Why is China's Economic Rate of Growth Slowing?

1 Christopher Peer 02/15/2016 Why is China’s economic rate of growth slowing? Introduction “The Chinese economy grew at it’s slowest pace in a quarter century last year and there is now no question that the debt-fueled, investment-lead, growth model that has driven it for so long has reached the end of its useful life”, stated Jamil Anderlini – Asia Editor for the Financial Times – in January 2016.1 The numbers don’t lie; as of 2015, China’s rate of economic growth sank to a low of 6.9% from 7.3% in 2014.2 After thirty years of near double-digit growth, China’s economy is slowing down. To answer the question “Why is China’s economic rate of growth slowing?”, I will examine issues within China’s economic and political institutions as well as how it’s demographic profile are contributing to a slowing rate of economic growth. To best answer this question, I will compare the perspectives of some of the world's leading experts on Chinese economics, politics and demographics during my literature review. Through investigating currency, labor, real-estate, political and demographic issues that are contributing to a slowing rate of economic growth on a case-by-case basis, I will identify competing narratives to be considered in the ‘theory’ section of my paper. It is my contention that ineffective policies implemented by –and political issues within– the CCP (Chinese Communist Party) are causal to China’s declining rate of economic growth. In the analysis section, as outlined in my research design section, I will be assessing case studies for CCP policies respective to each subtopic (currency, labor, real-estate, issues and demographics). 1 See Wildau et. al., 2016 2 See “GDP Growth” World Bank, 2016 2 Finally, in the conclusion section I will discuss policy prescriptions, alternative approaches to my research question, and questions for further research such as: “What are the implications of a slowing Chinese economy?” Being the most populous country on the planet with the second largest economy, China represents both the biggest economic competitor and partner to the United States on the world stage. This mutually held policy of interdependence means that an economic slowdown in one may well influence a slowdown in the other. At the same time, many developing and rising middle-income nations which have fed China’s vast demand for resources such as South Africa, Brazil and Venezuela have been wrought with inflation and food crises.3 The implications of these phenomena are indeed frightening and highlight the importance of China’s economy to the global financial system. Thus, a comprehensive answer to the question “Why is China’s economic rate of growth slowing” will inform economists and policymakers as they prepare for a future in which China rivals the United States in terms of international power and influence. Literature Review China’s path to economic ascendancy, a half-century in the making, has been at the same time impressively unique and periodically unstable. Begun during the Mao era of intense industrialization and rural collectivization, China’s GDP grew at a breakneck pace until leveling off in the 1970s. Since its inception, Communist China’s “planned economy” has been characterized by total state control - a policy that, after the death of Mao, seemed to be faltering.4 In lieu of economic reforms brought about by the “opening up” of China under Deng Xiaoping, the nation was able to supercharge economic growth through direct foreign 3 See Swanson et. al., 2016 4 See Calabrese, John 2015 3 investment by privatizing heavy industry in special economic zones. 5 In the past few decades, China has also begun selectively adopting capitalist practices - the first of which were based on the successes of its neighbor and economic competitor: Japan.6 Nevertheless, In 2010 China’s economy surpassed Japan’s as the second largest in the world behind only that of the United States.7 The Communist Party still retains significant control over the banking, industrial, and agricultural sectors today. Meanwhile, heavy industry remains at the center of China’s economic model and the nation very much remains the “factory of the world” – fueled by cheap labor.8 As of July 2015, the rate of China’s economic growth began slowing down. Per capita GDP had bottomed out at 6.9 percent – its lowest point in twenty-five years.9 Chinese leaders have begun to realize that the nation cannot stimulate the same level of growth as it once did with an economic model based primarily on the export of cheap goods and labor. Per-capita GDP has risen over the past three decades of steady, near-double-digit growth, which in turn has caused a rise in wages; labor is getting more expensive.10 At the same time, the Chinese middle class is growing; fueling a large portion of the demand for goods and services that the nation's own industry is now working to meet.11 Thus, experts are in agreement that if China maintains its current economic model, the nation faces economic stagnation. Restructuring the current economic model to jumpstart economic growth necessitates reform to China’s current policy of 5 See Ebsco 6 Ibid. Calabrese, 2015 7 See Barboza, David 2011 8 Ibid. Ebsco, Ibid. Calabrese, 2015 9 See "China's Economy Grew” Reuters, 2015 10 See Connet, Wendy 2014 11 See "The Great Fall of China" The Economist, 2015 4 tight state control and self-investment.12 In other words, Communist Party leaders must take steps to convert China’s economy to a more genuinely market-oriented model. As of Fall 2015, China’s tentative transition from a manufacture-based, command economy to an international, market-oriented economy has been mired by a steep decline in growth. However, scholars and experts disagree on precisely what factors are hindering this transition. According to the analysis of financial experts at sources like Bloomberg, Thomson-Reuters, and The Economist, China needs to more effectively manage the value of its currency, labor outsourcing to Asia, and real estate debt to revitalize its economy. Others, such as Nargiza Salidjanova; Senior Policy Analyst on Economics and Trade at the U.S.