One Year, Many Dragons

The start of the Year of the Dragon seems an appropriate time to resume this blog after diversions elsewhere during the second half of 2011. This looks like being a year when analysts and commentators will take even more sharply divergent views of China than before, with a corresponding fog of instant opinions based on minimal shifts in the purchasing manager’s index or house prices in a handful of cities.
Thankfully we have passed beyond the time when Jim O’Neill of Goldman flung his arm in the air to proclaim that China had reached “12 per cent growth and the sky’s the limit” (did Beijing really want that?), when the author Martin Jacques looked forward to the day when China ruled the world (ditto) and when the historian Niall Ferguson imagined a thought bubble rising from Hu Jintao’s head with the caption “We are masters now” as China claimed the 21st century as its own.

Indeed, the recognition of the long-standing challenges facing the People’s Republic has tilted opinion towards the bears as data are analysed for negative content. In a period when growth is falling in healthy fashion from the unhealthy heights of 2010, there is no shortage of downward curves on charts or of foreign suppliers of capital goods feeling the pinch of declining orders as Chinese buyers adapt to a less go-go environment.
The only important question is when that downward trend will slow and stop. Our view, set out in our note at the end of 2011, is that growth will come in at 7.5-8 per cent this year, with European demand the main wild card. This is in line with the trend envisaged by Wen Jiabao for the current Five-Year Plan and presumably endorsed by the new leadership which will take over this autumn. Yes, a drop from 11 to 8 per cent growth is a substantial slowdown, but, especially in global terms, 8 is still a pretty auspicious number.

Yes, there are pressure points through the economy – and in society as analysed in our short note this month and fuller report last autumn. Where are there not? But the ability of the system to absorb them remains great – perhaps too great given the strengthening of the state sector as a result of the 2008-10 stimulus package and the temptation to use it to inject another dose of the spending drug to cushion necessary adjustments. Still, rethinking is apparent in some key areas, notably the railways where the runaway ambitions of the sacked minister, “Great Leap Liu”, are being replaced by a more orderly approach after the Wenzhou high-speed crash and the revelation of the debts the former rail baron sparked off for the state whose control he evaded – not to mention the familiar pile of bribes.
Yes, the SMEs of Wenzhou are under pressure and some are going bust. But, as my colleague Bo Zhuang found when he visited the city last year, the picture on the ground is rather different from the media headlines (Subscribers, see his report On the road in Wenzhou: Assessing the credit crisis). Small firms may pay 2 per cent a week for bridging loans but that does not equate to the 100 per cent annual rates that made headlines. Credit costs are only part of a story that takes in higher wages, the cost of workshop improvements, currency pressures, late payment by Western retailers and property investments that have gone flat. How many SMEs have actually gone bust and how many bosses have committed suicide or absconded? Only a very small proportion of the 250,000 plus firms in the city.

Yes, local authorities have racked up NPLs, however many trillions they may amount to. But will the state not simply get the big banks to roll over the loans and then, if the problem grows to crisis point, bail out the banks through a vehicle that will take on those loans, as happened at the start of the century? Not healthy. Moral hazard. But that is how China works.

Yes, rising social troubles are evident, from Guangdong to Dalian, but there are signs that the authorities above local level are trying to find new ways of coping with them, as we explored in reports last autumn and earlier this month on Wang Yang’s interesting initiative down south.

Yes, tension is likely to rise between China and the US. President Obama’s fingering of China in his creation of a task force to monitor unfair trade practices has raised the bar a notch following his foray into the Pacific which, as we explained in a note this month note, is likely to run into the problem of China’s economic influence in the region. Realizing it has lost the game (and never quite got the plot) on the currency issue, the Obama administration has switched to a more broadly based China campaign focused on the statist nature of the economy – Tim Geithner told the World Economic Forum last week that this was “a really unique challenge to the global trading system”. What else might one might expect from the last major state ruled by a Communist Party with a history of state power stretching back to the First Emperor 2,300 years ago? No matter. This is Washington’s new line of attack and we are likely to see more of it in an election year (with Romney promising to declare China a currency manipulator on his first day in the White House). Expect a reaction from the Zhongnanhai leadership compound before the first quarter is out.

The world, and Washington in particular, thinks that the country which has gained more from globalization than any other should play by the international rules even if nobody knows how to pursue that forlorn course. Beijing says those rules have been framed by the rich nations, led by the US, in their own interests and that it should be free to pursue its development as it sees fit. If that applies to its foreign dealings, it does so in spades when it comes to the domestic economy. This may lead China into risky territory, as with the credit boom of 2009-10, and involve moral hazard, as with the treatment of local government debts, and increase the clout of the Party state. But that is the way it is and leads to the fundamental point about China.

The country’s economic expansion and its growing influence in the global balance have been the most important world events since the end of the Cold War. But, at base, this is not an economic story. Deng Xiaoping embraced growth through partial market mechanisms not because he had read a Western economic textbook and seen the light. He did so to rebuild his country’s strength from the ruins of Maoism and to ensure that it would continue to be ruled by the Party he had belonged to since his teenage days in France and which he could present as the one force capable of making China great again after a century and a half of decline from the great days of the High Qing. The basic story is one of power and politics, as it always has been in China, and the rest of the world had better understand that in the year of the predominant power symbol.