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12 July 2016

China: a lifebouy or a stone around one's neck?

Should China’s economy suffer a fully-fledged crisis, the Russian economy will also be in an extremely difficult situation

According to our leaders, Russia has decisively been aligning itself towards the East in recent years. That is, Russia has been turning towards China, seen by the Kremlin as its main ally for the coming years, as having an economy capable of “taking Russia in tow”, as a power with a similar political regime, similar attitude to the West and a similar geopolitical worldview. I have harbored skepticism regarding such a turn for many years; assuming that China as an industrial country is interested in maintaining our specialization in commodities; as a non-free society it will have a negative impact on Russian politics; as a state seeking to revise the global balance of power it could engage us in conflict with the West. It is clear now that we will become nothing more than a petrol station; that our own elite is forming a repressive regime even without the help of Beijing; we could teach many a thing or two about propensity to conflicts.

As they say in Russia, “contagion will not infect contagion” and there should be no serious objections to cooperation under such conditions. However, a very significant risk should not be ignored: in recent years, more and more indicators suggest that China, considered by Russia as the main island of stability in the world by default, may turn out to be the main source of global shocks in the coming decade. I do not intend to present detailed forecasts – let me direct readers’ attention to merely a few circumstances:

Almost everyone knows today that the Chinese economy is slowing down: its growth rate dropped from 14.2% in 2007 to 10.4% in 2010 and 6.9% in 2015. Of course, Russian politicians may disregard this (these indicators appear comparatively exceptional in the light of Russia’s corresponding indicators). However, there at least five noteworthy points.

To begin with, the unrivalled rapid growth of the Chinese economy in the 1980s and 1990s was due to a spectacular increase in the number of those engaged in industrial labor. 280 million people flocked from rural to urban areas over twenty years which made it possible to practically freeze the real wages of industrial workers for over a decade. However, during the last five years the number of resettlers has fallen to as low as 20 million i.e. the pace of this process has decreased by more than two-thirds. Cheap labor is depleting, wages are rising and the population is ageing. Moreover, according to Martin Wolf of the Financial Times, the productivity of Chinese economy has not grown at all since 2012. One important factor of growth has in fact outlived itself.

Secondly, for many years, China has been developing an export-oriented economy - and Beijing (based on statistics and not on the speeches of Chinese leaders) was not inclined to change its policy until very recently. In the 1990s, the average annual growth rate of exports was 15.4% and climbed as high as 21.7% between 2002-2008 (from the moment of China’s accession to the WTO until the onset of the financial crisis). But what do we see in late 2015? A fall in Chinese exports of 1.8%, moderate devaluation in an attempt to revive it, the lack of a coherent policy for supporting the stock market and a reduction in foreign exchange reserves of the People’s Bank of China by an impressive $512 billion within a year. Does Beijing have a strategy for the future?

Thirdly, since 2008, we have been hearing fables from Beijing party bosses regarding the claim that exports will be supplanted by domestic demand. And stimulation of the domestic market is carried out to this end. Perhaps, some initiatives have been undertaken. However, in 2000, household consumption constituted 47% of total demand whereas it had fallen to 38% by 2012 despite a boom in consumer lending and all the promises of “the party and government”. The propensity of the Chinese population to save money does not wane, a “consumer boom” is out of the question, demand for durable goods remains in stagnation for the second consecutive year and the number of unsold residential properties is growing.

Fourthly, the Chinese economy responded to this by increasing investment and development of heavy industry until recently. However, there is more than enough investment: the ratio of net fixed assets against volume of production of Chinese industry exceeded the US rate in 2014. Besides, investment cannot rise forever (investment constituted 35.8% of GDP in the 1980s, as much as 42.8% in the 2000s and 47.4% in 2010-2014). Investment is becoming less and less efficient; the incremental capital output ratio has halved during the last 15 years. No matter what investments tomorrow holds, they will not generate the levels of growth previously witnessed.

Fifthly, only Russian “experts” believe that China is a bottomless pit of money. Indeed, its foreign exchange reserves still total $3.31 trillion, the world’s largest. However, the total debt of households and companies rose from 121% of GDP in 2000 to 294% in 2015, which exceeded that of the USA (272%) (let me remind those Russian experts who are convinced about the imminent bankruptcy of America in particular of this). Let me reiterate, the reserves seem huge but they do not even equate to 15% of this sum (at the current exchange rate). Moreover, it is noteworthy that nearly half of this debt is generated by loss-making state corporations along with construction companies vulnerable in the event of a crisis.