-China Economic and Security Review Commission, believe that a pathological fear of failure and instability within the Chinese Communist Party is to blame for its reticence in implementing reforms that could jumpstart economic growth.13 Meanwhile, Feng Wang of the Brookings Institution and John Parker of the Economist maintain that longstanding demographic issues are catching up with China, slowing the rate of economic growth.14 Below, I review these competing theories by concept in respective subsections to learn which one is the primary cause of China’s decline in economic growth. Currency Issues While the world's reserve currencies (the U.S. Dollar, the Euro, etc.) are floating in value, the Chinese government has tightly regulated both the value and the international use of its currency, the Renminbi. Subsequently, while capitalist economies are exposed to the boom and bust of the free market, China’s is more or less walled off. Instead, the Chinese Government 12 Ibid. Calabrese, 2015 13 See Salidjanova, Nargiza 2015 14 See Parker, John 2012, See Wang, Feng 2012 5 continually adjusts the value of the Renminbi to keep the price of exports artificially low.15 Thus, American politicians and corporate leaders alike have repeatedly called for the Obama Administration to label China a “currency manipulator” and implement higher tariffs on Chinese goods.16 In July 2015, the Chinese economy had hit an all time low - exports were down 8.3% from the previous year. On August 24th, the Chinese government responded by sharply devaluing the renminbi in what the Public Bank of China claimed was as a one-off maneuver to realign its currency with the principles of supply and demand.17 Essentially, China was attempting to sell the move as market-oriented reform. Nevertheless, investors panicked worldwide as the Dow Jones Industrial Average fell more than 1000 points. With $5 trillion wiped off global equity markets - the most precipitous drop in the DOW since 2010 - even the Chinese state media has referred to it as “Black Monday.”18 Western economists are largely in consensus that China’s motives were primarily to “deter capital outflows” and “make a case for official reserve currency at the International Monetary Fund.”19 Was the devaluation in the spirit of genuine market-oriented reform? Furthermore, is China’s currency manipulation ultimately hindering economic growth? Experts are in disagreement. According to Liu Li-Gang, chief economist at ANZ in Hong Kong, China’s sudden policy move in August was mostly “a reaction to a significant weakening of export numbers in July and rising deflation risk.”20 Indeed, China needed to remedy sagging exports and devaluing 15 See Li, Fiona 2016 16 Ibid. Li, 2015, See Owens, Bill 2015 17 See "China Rattles Markets" Bloomberg 2015 18 See Hayes, Adam F., 2015, Ibid. "The Great Fall” 19 Ibid. “China Rattles Markets” 20 Ibid. "The Great Fall” 6 the Renminbi has been China’s go-to tactic for years. Devaluing the state currency lowers the price of Chinese goods for international consumers and, in effect, increases exports. Many investors see this as the start of a desperate, long-term strategy designed to remedy a faltering economy, rather than a case of free-market reform.21 Others argue that China’s policy move is not so short sighted; that it is in line with the fundamentals of free-market reform.22 While China’s decision to devalue its currency was derided by investors and politicians, it was lauded by the IMF, which, as of November 2015, elected to accept the Renminbi among the reserve currencies in its Special Drawing Rights (SDR) Basket.23 Indeed, SDR status is no small feat, as it could trigger a $1 trillion worldwide switch into Chinese assets over the next several years. The Renminbi is set to join the IMF’s other reserve currencies to be used in the disbursement and repayment of international bailouts.24 This achievement, long sought by the Chinese Communist party, begins to paint a picture of the nation’s economic grand strategy. Xi Jinping, President of the CCP realizes the necessity of reducing government control on the financial system to revitalize the Chinese economy. He argues that China can no longer sustain its growth under an industrial, command economy and that it must support exporters by boosting the role of market pricing. Rather than being regulated by the Public Bank of China, “the yuan exchange rate will be more market-oriented going forward… Volatility of both the onshore and offshore rates will pick up significantly,” writes economist Zhou Hao, of Commerzbank in Singapore.25 However, China’s currency is still not widely used: only about 3 percent of global payments are made in yuan, while China accounts for over 10 percent of world 21 See Lee, Jason 2015 22 Ibid. Lee 23 Ibid. Ebsco 24 See Bradsher, Keith 2015 25Ibid. “China Rattles Markets” 7 trade.26 According to Bloomberg economists, the renminbi’s inclusion among the IMF’s reserve currencies will increase the popularity of the currency and accelerate reforms. This process - the long-term injection of the renminbi into the economy - is referred to as “internationalization,” and it includes a political dimension as well. Internationalization means that China will be actively promoting the use of its currency worldwide, challenging the hegemony of the US dollar. The logic is simple: a more widely used currency means greater authority in setting the price of commodities.27 China’s grand-strategy of internationalization is not without flaw; there are inherent risks in seeking currency convertibility. The first is that the Chinese economy may fall victim to the volatility of the open market and lose momentum.28 Tom Orlik, chief Asia economist at Bloomberg Intelligence warns that in devaluing its currency, China must “balance the need to boost exports against the risk of capital outflows.”29 Secondly, currency devaluation cannot be used as a long-term tactic: As consumer demand rises following currency devaluation, so do prices. Over time, increasing demand negates the effect of the devaluation.30 Furthermore, China could incite a “currency war” as rival exporters competitively devalue their currencies in a so-called “race to the bottom.”31 In regards to China’s currency devaluation in August, Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia commented: “It’s hard to believe this will be a one-off adjustment... In a weak global economy, it will take a lot more than a 1.9 percent devaluation to jump-start sagging 26 See "Trade Profiles." World Trade Organization 27 Ibid. Lee 28 Ibid. Li 29 Ibid. “China Rattles Markets” 30 Ibid. Hayes 31 Ibid. “China Rattles Markets” 8 Chinese exports… a race to the bottom just became a good deal more treacherous.”32 Indeed, Roach’s comments put the issue at hand squarely into perspective: China’s arbitrary currency re-valuation is part of an ambitious, long-term strategy of internationalization that may, nevertheless, be undermining China’s economic growth in the near term. Labor Outsourcing Over the past few decades, “Factory Asia” has been at the center of gravity for world industry. China has established primacy amongst East Asian manufacturing giants - accounting for half of Asia’s gross domestic product today.33 However, as China establishes itself economically, workers are beginning to demand higher wages. With average wages rising at a rate of 12% a year, Chinese companies are being forced to outsource industry to other developing economies in order to optimize profit margins.34 As large portions of North American industry were once outsourced to mainland China in the 1990s, Chinese industries must now follow suit. This presents another possible variable contributing to China’s declining rate of economic growth; if high-end manufacturing and services sectors are growing at a slower pace than China’s outsourcing of labor, the deficit could lead to capital outflows. While it is not inaccurate to say that China is graduating from an economic-model based overwhelmingly on low-end manufacturing, it certainly has yet to earn its diploma. In fact, it may not entirely want to. Manufacturing goods in China is still far cheaper than in most developed - and developing - countries.35 It all comes down to efficiency. Though China has begun outsourcing certain low end-sectors (such as textile manufacturing) to its neighbors in 32 Ibid. 33 See "A Tightening Grip." The Economist. 