The Future of the Middle Kingdom

Beijing, China – January, 2013

Examining the prospects of the People’s Republic of China as a 21st century economic power requires a brief understanding of its history. A millennium ago China was a world power, equivalent in influence and wealth to modern day United States and 19th century Britain. After a prolonged period of supremacy, however, China encountered several centuries of economic decline. After centuries of suffering from economic and geopolitical impotence, Chinese leaders experienced a cognitive dissonance, unable to reconcile their perceived destiny as a world power with their current status as an impoverished, developing country (Drench). This cognitive dissonance is responsible for Chinese leaders’ push for economic and political empowerment, resulting in the Communist Party swapping decades of socialist policies for capitalistic reforms. Deng Xiaoping, a preeminent Chinese leader in the 1970’s instilled this desire for capitalistic reforms into his party members when he said, “It doesn’t matter if the cat is black or white as long as it catches mice,” alluding to the fact that whether policies were socialist or capitalistic was irrelevant; the only thing that mattered was whether or not policies fostered economic growth.

Following a string of policies that have led to reform and economic prosperity, China’s economy has maintained nearly double-digit growth rates for the past three decades. If this growth were to continue, China would be poised to overtake the US’s economy as the largest in the world. In spite of its consistent growth and heavy investments in education, infrastructure, and technology, there remain serious doubts about China’s ability to maintain its impressive growth rates. Steven Rattner, an expert on China’s economy alludes to this uncertainty discussing how, “the ‘plum rain’ that envelops Shanghai every Summer (a mixture of fog and smog) is a handy metaphor for the murkiness that currently enshrouds China’s economy.” (The New York Times) Responding to recent subpar growth rates and social and political turbulence that currently afflict Mainland China, many analysts have argued that China’s ascendency as a world economy is unlikely. What fewer analysts have argued, however, is that China’s economy will confront an economic downturn. From excessive pollution to a growing housing bubble, there remain numerous domestic issues that must be addressed in the coming decade. These issues coupled with an aging population and risk of political instability can be most adequately described as a cluster of ticking time bombs set to go off over the next two decades. Due to China’s inability or unwillingness to address these imminent crises, it is likely that China will confront economic decline over the next twenty years.

Environmental issues are currently paramount among China’s concerns in terms of urgency. Major cities across China are seeing high levels of toxins in the air resulting from unsustainable levels of manufacturing, intensive coal burning, and a general lack of regulation. One of the more notorious examples of China’s pollution issue is its own capitol. Beijing, China over the past winter broke records with its PM 2.5 levels (particulate matter 2.5). A toxic chemical which has seen its levels surge in recent years, PM 2.5 is a matter of serious health concern with prolonged exposure causing a host of respiratory problems. Measured on a chart that typically goes from 0 to 500 on the air quality index (AQI), this winter the levels exceeded the chart’s limits going above 800 on the AQI, corresponding to a record number of heart attacks in the Beijing. The situation is so dire that parents seriously consider the quality of a school’s air ventilation systems when deciding where to send their children to school. In spite of the fact that millions of people have called for policy reforms to curb pollution, China’s government has been hesitant to address it as an issue for fear of economic side effects. This is not surprising, as much of China’s rapid economic growth has been facilitated by unsustainable development. Now that the effects of pollution have more than surpassed toxic levels, the government faces an impending health crisis, and the dichotomy between the well being of its population and its continued growth and development. James Fallows, a correspondent for the Atlantic and expert on China has remarked that, “environmental catastrophe is, far and away, the main destructive side effect of China’s economic miracle of the past three decades, and the main threat to its continuation” (The Atlantic). As the levels of pollution continue to rise, and the health effects continue to resurface, China will have no choice but to sacrifice a portion of its economic growth for more sustainable practices.

The harsh environmental policies that China will be forced to legislate will likely prove as crippling to their economy as their aging population. Responding to China’s oversized population, central leaders instituted a nationwide mandate restricting its people to have no more than one child per family beginning in 1979. The effects of this policy have been instrumental to their economic resurgence. With the birth rate intensely curtailed for the course of several decades, China’s economy has benefitted immensely from having a high ratio of working adults to dependent children. Referred to in economics as a demographic dividend, this economic phenomenon results in a nation’s labor force remaining vigorous while the costs to society of non-working dependents decreasing considerably. However, after two decades of paying tremendous dividends to its economy, the advantages of China’s demographic dividend are beginning to expire. Fallows reports that, “China’s working age population is about to start falling (official statistics say it peaked in 2012; the UN says 2015)” (The Atlantic). As the labor force of twenty to thirty years prior begins to retire and is replaced by a labor force more than half its size, China’s economy will experience an economic cardiac arrest. Not only will China’s labor force dwindle, but its population of dependent elderly will surge dramatically introducing enormous costs to its citizens and local governments in the form of health care costs and retirement care. As its labor pool continues to shrink, China’s manufacturing industry will be forced to pay higher wages, reducing its competitiveness as a manufacturer of cheap goods, and eating away at a major source of national revenue.