In other words, China is facing complex dilemmas. Should the country fail to support investments at an exorbitant level, a collapse of the construction sector along with a collapse of the development of infrastructure will be inevitable. At the same time, maintaining investments at a high level increases debt, keeps consumption at a low level and does not allow for necessary structural reforms to be carried out in the country. All of this is confirmed by an obvious (and proven, given the case of the Soviet Union) thesis that restructuring and acceleration cannot occur simultaneously. However, Chinese communists have no other option.

And here come the political problems. Strange as it may seem, Chinese leaders, in parallel to Vladimir Putin, are looking for some sort of a new consensus which could be offered up to the population. They are trying to replace increased well-being with slogans of “order”, “greatness” and even nationalism. So far, the population is not too imbued with enthusiasm about new goals (and some may even disagree with them). However, the President of the People’s Republic of China, Xi Jinping, has managed to break the unspoken rule of immunity of the current and former members of the Standing Committee of the Central Political Bureau of the Communist Party of China (the most high-profile cases being those of Bo Xilai and Zhou Yongkang) as well as depart from the foreign policy conducted by Deng Xiaoping which implied the country would have minimal involvement in foreign policy escapades. For decades, China has successfully applied the model of crony capitalism which established solidarity of party-and-state elite in exchange for the formation of corrupt networks which serviced the business interests of its representatives. The model is rapidly being destroyed today or has already been destroyed.

The Kremlin does not tire of reiterating that China is testament to the prosperousness of the “non-Western” growth model, resistant to economic and political shocks. It may well have been so – but now the People’s Republic of China has reached the natural threshold of its development. None of the dictatorships (except for petroleum Emirates) have ever reached such performance indicators of economic growth. Today, according to the estimates of Minxin Pei, as regards GDP per capita, China is only next to democracies, “partly free” countries (according to the classification of Freedom House) and petro-states. An ascent to the “premier league” is unlikely without competitive policy – if not Western democracy – as well as reliable jurisdiction and recognition of fundamental (both economic and political) rights of citizens. So far, the party has followed the opposite route by increasing pressure on dissenters, strengthening censorship of the press and the Internet, and increasingly resorting to historical, military and nationalist rhetoric to justify its autocratic claims.

What am I driving at? In my opinion, by opting to favor China (even if this course is referred to as “Asian” or “Eastern”), Russia is effectively exposing itself to substantial risk today. Of course, one can understand Vladimir Putin who believes that the breakup of the Soviet Union was “the greatest geopolitical catastrophe of the twentieth century”. However, it seems to me that this event has been the greatest catastrophe of the millennium for fraternal socialist state Cuba, for example (comparable only to the arrival of the conquistadors as far as its consequences for the natives go). To be left without the ally one has devoted practically everything to is even worse than watching the way one’s own country unravels.

In 1989, Chinese leaders looked on as developments in the country of their big brother unfolded and they managed to avoid taking the same path, having consolidated the political regime and accelerated economic reforms. On the other hand, relations with the USSR were not so important for Beijing and the collapse of the Soviet Union delivered benefits for China rather than problems. Today, Moscow sees its big sister as the only hope: a political ally, a purchaser of resources, a potential creditor of last resort and even a military ally. Should China’s economy suffer a fully-fledged crisis, the Russian economy will also be in an extremely difficult situation. However, should China survive political upheavals and implement reforms (though probably more cautiously than Moscow did in 1986), the prospects of Russian leaders may resemble those of leaders of Soviet satellites in 1989. This is especially so since Chinese friends are capable of being even less compassionate than new Russia was towards Erich Honecker - and access to the West remains virtually cut off.

Vladimir Putin has tried out all options of geopolitical orientation during his fifteen years of rule. In 2000-2001 Vladimir Putin visited Cuba and even North Korea trying to revive former Soviet connections. Later, he befriended George W. Bush Jr. against the backdrop of the fight against terrorism (between 2001 and 2003). Then he befriended Europeans trying to defend abstract principles of sovereignty and Saddam Hussein’s regime (in 2003-2004, until the Orange revolution). China is the last superpower to perceive Russia as a “normal” country. And no matter how much we look up to Beijing, it is necessary to thoroughly and impartially analyze not only China’s achievements but also its weaknesses, especially given the fact that many of these weaknesses have surfaced lately. One does not want to become too strongly attached to the country which appears to be a lifebuoy but could turn out to be a stone around one’s neck.

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