2015 34 Ibid. 35 See Loyalka, Michelle Dammon 2012 9 Southeast Asia, it’s co-habitants may not be up to the task. According to The Economist, labor productivity increased by 11% a year in China from 2007 to 2012, compared with 8% in Thailand and 7% in Indonesia.36 Inferior infrastructure, lower education levels per-capita, and high tariffs make production in Southeast Asia more costly than in China. Furthermore, manufacturing in China requires less and less manpower due to increased automation. According to the International Federation of Robotics, China was the largest market for robotics in 2013.37 Foxconn, a major Taiwanese Corporation in China, has set a goal of 70% assembly line robotics by 2018.38 Thus, we begin to see how China is developing the capability to manufacture high-end goods for its burgeoning middle-class consumer base. Mainland China’s tax breaks and cheap land have proven to be a boon for foreign investors. A huge labor pool, excellent transport links, and reliable inputs ensure China’s continuing appeal for large, international corporations for years to come. To counteract rising labor costs and to keep manufacturing within its borders, China has been known to periodically relocate factories to poorer areas. Over the years, Foxconn has shifted its heavy industry from the present-day megacities of Hong Kong and Shenzhen to rural, working class areas such as Henan, Sichuan, and Guiyang. The result? Textile production has actually increased since 2012 despite significant outsourcing to Southeast Asia.39 Summarily, it is safe to say that China will remain the world’s preeminent producer of “things” in the foreseeable future. Though China has achieved tremendous growth under an industrial command-economy, certain phenomenon within the labor pool threaten to undermine its longevity. China’s working- 36 Ibid. "A Tightening Grip." 37 See “IFR” 38 See Kan, Michael 2015 39 Ibid. "A Tightening Grip." 10 age population peaked in 2012, surpassing the global median of 29.7 years. Meanwhile, rural migration to the urban centers is slowing. With an aging population and waning urbanization, China is experiencing what Dr. John Calabrese of the Middle East Institute calls “a fundamental mismatch between economic growth and demographic profile.”40 Furthermore, the attitude of the modern Chinese worker is much different than that of one in the days of Mao and Deng. “Expectations have risen along with incomes,” writes the Economist, “fewer young Chinese are willing to endure the same drudgery their parents did… Chinese workers are increasingly vocal about their rights”41 This sentiment is evidenced by recent strikes and disputes at the Nike, Adidas, IBM and Nokia factories in 2014 and 2015.42 It is in light of these events that Chinese Communist Party leaders prepare for the inevitable. With average hourly wages at $27.50, low-end Chinese industry will have trouble competing with the likes of Indonesia and Vietnam’s average hourly wages of $8.60 and $6.70 respectively –but it doesn’t have to. 43 The relatively young populations of Southeast Asia will be able to pick up China’s leftover low-end industrialization.44 As Chinese consumption rises, immediate cross-border trade access and agreements will constitute an economic and geo-strategic advantage –not only for China– but for factory Asia at large. Nevertheless, China’s ability to effectively manage labor outsourcing in the near term while transitioning to a free-market economy will prove critical to ensuring future economic growth. Real Estate Excess & Subsequent Debt “The U.S. currently has 12 cities with over 1 million people,” explains Dr. Jonathan 40 Ibid. Calabrese 41 Ibid. "A Tightening Grip." 42 See Ruwitch, John, and Alexandra Harney 2014, See "China Workers” Bloomberg 2014 43 Ibid. "A Tightening Grip." 44 Ibid. 11 Pollack of The Brookings Institution, “Today, China has 260.”45 Since the 1980s Chinese society has undergone a change that can only be described as evolutionary. Through intensive, state-sponsored urbanization efforts, China has relocated much of its citizenry from the countryside to burgeoning metropolitan areas.46 Impressively, this policy of “fighting poverty through urbanization” has, over the last thirty years, “moved more people out of poverty than any other country on earth.”47 Nevertheless, this surge in property development has in many ways gone too far. Development has continued at a steady rate while urbanization has slowed; much developed property remains vacant. Hence, a massive real-estate bubble has developed within China’s property market –one that may well be stifling economic growth. In 2008, China kicked it’s development and urbanization policy into overdrive by initiating an infrastructure-building stimulus to sustain economic growth during the worldwide recession.48 Jamil Anderlini, Beijing Bureau Chief of the Financial Times explains: “when the crisis hit and the economy went into freefall, Beijing decided it had no choice but to refill the property bubble with a tidal wave of credit.”49 The construction boom that followed was nothing short of unprecedented, “in just two years – 2011 and 2012 – China produced more cement than the US did in the entire 20th century,” and with it, a gargantuan pile of debt.50 With all land owned by the state and foreign investment aplenty, the Chinese government has continued to step up it’s agenda of urbanization in recent years. By 2013, 60 per cent of local government’s 45 See Pollack, Jonathan 2015 46 See Antholis, William J. 2013 47 Ibid. 48 Ibid. 49 See Anderlini, Jamil 2014 50 Ibid. 12 budgetary revenue was comprised of land sales, according to JP Morgan.51 Milton Ezrati, Senior Economist and Market Strategist for Lord, Abbett & Co, writing for the National Interest provides further context: From 2012-2014 “(China) was increasing national floor space at a rate approaching 50 percent a year,” with residential construction comprising an unsustainable 10.4 percent of the country’s GDP.52 Consequently, China has been left with an excessive 30 square meters of floor space per capita (Japan has 22) and the second largest housing bubble in history.53 Indeed, experts have begun to question the sustainability of this construction-centric urbanization strategy, facetiously referred to by western media as “build it and they will come.”54 Rather than expanding existing cities as the population naturally increases, Chinese government contractors (under a Chinese version of eminent domain) are transforming swaths of rural land into entirely new cities –in many cases, years before they can be populated.55 According to Ezrati, existing unsold properties in China amount to a whopping two years of sales.56 The end result is a phenomenon that has baffled China-watchers the world over; enter China’s infamous “Ghost cities.”57 As of November 2015, Chinese officials have approved development plans for the housing of 3.4 billion. Given China’s current population of 1.4 billion, this building project will far exceed China’s needs for years to come.58 With 12 provincial capitals planning 55 new 51 Ibid. 52 See Ezrati, Milton. 