While not on the same scale as the after-affects of the one-child policy, another impending crisis is capable of severely incapacitating its economy. Over the past decade China’s real estate market has developed into a bubble, with real estate prices in Beijing nearly three times that of prices in Washington, D.C. Much of this is a result of cultural norms in China. For most young men, buying a home is a prerequisite for finding a wife. In line with this inelastic demand, the prices of real estate across the country has skyrocketed in recent decades, facilitated by both unwavering demand and parents and grandparents’ ability to collectively buy a home for their sole male descendent. Li Yanqi, a contributor to the Wall Street Journal writes that, “one third of the economists polled see a possibility that the housing bubble will burst following the strong rebound in prices so far this year. None of the respondents believe the central government’s latest measures to curb prices will work.” (Wall Street Journal). Analysis of price to rent ratios coupled with expectations of China’s future buying rate over the next twenty years indicate that prices of real estate are severely overinflated and unsustainable. Reuters reports that, “the ratio between house prices and rental rates in several of China’s leading cities has soared well above levels that often indicate a property bubble”. It is unclear when or if the bubble will burst, but there is no denying that a drop in prices is inevitable. This in and of itself will cause an economic slowdown, eating away at the growth precipitated by construction, local development, and land purchases. Many people in China have the majority of their wealth tied up in real estate, so a drop in prices would be followed by a huge decrease in household wealth and domestic spending, causing immediate drops in China’s GDP. An all out burst in the real estate bubble would be even more catastrophic, causing local, municipal, provincial, and national revenues related to real estate development to evaporate.

Independent of the aforementioned crises is a crisis of political nature. China’s Communist Party has been in power for over six decades as an authoritarian regime. Only a small portion of China’s 1.3 billion citizens is part of the Communist party and of those party members only a few have any real influence on policies. Currently the Party Secretary Xi Jinping, the Premier Li Keqiang, and five other ministers make all of the political decisions for the People’s Republic of China. A political structure of this kind is inherently unstable. With one of the highest gini coefficients in the world, and a hukou system (household registration system) that discriminates against rural migrant workers, who compose 15% of China’s population, there are millions of people who would benefit from political reforms. China has managed to maintain control of its population since calls for democratization and reform in 1989, but if economic decline occurs again or a political scandal resurfaces there is a high likelihood that protests would occur across Mainland China. If the Communist Party’s authoritarian regime were to crumble and be replaced by a democracy, there would be immediate slow downs in the economic sector. Scores of social issues would need to be addressed and there would be high inefficiency in governance, legislation, and policy reform. This inefficiency would only be exacerbated by China’s diversity. China is a country with fifty-six different ethnicities and intense economic and social inequality. It would be impossible to adequately reconcile the numerous political demands of these varied demographics. A significant proportion of China’s rapid growth has been the result of its streamlined political structure. It is highly efficient to rapidly develop and promote growth in a country where citizens have no rights and its government can focus solely on economic initiatives rather than on social issues and rallying for political support from varying factions and demographics. Thus, as political instability becomes more likely, China will need to consider the negative economic ramifications that would follow such a restructuring.

In spite of the crises that China faces, it still possesses some tremendous advantages. There are potentially huge dividends from China’s domestic investments, totaling 48% in recent years compared to a meager 16% in the United States (A Bubble in Pessimism, The Economist). These investments, one could argue may lead to increased domestic spending, foreign investment, and increased productivity in the years to come. Additionally, China has made valuable economic and political investments abroad, buying stakes in treasuries and companies in the United States and in Europe. The successes of SOE’s, State Owned Enterprises, are also cited as sources of economic viability. Corporations such as Huawei, Lenovo, and Alibaba are international brands with the potential to attract continued investment and revenue to the PRC. These investments and valuable corporate holdings could be seen as reliable sources of economic viability.

