China’s homegrown crisis

 

China’s economic reality, until recently, was nothing short of extraordinary. Its annual economic output soared from under US$500 billion to US$18 trillion between 1992 and 2022, with years of double-digit growth pushing annual gross domestic product per capita from less than US$400 to US$13,000.

In recent years, however, growth has slowed significantly. To some extent, this was inevitable: moving hundreds of millions of people from inefficient rural agriculture to higher-productivity factory work in cities can only be carried out once.

Along the way, China received the support of the US and much of the developed world. They invested, extended loans, and transferred technology, while welcoming China into the World Trade Organization (WTO).

They also tended to look the other way when China stole intellectual property, violated its WTO commitments, and kept important parts of its economy closed to foreign competition.

The West was motivated partly by a simple economic calculation: the promise of gaining access to a consumer market of 1.4 billion people. In principle, as China got richer, its people would be able to purchase more from the West.

China’s low labour costs also enabled multinational corporations to produce and sell their goods for less, keeping inflation down and allowing consumers to purchase far more.

In addition to the West’s economic logic, there was also a political one: a hope or even expectation in the US and Europe that China’s economic rise would bring political liberalisation. Many envisioned a wealthier China that would become more open, democratic, and market-oriented.

It was also believed that a China increasingly benefitting from investment and trade would act with restraint abroad in order to safeguard the relationships that were contributing to its rise.

As a principal beneficiary of the existing international order, China, it was hoped, would become a “responsible stakeholder” within that order, rather than seeking to overturn it.

Over time, though, many of these hopes were dashed. Jobs at home were lost as less expensive Chinese exports displaced domestically produced goods. China did not become more open or moderate at home or abroad; just the opposite happened.

As a result, the US and other Western countries are becoming more selective about the technologies and products they make available to China and the investments they allow their companies to make there.

These restrictions have contributed to China’s slowdown. But the principal reasons for the country’s economic difficulties are internal; like much else, they are made in China.

Above all, the economy has remained overly reliant on increasingly unproductive investments (especially infrastructure) and exports, bloated and uncompetitive state-owned enterprises, and ballooning debt.

All of these problems stem in whole or in part from Chinese leaders’ decision to expand the role of the state in the economy, to ignore or suppress market forces, and to stymie the emergence of a private sector and middle class.

Chinese leaders now have three choices. One is to stay the course, prioritising political control over economic growth. This will be the most likely path if current difficulties ease.

But if today’s problems linger or even fester, the resulting prolonged period of modest economic growth could stimulate the very challenges to political control the leadership seeks to avoid.

High levels of unemployment among young people could be a powder keg. Making matters worse, time is not on China’s side, as a shrinking and ageing population will be an additional drag on economic growth and productivity.

The second option for president Xi Jinping and his inner circle is to change course. Chinese leaders tend to resist policy change, as it suggests a degree of fallibility that could be seen as weakness and invite challenges by political rivals. For now, they will likely resist doing so, fearing that major economic liberalisation could create pressure for liberalising political reforms.

Nevertheless, they may choose to change course if the alternative to more of the same is judged to be less risky. There is recent precedent for such a calculation. For several years, the government’s approach to Covid-19 featured frequent testing and extended lockdowns. Popular frustration grew.

Suddenly, in December 2022, the authorities abandoned the “zero-Covid” policy in favour of one that allowed the virus to move more freely among the population.

An unknown number of people died, but within a few months the country reached a new equilibrium that allowed for more normal activity at acceptable levels of risk. It is possible that economic policy, too, will one day become at least somewhat de-politicised.

There is a third option, an alternative to either staying the course or changing course: China could opt to change the conversation. The simplest and most likely way to do this would be to accelerate efforts to alter the status quo on Taiwan. The regime could embrace even more aggressive nationalism, rather than economic growth, as its source of legitimacy.

This path could well prove tempting. Some might argue that it would be less difficult and risky than engineering an economic turnaround. After all, China enjoys advantages of geography, and its military is far stronger than it was.

Moreover, Taiwan and its would-be partners have allowed themselves to grow economically dependent on China, and a politically polarised US has its hands full in supporting Ukraine as well as lacks the military might and manufacturing base to continue arming Ukraine and fight a war over Taiwan simultaneously.

But, as Ukraine demonstrates, wars are unpredictable. China’s military lacks any recent battlefield experience. Taiwan enjoys strong bipartisan support in the US, and economic sanctions levied against China would cripple its economy.

Moreover, the war in Ukraine and China’s aggressive behaviour have stimulated defense efforts and coordination among Japan, South Korea, Australia, and the US.

It will be impossible to change China’s dreams, but it is possible to affect its calculations. The goal for the West ought to be to persuade China’s rulers that changing the conversation, that aggression, would be folly, and that their only real choice is economic, between staying the course or changing course. What is certain is that this decision will determine Xi’s legacy, China’s future, and quite possibly the course of history this century. - FMT

Richard Haass is president emeritus of the Council on Foreign Relations.

 

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.