53 Ibid. 54 Ibid. Antholis, Ibid. Ezrati, Ibid. Anderlini 55 See Shephard, Wade. “Ghost Cities of China” 2015 56 Ibid. National interest 57 See Shephard, Wade "The Myth of China’s Ghost Cities." 2015 58 See "China Is Still Building Ghost Cities." The Diplomat, 2015 13 districts (12 of which are planned for one province alone) urban development is “out of control,” writes The Diplomat.59 While China intends to populate these new small-scale urban centers gradually, there is little coordination in their development with the development of larger ones. Thus, China’s megacities are continuing to suffer from overcrowding and pollution issues as resources are misappropriated for the development of separate, decidedly non-essential projects.60 Development-incurred debt has also been a cause of serious concern amongst experts. As Anderlini wrote in August 2014 “China’s real estate bubble is showing serious signs of strain… A housing market slowdown is the major near-term macro risk in China.”61 Land and asset price increases since the 2008 stimulus have left the property market vulnerable to price drops. “China has simply built too much,” he concludes.62 In September 2015 Ezrati concurs: An “adjustment to (the real estate bubble) will take years to complete and will inevitably have adverse economic and financial implications.”63 With almost half of outstanding Chinese credit tied up in real estate, he writes: a “significant portion of this total seems likely to default, with some estimating that a fifth of all the real-estate debt will fail in one way or another.”64 However, Ezrati disagrees with the doomsayers: “China can avoid the implosion,” he states; a much needed “adjustment has already begun and ...promises to avoid ...financial collapse.”65 While he cautions against construction cutbacks, warning that they should be managed carefully so as not to harm the economy, Ezrati believes they are possible, pointing to 59 Ibid. 60 Ibid. 61 Ibid. Anderlini, 2014 62 Ibid. 63 Ibid. "China Is Still Building Ghost Cities." 64 Ibid. 65 Ibid. 14 continued economic growth in spite of cutbacks in 2014. The difference was made up for as property prices fell and existing inventory was sold.66 Overall, Ezrati’s position comports with the IMF’s in that China can wean itself off of it’s construction addiction by proceeding along a “gradual, orderly glide path that will permit the overall economy to continue its expansion, if at a less rapid pace than in the past.”67 Kenneth Rapoza, an emerging markets expert for Forbes, believes that the Chinese property market is stabilizing and dismisses comparisons of China’s current situation to the U.S. housing bubble in 2008. “China’s housing market, unlike the bubble market in the U.S., depends on a growing urban migrant community, rising incomes, and cash-rich investors who are required to put down at least 20% or more on a property.”68 China’s financial regulations, he points out, are too stringent to permit the kind of subprime lending and junk mortgage trading that occurred in the U.S. derivatives market prior to 2008. Furthermore, in contrast to the U.S. market, Chinese “state run banks can more readily write off bad debt if non-performing mortgage loans became a problem for the economy.”69 Nevertheless, investors are still hesitant to buy Chinese securities due to prevalent real-estate and debt issues. Moody’s investor service concedes that, while “growth in nationwide property sales will slow,” the Chinese property market is stabilizing for 2016.70 Their outlook for the next fiscal year is similar to that of the IMF, predicting, “that the Chinese government will continue to implement supportive monetary policies and fine tune regulatory measures for the property sector, against the backdrop of a 66 Ibid. 67 See, "IMF Survey” 68 See Rapoza, Kenneth 2015 69 Ibid. 70 See "Moody's: China Property Outlook for 2016 Stable” Moody’s 2015 15 slowing Chinese economy.”71 China’s attempt to ‘build’ its way out of financial ruin and unemployment by funding massive infrastructure development programs has indeed come at a cost. The “borrowing binge” that followed the 2008 recession created a massive debt bubble which, seven years later, has doubled in size to a staggering 28 Trillion RMB–the fastest accumulation of debt by an emerging market in history.72 Nevertheless, experts are in disagreement on whether or not China’s debt represents a threat to the nation and “the global economy” at large or a “manageable byproduct of the boom that created the world’s second largest economy.”73 To some experts, concerns about China’s debt crisis are “overblown.”74 Justin Yifu Lin, former World Bank chief economist, is optimistic: “seemingly dumb investments in infrastructure can become sound investments.”75 China will need this infrastructure in the near future, Lin argued in 2013. Lin and others like him believe that the sheer growth of China’s economy is likely to alleviate the debt incurred by Chinese building companies.76 At the same time, the Chinese have plenty of hard assets in savings. In the absence of social programs provided during the Mao and Deng eras, Chinese citizens (particularly the elite) save 50 to 70 percent of their disposable income.77 Should a systemic default cripple the Chinese economy; there is plenty of hard currency in Chinese coffers to fall back on. In this sense, the system may truly be “too big to fail.”78 71 Ibid. 72 See "Debt and (not Much) Deleveraging." McKinsey & Company 2015 73 See Curran, Enda 2015 74 Ibid. 75 See Davis, Bob 2013 76 Ibid. Curran, 2015 77 See Roberts, Dexter 2015 78 See "Are Chinese Banks Too Big to Fail?" Bloomberg. 2015 16 Critics, on the other hand claim that the Chinese economy may not survive a mass default. The state, they say, needs to make a concerted effort to “tackle nonperforming loans and stave off defaults.”79 Indeed, China’s slowing rate of economic growth is creating a very different kind of market for investors. Former Fitch Ratings analyst Charlene Chu warns that inflation is slowing down along with the economy, making debts harder to repay.80 At the same time, the central Chinese government has attempted to ameliorate outstanding debt owed by local governments by “kicking the can further down the road,” so to speak: Beijing has allowed local and municipal governments to exchange 1 trillion yuan in existing high-interest debts for lower-cost bonds.81 Certainly, most experts agree, this cannot be considered a long-term remedy to China’s debt problem. Even so, there are inherent issues within the Chinese local government system of borrowing. To circumvent the strict budgetary oversight of Beijing, local governments have turned to a practice of off-the-books borrowing known as “shadow banking,” - in some cases to fund questionable real estate and infrastructure projects.82 Practices such as these make it difficult for the central government to correctly assess the debt owed by Chinese municipalities, let alone develop an effective means of top-down debt restructuring. Hence, quantifying the weight of shadow-banking related debt on economic growth is of similar difficulty. Political Issues China is a communist country, whose primary political party –the Chinese Communist Party (CCP)– was