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MACROECONOMICS 

THE THREAT OF A DECLINING CHINA

macroeconmics china

Many Americans view China’s emergence as the world’s second largest economy with trepidation.  The US, it seems, is in decline. China is a ‘rising power’ destined to take over America’s role as global hegemon sometime in the not-too-distant future.

Recently, however, China’s prospects are looking less rosy.  Since hitting a post-financial crisis high of 11.9% in the first quarter of 2010, Chinese quarterly GDP growth has risen in just two of the subsequent thirteen quarters.  The latest figure of 7.5%, for the second quarter of this year, is down from 7.7% in the first quarter and 7.9% in the last quarter of 2012.

As the Chinese juggernaut starts to lose momentum, should Americans be breathing a collective sigh of relief?  Not really. Unfortunately, China’s decline is likely to be a lot less peaceful than its rise.

A SUSTAINED DECELERATION

Beijing is hoping to keep the economy on track by transitioning to a new ‘growth model’ based on consumption and productivity gains.  Yet so far there is little evidence to suggest that this strategy is working.  Indeed, there is really no reason to believe that such a transition can be achieved under the country’s current political-economic system.

China’s economic model, like the Soviet model on which it is based, is designed to channel national income into state-promoted investment.  In the initial phases of economic development, this strategy can work because it is relatively easy for planning authorities to identify investment projects that make sense on a cost-benefit basis.  Productivity growth is relatively unimportant and a case can be made for postponing consumption for the sake of rapid industrialization.

In China, this “big push” phase could be said to have ended in the late 1990’s, when excess-capacity problems emerged in many sectors that had previously experienced excess demand.  The country had reached a point at which, as then-premier Zhu Rongji told the National People’s Congress in 2001, “further development would be impossible without structural adjustment.”

Yet structural adjustment has proved elusive.  As the Soviets discovered in the 1980s, a productivity renaissance cannot be brought about by fiat.  Nor are government and state enterprise elites going to allow a significant reduction in the state’s share of the national income pie for the sake of stimulating household consumption.  As long as the economy is dominated by the state, switching to a new “mode of growth” is not a real possibility.

China is now facing a sustained deceleration.  In the absence of any other driver, GDP growth is not going to pick up until investment recovers.  But with the return on investment continuing to decline, such a recovery will prove to be short-lived.

DEFENDING THE MOTHERLAND

Slower growth will pose an existential problem for the Chinese Communist Party.  Ever since the end of the Maoist era in 1978, economic development has been the Party’s primary source of legitimacy.  A prolonged slowdown will weaken its hold on power in much the same way that crop failures during imperial times undermined the emperor’s claim to the ‘mandate of heaven’.  If China is not going to be ‘number one’ after all, some other justification for Party rule will be urgently needed.

The Party’s best bet will be to play the nationalist card, making the defense of the ‘motherland’ its primary mission.  This will not be difficult.  It will be easy to blame China’s economic failures on the machinations of foreign powers, even as Mao Zedong did in his famous speech proclaiming the founding of the People’s Republic in 1949.  The fact that China had “fallen behind,” he said, was “due entirely to oppression and exploitation by foreign imperialism and domestic reactionary governments.”

It will also be easy to put the Chinese economy on a war footing.  China’s central planning institutions are actually better suited to the mobilization of resources for defense industries than they are to the management of peacetime economic activity.  A military buildup would also help to alleviate excess capacity problems in heavy industry.  Total excess capacity in the steel sector, for example, already exceeds total US capacity.  Arms manufacturing is likely to be seen as a good way to put idle plants back online.

AN ACE IN THE HOLE

The implications for China’s neighbors are already evident in Beijing’s increasingly bellicose insistence on irredentist territorial claims.  There have been escalating tensions with Japan over the Senkaku Islands, spats in the South China Sea involving areas claimed by Vietnam, and even a Chinese incursion into an Indian-controlled Himalayan region claimed by both Beijing and New Delhi.

Such incidents are often described as competitions for the control of natural resources such as the South China Sea’s oil and natural gas.  They are, however, better understood as consequences of the Party’s domestic agenda.  And as public relations exercises they have been remarkably successful.  Chinese anti-Japanese sentiment is now at fever pitch, with many of China’s netizens expressing strident support for military action against Japan to recover lost territories, right historical wrongs, and avenge past humiliations.

US policy makers need to realize that this type of nationalist sentiment is going to be the Party’s ace in the hole once the economy slows.  Beijing can therefore be expected to prefer that international disputes remain unresolved.  Its objective will be to keep the Chinese public distracted by possible foreign threats to China’s national security and economic development.

China, not the US, is fated to be the ‘declining power’ for the remainder of this decade.  This means that Washington’s preferred policy of ‘engagement’ will not work.  Beijing will be unable to give ground in disputes with its neighbors because doing so will weaken the Party domestically. Events like last June’s summit between President Obama and General Secretary Xi Jinping are not going to improve US-China relations when the Party’s survival depends on escalating tensions.

Given that dialogue is likely to be ineffective, the US must focus instead on defending its strategic interests in the Pacific. It must continue to strengthen ties with its regional partners, particularly Japan and Taiwan, which are likely to be the main targets of Chinese military adventurism. Most importantly, the US must avoid helping the Party stifle demands for political reforms at home by handing it easy victories abroad.

Mark A. DeWeaver