Managers Index of China has also been cited as a reflection of China’s problems. Stock piles and inventories have been building up over a long period and many of the orders for those stockpiled items were inflated.

However, there are analysts who believe the PMI slump has reached the bottom and China is on the path for a slow recovery. Improvement should be seen in the 4th quarter and continue into 2013 if this view is valid.  And today (22 November) the HSBC Flash PMI emerged from a thirteen month-long sojourn below 50 (which is the demarcation between contraction and expansion), recording a reading of 50.4.  One small step, but every journey begins with the first step.

(Note: Flash refers to a preliminary reading. The HSBC survey covers mostly small and mid-sized privately held businesses. This has been giving negative readings forover a year and has been significantly lower than the official PMI covering mainly large SOE companies.)

Rearranging the Chinese economy will not be an easy task for politicians though. The people of China have been used to a boom of jobs and growth.  Over the past 15 years China has become increasingly an investment and export led economy.

Click on graph (from Tiburon Partners) for larger image.

china-gdp-1978-2009-1H-Tiburon-Investments-580px

This recent period has seen the absence of the large business cycle swings of the previous 15 years.  An economist without a sense of shame might use the terminology that China has experienced a period of “great moderation” coinciding with a period of exceptionally high economic growth.  But many voices are not making such an assessment, which proved in hindsight to be so embarrassing to many western economists with the onset of The Great Recession.  Instead there is a significant opinion that the experiences for China over the last two decades are not sustainable and a rebalancing is required.

In order to balance out the economy and avoid a bursting bubble, China must return to more of a consumption-led economy, as was the case for the first half of the 30-year period above. GEI contributor Michael Pettis has written many analysis articles about the need for the rebalancing over the past year.

The newly elected officials must encourage policy reform which would allow for increased Chinese consumer spending. This would involve such actions as allowing a more rapid appreciation of the renminbi vs. other leading currencies and an aggressive program of wage increases. China has followed a long standing pattern (over much of the past 25 years) of saving and exporting. It has seen consumption contributing a declining proportion of GDP growth. That is the pattern that needs to be reversed.

It is interesting to note that outgoing party leader Hu Jintao, in his farewell address, also indicated a policy was needed to double the Chinese per capita income over the next seven years. What is most significant about that is what it is not: (1) It is not a statement by those coming into power; (2) it is not backed up with any stated analysis that such an increase (an average of about 10% per year) would actually be sufficient; and (3) it creates a conflict with rapidly shrinking profit margins of Chinese corporations.

How much influence the remarks of the outgoing party leader actually have should be very much in question.  After all his successor has pointedly avoided mentioning Hu’s call for democratization of the country, which has been another of the departing leader’s primary propositions.

The Chinese stimulus spending in 2009 was considered a key to bringing the country out of The Great Recession quickly. As the following graph (from Key Trends in Globalization shows), stimulus was directed into an investment spurt and accounted for virtually all of the GDP change from 2008 to 2009 as the other components netted to near zero.

China-GDP-Changes-2008-09-Key-Trends-in-Globalization

The 2009 investment spurt was a repeat of a pattern seen over the past three decades. See 1978, 1985, 1993 and 2003 in the Tiburon graph. In all the previous cases the investment spurt was followed by a boom in exports over the next several years. Given the current global economic malaise it is not evident that a similar export boom can be repeated. A change from a dependance on exports to one on increased domestic consumption is clearly the needed direction.

But there are signs of hope. Consumption outweighed investment the first nine months of 2012. The figures were respectively 55% for consumption and 50.5% for investment (- 5.5% for net exports). This is a dramatic change from just three years ago when domestic consumption was less than 30% of GDP, at a time when net exports were subtracting almost the same amount from GDP that consumption was adding. These figures represent a major improvement over the 2009 situation and may start to alleviate the worries some have that the Chinese model will lead it down the same path Japan took right before its “bubble” burst.

With the rest of the world experiencing recession and, in some cases depression-like conditions, the purchasing power of consumers outside of China is decreasing. It would only seem natural for China to pursue a policy to encourage more domestic consumption. Uncertainty still looms over China and data out of the Chinese government has been criticized as not always the most reliable. But the World Bank is projecting that the movement is in the right direction.

China-GDP-components-2007-2013-World-Bank-April-2012

The crash of the U.S. economy took place suddenly. There was no gentle let-down period. There is no a priori reason to think China should be able to have a different experience. They have repeated a previously successful massive investment stimulus in a world that, this time, is different. Thus previous the results may not be repeated.

Knowledgeable economists like Michael Pettis are warning that the pace of reform is too slow. This time could indeed be different.

We need to remain alert that what happens in China may catch us as well as the Chinese government by surprise. The new conservative Chinese government certainly has a lot on its plate. If they can maintain a policy that follows the World Bank’s projections, and continue the trends forward into the subsequent time period (2014 and beyond), they may be able to pull off effective rebalancing.

The concern expressed by many observers is that China may err on the side of being too “conservative” in implementing reform.  After all, how easy is it to reduce corruption, increase democratization and double per capita income when the unreformed system has produced decades of very high growth?


References that were not linked in the article

China’s New Government is Conservative: Global Economic Intersection

China: Will a Concrete Bubble Turn into Concrete Shoes?: Global Economic Intersection

China’s Macroeconomic Miracle: Kleptocracy: Global Economic Intersection

Gathering Storm: China’s Epic Hard Landing: Global Economic Intersection

Imbalances, Disequilibria and Correlation Traps: Global Economic Intersection

China’s Elites and Development: China Century Institute

China’s New Leaders, No Reform Dream Team: Asia Unbound

Through Retirement Hu Jintao Seeks Victory: The Epoch Times

Hu Jintao’s Report at 18th Party Congress: Voltairenet

New Chinese Credit Rating Agency: The Nation

Analysis and Opinion articles about China

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