founded on Marxist, socialist principles. The institutions and systems through 79 Ibid. Curran, 2015 80 Ibid. 81 See "Defusing a Bomb" The Economist 2015 82 Ibid., Ibid. Curran 17 which the party maintains control, however, are not so monolithic. The “matrix of power in China is far more complex than the essentialized description found in mass media and even in some standard textbooks,” writes Professor Ming Xia of the College of Staten Island's Modern China Studies Group in a reference column for the New York Times.83 A crosshatching of horizontal and vertical lines of power, known as “tiao” and “kuai” respectively, mesh to create China’s complex power structure. To maintain order, Beijing has positioned itself as the final authority in a “democratic centralist,” model. Nevertheless, the degree to which China has democratized its institutions remains dubious at best. Ming points out that, in practice, “centralism without democracy” is probably a more accurate description of the CCP.84 China’s enigmatic president Xi Jinping has outlined what he sees as one of China’s most pressing challenges: Widespread corruption at all levels of the state, corporate, and military sectors.85 While the CCP maintains steadfast control from the top, it’s totalitarian oversight “has created space for autonomy, loopholes for bargaining, and hopes for democratization,” writes Ming.86 Municipal governments often pursue their own agenda, flying under Beijing’s radar to partake in extralegal practices that range from off-the-record patronage agreements to shadow banking. Nargiza Salidjanova, the Senior Policy Analyst on Economics and Trade at the U.S.-China Economic and Security Review Commission believes that corruption is a “huge drag” on the Chinese economy.87 She explains how Xi Jinpeng’s commitment to prosecute both the “tigers and the flies” of corruption (high and low-level officials alike) is needed yet, in some ways, 83 See "China Rises” 84 Ibid. 85 See Li, 2014 86 Ibid. “China Rises” 87 See Salidjanova, Nargiza 2015 18 implausible.88 She explains: For municipal-level government, the patronage system is deeply engrained at the institutional level. While it may leach funds from Chinese coffers, a wholesale abolition of the system –persecuting every individual who has partaken in patronage– could lead to a total collapse of municipal government. Nevertheless, Salidjanova explains, corrupt officials at all levels of government stand in the way of the CCP’s ability to implement liberal reform and reinvigorate the floundering economy.89 Pressures on the CCP to implement liberal reform in all sectors come both from at home and abroad. During Hong Kong’s Umbrella Movement in the Fall of 2014, (an event which I personally witnessed) Hong Kongers filled the streets of Downtown Central to protest reforms implemented by Beijing that they claimed were designed to increase the CCP’s electoral oversight.90 Professor Ming Xia points out that Hong Kong, a special administrative region of China since 1999, “enjoys the highest degree of autonomy of all other provincial units, but its residents are demanding more (liberalization).”91 Indeed, her insight highlights a new reality that the CCP is being forced to come to terms with in which it must “manage a new relationship with the economy, the society, and the global community.”92 Salidjanova portrays these trends as being symptomatic of the failure of government institutions to grow in tandem with China’s rapidly expanding economy and, in effect, social consciousness.93 Professor Ming Xia provides insight on what she believes will be the most significant political issues China will face in the near future. One such observation is that China’s economy 88 Ibid. 89 Ibid. 90 See Stout, Kristie Lu 2015 91 Ibid. “China Rises” 92 Ibid. 93 Ibid. Salidjanova 19 is beginning to “outgrow” the CCPs ability to govern. According to Ming, the question is: whether or not “the current regime... (can) continue to provide political foundation and institutional support to the soaring economy…”94 Furthermore, with an ever-wealthier middle class, the Communist Party will have to implement genuine democratic reforms lest it find itself beset by the sort of public pressure that I witnesses in Hong Kong. Salidjanova warns that the Communist Party’s paranoia of losing control could ultimately prove to be a self-fulfilling prophecy. Strict controls, fear of failure, and fear of instability plague the party ranks – Each political action is calculated in terms preventing instability.95 Nevertheless, as Ming points out, “market forces… civil society... dissident forces in the society, and international standards… are pressuring and inducing the Chinese government to make more changes.”96 Demographics Today, China’s population is old, predominantly male, and –despite economic leaps and bounds– still disproportionately poor and undereducated. According to Feng Wang of the Brookings Institution, “China is already an aging society.” It’s replacement level, (based on the ratio of births to deaths) is 1.4, well below the developed-world average of 1.7, leaving China demographically on par with most developing countries.97 This youth deficit can, in large part, be attributed to China’s infamous one child policy adopted in the 1970s.98 Meanwhile, per capita purchasing power is about a fifth of most developed countries; China’s economic growth has yet to benefit a majority of it’s rural population on the fringes of society.99 As John Parker, 94 Ibid. “China Rises” 95 Ibid. Salidjanova 96 Ibid. “China Rises” 97 See Wang, Feng, 2012 98 See Zraick, Karen, 2015 99 Ibid. Wang, 2012 20 Globalization editor at The Economist wrote in 2012: “It seems highly unlikely that China will be able to grow its way economically out of its population problems… Instead, those problems will weigh down its (economic) growth rate”.100 He concludes that the structure of China’s demography represents it’s “Achilles heel”.101 From 1980 to 2010, China’s predominantly “young” age structure accounted for between 15% and 25% of per-capita GDP growth. Today, with a lower replacement level, China’s economy has begun to falter. Dr. Wang argues that this is significantly attributable to a lack of young workers. As Dr. Wang points out: “China’s economic and political governance model is premised on near double-digit growth” – a rate of growth sustained by, one might add, a favorable supply of low-income, working-age citizens. Therefore, thorough institutional change will need to be implemented, with new policies drawn up to accommodate China’s “older” demographic profile.102 Savings is the most significant source of capital investment in China. For various historical and social reasons, many Chinese put a significant amount of their earnings away in savings –particularly those over fifty.103 Meanwhile, younger generations of Chinese are increasingly exposed to the influence of consumer culture both abroad and at home. As this cohort of “senior savers” moves increasingly into retirement, China is experiencing a drastic social and cultural change. As China’s per capita GDP rose over the past thirty years, younger Chinese have become less willing to endure long hours of assembly-line work than their 100 See "China's Achilles Heel." The Economist, 2012 101 Ibid. 102 Ibid. 103 Ibid. 21 forbearers.104 Thus, China needs to transition from a manufacture-based economy to a more consumer-centric economy –essentially out of necessity– to match its changing demographic profile and resume economic growth. Theory It is my contention that the Chinese Communist Party has pursued policies that have directly and indirectly contributed to a slowing rate of economic growth. Furthermore, policies enacted by the CCP serve primarily to keep the party in power, rather than to promote Chinese economic growth. For the CCP, maintaining control over the economy and the population is more important than implementing forward-thinking, free-market reforms. This theory builds off of Nargiza Salidjanova’s position that short-sighted policies pursued by the CCP undermine China’s potential for economic growth.105 As she states, “Strict controls, fear of failure, and fear of instability” have lead the CCP to micromanage China’s economy under a faulty economic model that provides for such interference.106 My research indicates that state micromanagement of the economy under the pretenses of maintaining power, in conjunction with rampant and systemic corruption, are exacerbating China’s slowing rate of economic growth. Thus, I theorize that political issues lie at the center of China’s issue of declining economic growth. Research Design According to my theory, the variables: currency issues, labor outsourcing, real-estate excess and demographic issues are ‘symptomatic of’ rather than ‘causal to’ China’s slowing rate of economic growth. Causality, I contend, is attributable to political issues, denoting misguided policies issued by –and corruption within– the Chinese Communist Party. To test this theory, I 104 Ibid. Roberts, 2015 105 Ibid. Salidjanova 106 Ibid. 22 will analyze how the Communist Party has influenced China’s economic rate of growth over the past thirty years through policy directives on currency, labor, debt, and demographics. Case studies are discussed using a variety of primary and secondary sources in respective subsections below. In effect, I will be analyzing the relationship between my independent variable: “political issues” and my dependent variable: “slowing economic rate of growth”, to approach the question: “Why is China’s economic rate of growth slowing?” Analysis CCP Policies on Currency The Chinese Communist Party (CCP) has been reluctant in implementing true, market-oriented, reforms out of fear that increased market volatility may harm economic growth. “China wants its currency and its markets to break into (world markets), but not if that comes at the expense of growth, which it equates with social stability,” writes Matt O'Brien, former senior associate editor at The Atlantic.107 Therefore, the CCP has chosen to manipulate the value of the Renminbi in response to varying market conditions. However, this strategy has ultimately proven to be counterintuitive; Beijing’s moves following the stock bubble bursting in July –particularly its sudden devaluation of the Renminbi for the purpose of stemming capital outflows– have significantly undermined confidence amongst foreign investors.108 In the Spring of 2016, Chinese sovereign credit ratings have dropped precipitously as investor services re-evaluate their outlook on Chinese government-backed securities.109 Moody’s investor service, which changed it’s Aa3 Chinese government bond rating to a negative outlook in March 2016 has stated that “…a continuing fall in reserve buffers due to capital outflows …and uncertainty about the 107 See O'Brien, Matt 2015 108 Ibid. 109 See, Tan, KimEng et. al., 2016 23 authorities' capacity to implement reforms… highlight currency and growth risks.”110 As such, the close relationship between China’s political troubles and currency issues are best illustrated by the Communist Party’s continued manipulation of the value of the Renminbi. In July of 2015, the Chinese stock-market bubble popped. While many factors contributed to the bubble, it is perhaps sufficient to say that the Chinese fledgling stock market was simply not prepared to withstand the tumult of a bear market.111 With it’s largely unsophisticated investor base (65% do not have a high school education), the bull market growth leading up to the bubble was of a highly unstable nature.112 Yet, it is the manor in which the Chinese government handled this downturn which constitutes a worthwhile case study in how a paranoid Chinese politics has caused currency issues with the renminbi. The harsh manor in which the CCP dealt with the stock market crash of 2015 drew negative attention from investors and politicians alike. “Look at how Beijing reacted when the country's stock bubble burst”113, wrote O’Brien in August, “It didn't sit back and let the market run its course. It suspended the majority of shares, forced companies to buy their own, threatened to throw people into jail for selling theirs, and printed money to purchase even more with.”114 These types of actions portray a government that is only willing to implement reforms insofar as whether or not said reforms serve its own interest. In O’Brien’s words, “All (the CCP) cared about was getting stocks to stop their vertical descent… China's commitment to market-based reform is only as strong as its growth”.115 If, however, they are not in alignment “the Party will 110 See "Moody's Changes Outlook” Moody’s 2016 111 See Schell, Orville 2015 112 Ibid. 113 Ibid. O’brien, 2015 114 Ibid. 115 Ibid. 24 choose short-term growth every time.”116 Hence, we begin to see how the Communist Party’s micromanagement of economic affairs is diminishing confidence in it’s investor base and, by implication, undermining it’s potential for future economic growth. CCP Policies on Labor China’s high rate of economic growth over the past few decades has contributed to increased wages in Asia’s “factory of the world.” Subsequently, Chinese manufacturers are being induced to outsource labor to Southeast Asia. If tentative trade agreements are successful, the gradual dispersion of manufacturing could benefit the entire region as a whole. Nevertheless, this process of regional consolidation hinges upon China’s willingness to make necessary market-oriented reforms that would allow its goods-and services sector to flourish. A revised economic model, based on consumerism rather than industry, would provide China’s middle-class with fresh capital and a stable economy in which to spend it. The end result: An increasing per-capita GDP and stable Chinese economy. Today, China’s economy is still highly centered around exports and minimum wage labor; as of 2011, low-end manufacturing jobs still account for almost a third of labor productivity on mainland China.117 It seems that the Chinese economic and political complex, through practices such as strategic relocation and tax exception, want to keep low-end manufacturing within China’s borders for as long as possible. After all, China’s export driven economic model thus far has proven to be an effective means of creating short term economic growth – and lots of it. On the other hand, many experts maintain that, given the current and projected growth of China’s