This viability quickly comes into question when one examines these advantage’s potential effects on their economy. China’s investment percentage is impressive, but it remains unclear how effective these investments will prove to be. True, the investments made in the economies of Europe, the US and Africa will likely pay out, but it is unclear what these dividends will be in relation to the impending costs that China will confront in the coming years. The costs that China will face relating to environmental regulation, a shrinking labor pool, and a growing housing bubble are astronomical compared to the meager trillions of dollars invested in foreign treasuries. As for domestic development, while any economists would agree that government investments in infrastructure could pay dividends, not all domestic investments prove productive. Many of their investments have been made into projects of questionable soundness, meaning only a portion of China’s 48% investment rate is really being put to work. China’s huge investments into high-speed trains and into new special economic zones have been incredibly costly, and it remains unclear if these investments will yield gains. Tieling, a new city that cost the Communist party billions of yuan to construct remains a ghost town, and many of its high-speed trains are far from capacity due to the exorbitant fares that few Chinese citizens can afford.

China’s SOE’s do represent impressive corporate successes that could provide national revenue in the years to come, but their success are dependent upon discriminant economic policies. Much of the reason that China has been able to foster the growth of its SOE’s has been due to economic policies that deprive citizens of discretionary income. With bank interest rates well below inflation rates and very few safe ways for less affluent Chinese citizens to invest, many are seeing their real worth decline as the Communist Party benefits from an inflation tax. The Economist describes this trend, “Because the government sets an interest-rate ceiling on deposits, the banks underpay depositors and undercharge corporate borrowers—in effect, a tax on household savers and a subsidy for state business” (A Bubble in Pessimism, The Economist). China’s lending systems while very open to SOE’s and government-sanctioned businesses, are inaccessible to common citizens, which makes increased domestic spending from local entrepreneurship or purchases made with borrowed funds nearly impossible. Until China restructures its lending systems to empower its citizens financially in the same way it has empowered its SOE’s, its economy will not see its domestic spending reach that of more developed OECD countries, a critical step towards economic supremacy.

China’s resurgence as an economic power in decades to come is unlikely, but what remains unwavering is its people’s resolve to reclaim their country’s status as a world power. China’s name in Mandarin is zhōngguó, meaning middle country, an origin tied to its people’s belief that their country has always been destined to rule the world as the middle kingdom. It is this belief that many credit for their ceaseless drive for economic, political and economic empowerment. This drive for economic resurgence is not something that will decline amidst impending economic downturns. China is certainly in a weaker position in terms of economic prospects than it was a decade ago, but there is still a chance for China to overcome its impending crises over the next century and rebound stronger than ever. Such a rebound, however, will require the perseverance of China’s leaders and populous through what will undoubtedly be a tumultuous and economically challenging period. If the People’s Republic of China manages such a feat it will truly have earned its status as the middle kingdom.

Sources Cited
Drench, Peter. “History of China.” History of China. Phillips Academy Andover. Samuel Phillips Hall, Andover, Massachusetts. 3 Oct. 2010. Lecture.
Rattner, Steven . “China’s Optimistic Economy – NYTimes.com.” The New York Times – Breaking News, World News & Multimedia. Web. 9 Oct. 2013. <http://www.nytimes.com/2012/07/12/opinion/chinas-optimistic-economy.html?_r=0&gt;.
Fallows, James. “Air Emergency: Beijing – James Fallows – The Atlantic.” The Atlantic — News and analysis on politics, business, culture, technology, national, international, and life – TheAtlantic.com. Web. 9 Oct. 2013. <http://www.theatlantic.com/international/archive/2011/11/air-emergency-beijing/247642/&gt;.
Qi, Liyan. “China’s Economists Find Local Debt, Property Market Worrisome – China Real Time Report – WSJ.” WSJ Blogs – WSJ. Web. 9 Oct. 2013. <http://blogs.wsj.com/chinarealtime/2013/08/19/chinas-economists-find-local-debt-property-market-worrisome/&gt;.
“China’s price-to-rent ratio suggests bubble: study| Reuters.” Business & Financial News, Breaking US & International News | Reuters.com. Web. 9 Oct. 2013. <http://www.reuters.com/article/2007/05/05/businesspro-china-property-dc-idUSPEK1435320070505&gt;.
“The economy: A bubble in pessimism | The Economist.” The Economist – World News, Politics, Economics, Business & Finance. Web. 9 Oct. 2013. <http://www.economist.com/news/china/21583691-chinas-economy-inefficient-it-not-unstable-bubble-pessimism&gt;.

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