middle class, the nation cannot sustain high levels of economic 116 Ibid. 117 See “EMPLOYMENT IN INDUSTRY” 25 growth if it does not implement reforms and switch to a goods and services based economic model. Can China make this transition and effectively launch its economy into the next stage of development or will it opt for shortsighted means of sustaining growth by focusing on the maintenance of it’s unsophisticated low-end manufacturing base? The CCP has no easy task. Though it seems that private enterprise related issues are beyond the CCPs ability to control, the truth is that reforms enacted from the top down can and will dictate whether or not this complex web of variables plays into China’s favor – especially given the CCP’s authoritative track record. Therefore, the revival and sustainment of China’s economic growth depends on whether or not it can make reforms towards a goods and services based economy. If the Chinese government fails to enact reforms and transition effectively to a market-based economic model, the ensuing plateau in growth could lead to a loss of confidence in the CCP. Social instability could ensue as low-end manufacturing is outsourced to Southeast Asian nations that are rapidly industrializing. With a deficit of labor in an economy caught halfway between export-centrism and consumer centrism, China’s economy would stagnate and fail. Thus we begin to see how the transformation of the Chinese working class society moves toward a middle-class consumer base and the overall success of the economy is predicated upon market-oriented reforms. CCP Policies on Real-Estate Debt After the failure of Mao Zedong’s “Great leap forward”, Deng Xiaopeng initiated a process of fighting poverty through urbanization that would continue into the twenty first century. This practice, while hugely effectively, was compounded following the financial crisis 26 of 2008 as China attempted to “build its way” out of the recession. Nearly a decade later, a massive debt bubble has developed in the Chinese real-estate market. With such a high concentration of resources in property development the risk of mass default has reached an all time high.118 Recently, investor services such as Moody’s and S&P have adjusted their outlooks on Chinese investments to negative – partly as a response to the way the CCP handled the stock market bubble over the summer.119 In the near term, China’s looming debt bubble and downgraded outlooks have undermined confidence amongst investors. However, there are some who hold a more optimistic view of China’s property investment. Wade Shephard, an ethnographic journalist for Thomson-Reuters provides valuable sociological insight into the phenomenon of China’s overbuilding in his book: “Ghost Cities of China: The Story of Cities without People in the World's Most Populated Country (Asian Arguments)” published in May 2015.120 In it, Shephard maintains that China “isn't just creating new urban areas, but also engineering a new culture and way of life.”121 In this sense, China’s construction buildup serves to rapidly stimulate the economy while gradually urbanizing on a massive scale. According to Shephard, these strategies intersect as “the shedding of traditional social structures in the country is at an advanced stage, and a rootless, consumption-centric globalized culture” takes its place.122 Shepherd explores China’s ghost cities first hand, for months traveling by bicycle, often sleeping in a tent (hotels had largely been built but not yet occupied). He investigates the city of Yujiapu, one of China’s “knockoff” cities, which amongst others, is in developmental limbo due 118 See “Bubble Definition | Investopedia." 119 See "Moody's Changes Outlook” Moody’s, 2015 120 See Shepard, Wade 2015 121 Ibid. 122 Ibid. 27 to a shortage of foreign investment.123 China’s “future financial capital of the world,” Yujiapu was designed in the likeness of New York City’s Manhattan –replete with a beam for beam replica of Rockefeller center and a curiously familiar set of “twin” towers and sort of Empire State building/1-WTC hybrid dominating the skyline. This ghost city is not alone; China has also imitated a dozen European cities, including Paris (354-foot Eiffel Tower included), a canaled Italian “Florentia Village”, and a near-exact copy of Switzerland's Interlaken. 124 Failure to populate, or even complete most of these cities due to lack of investment and exorbitant debt is, Shephard believes, an unanticipated yet temporary stage of development.125 Citing a report by Standard Chartered he posits, “it generally takes at least a decade for China’s new urban developments to start breaking the inertia of stagnation. But once they do, they tend to keep growing… blending in with the broader urban landscape and losing their “ghost city” label.”126 To Shephard, China’s Ghost cities are not wasteful travesties of a misguided state initiative; they are “Seeds of Modernity” in a civilization still wrought with the underpinnings of a developing-world society.127 If Shephard is correct and the building-spree was not so shortsighted as some have been lead to believe, the Chinese government cannot be faulted for it’s policy moves –even if they have lead to a short-term decline in economic growth. Nevertheless, Shephard’s sentiments fall mostly on deaf ears. Politicians and pundits - many of whom regurgitate the same pessimistic tropes about a failing Chinese Economy – have pointed to China’s Ghost cities as an obvious symptom of a failed economic model that knows no bounds. One must surmise that these sentiments are, to some extent, the result of a partisan 123 Ibid. 124 See Hoeller, Sophie-Claire 2015 125 See Shephard, Wade 2015 126 Ibid. Hoeller 127 Ibid. Shephard 28 agenda or underlying prejudice. Nevertheless, it is hard to imagine how China will be able to turn a profit on it’s investment given it’s demographic dilemma (discussed in detain in the next section). Still, the debt-bubble that has resulted from China’s over-building could weigh down economic growth in the foreseeable future. With a falling rate of population and economic growth, the likelihood that China’s ghost cities will be occupied by wealthy tenants seems all the less likely. CCP Policies on Demographics The repeal of China’s infamous one-child policy in October 2015 marked the end of one of the most draconian manipulations of a nation’s demographic profile by it’s respective government in modern history. Nevertheless, with an increasingly precarious demographic profile, there are indications that Beijing’s policy liberalization arrives – as prominent China commentator Gordon G. Chang puts it – “too little, too late”. Since its inception, the one-child policy has derailed the birthrate such that China’s replacement level (a statistic that measures the ratio of births to deaths over time) has declined precipitously. This phenomenon was compounded by a cultural preference among Chinese for boys – leading to the abortion and abandonment of many baby girls. Thus, China currently faces what John Calabrese terms a “a fundamental mismatch between economic growth and demographic profile,” that will, according to economist John Parker, “weigh down it’s growth rate” over time. The effects of the one child policy are, it seems, irreversible. China’s working age population is already on the decline and demographers estimate that it’s gross population will peak in 2026. “China now probably faces a long period of ultra-low fertility, regardless of what 29 happens to its one-child policy,” concludes The Economist.128 Thus, by invoking the one-child policy in 1978, the CCP may have condemned China to “growing old before it grows rich.” A surplus of seniors will draw pension before China has even had the chance to adequately develop a cohesive social security system. Meanwhile, the labor pool will run dry, threatening economic stagnation and a further decline in economic growth.129 “Frightened by the demographic trends they themselves created, Chinese leaders have progressively relaxed the policy over time”, conceded Chang. However, he believes that the party has more or less sealed China’s fate; that Beijing’s recent policy adjustment is not sufficient to assuage the looming crises manifest in the demographic dividend: “Demography may not be destiny, but population trends define the realm of the possible and are, especially in China’s case, unforgiving.”130 Conclusion China’s rate of economic growth can be seen as the “pulse” of the “BRICS” nations (Brazil, Russia, India, China and South Africa). Low and middle-income nations across Africa, the Middle-East, Asia, and South America have maintained extensive trade relations with the “factory of the world”, feeding the flames of it’s industrial furnaces. These same countries have opened their doors to foreign investment from China to develop their own fledgling economies and have thus become heavily reliant on China’s continued economic progress. To be sure, China’s recent decline in economic growth has sent shockwaves through these fragile emerging markets. Nevertheless, China’s economic downturn also threatens the United States’ economy; China being the number one international holder of US treasury bonds. The notion of the US being held “hostage” through securities holdings to an economically unstable China becomes all 128 Ibid. "China's Achilles Heel." 129 Ibid. 130 See Chang, Gordon C., 2015 30 the more foreboding. Thus, China must rebalance and stabilize its economic rate of growth – not only for itself – but for the world economy as well. While the theory of cyclic economic growth dictates that China’s expansion necessarily end at some point, the sheer abruptness of the recent downturn –compounded by increasingly apparent political and social uncertainties– suggest that other factors are at play. After reviewing the relevant literature, I hypothesized that political factors involving namely the Chinese Communist Party (CCP) have contributed to this precipitous decline. Through the analysis of four cases I explained how short-sighted and ineffective policies calculated by the CCP primarily in terms of maintaining control over the population and keeping the party in power –rather than in the interest of the people which it claims to represent– have exacerbated China’s declining rate of economic growth: A case study of the CCP’s reactions following the 2015 Shanghai Stock Market Crash illustrate just how little tolerance the CCP has for the kind of volatility commensurate with a fully formed stock market. Actions by the communist party in the weeks that followed the crash undermined the confidence of international investors, further damaging prospects of future economic growth. Next, I explain how incipient labor shortages caused by China’s socio-economic and demographic profiles are inducing the CCP to develop the nation’s goods and services sectors. The CCP’s policy of strategically relocating industry and providing tax-breaks to manufacturers indicate a resistance to these trends – a shortsighted maneuver that will surely slow China’s economic growth in the long run. Thirdly, a case-study of China’s “Ghost Cities” provides unique and invaluable insight on China’s seemingly foolish investment strategy that may or may not pay off in the future, should economic growth continue to decline. With a 31 looming debt bubble that poses the risk of mass default, China’s economy could implode altogether thanks to the CCP’s ill-conceived stimulus policy initiated in 2009. Finally, a case study of the One-Child Policy reveals that the CCP may well have predetermined China’s demographic destiny for the better half of the century. Indeed, working-aged labor supply is the life’s blood of any economy – particularly in the “factory of the world”. Therefore, it can only be expected that China’s rising median age will share an inverse relationship with it’s falling economic rate of growth. In accusing the Chinese Government of abetting China’s economic downturn – implicating the CCP as the “primary” catalyst – one risks sounding ignorant of the world economy’s interconnected nature. To be sure, the Chinese Economy (or any economy for that matter) does not exist in a vacuum; factors at the systemic and global levels of economics and politics have surely influenced China’s economic rate of growth to some extent. That being said, one possible question for further research would be: How have economic factors at the systemic and global levels contributed to China’s declining rate of growth? This begs another question for interesting research, given the interdependence of developing economies on that of China; How is China’s economic decline affecting the economies of other nations? Questions alluded to during this research are of, perhaps, more immediate concern. For example; though China currently faces the challenge of implementing market oriented reforms to rebalance its economy towards the development of goods and services, precisely what types of reforms need to be made? Which policies would be best suited for China’s unique situation? Politically, China’s unprecedented amalgam of plutocratic communism and authoritarian democracy makes it a somewhat sui-generous case – an experiment in a plurality of traditionally 32 opposed theories and concepts. Can the CCP reconcile its self-aggrandizing policy platform with societal and economic realities that are slowly but surely stymying China’s economic growth? Only time will tell. In the foreseeable future, China’s economic rate of growth will probably continue to decline – the question is: When will it plateau? As the Communist Party deepens its institutions and vanquishes corruption from within it’s ranks, one would hope that reforms decrease CCP oversight over the economy rather than tighten it. However, history shows us otherwise; the CCP has always placed a premium on “control” over all aspects of Chinese life – particularly the nation’s economy. While conventional wisdom tells us that volatility yields growth, the CCP is hesitant to permit virtually any within it’s fledgling stock market. To break into world markets and internationalize the renminbi, the CCP must liberalize the Chinese economy and diverge from their sole strategy thus far of flooding the market with cheap goods. 33 Works Cited - Calabrese, John. "U.S. - China Relations." 4000 BRANDYWINE STREET NW 20016, Washington, D.C. 28 Oct. 2015. 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