China's Economic Transition and the Woes of State Capitalism Alexander
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China’s Economic Transition and the Woes of State Capitalism Alexander Chen Grade 10 Archmere Academy December 12, 2020 1 Recent decades have been characterized by the slowly declining influence of the United States and the long-anticipated rise of China to superpower status. China’s rapid economic growth since the enactment of market-oriented reforms in 1978 has lifted more than 850 million Chinese out of extreme poverty, built an enormous export-oriented economy, and driven average Chinese incomes up.1 Yet recent drops in GDP (Gross Domestic Product) growth point towards a slowing export sector and an unfavorable geopolitical situation. 2 Rising wages and a severe demographic crisis are putting immense pressure on China’s export-oriented economy, which relies heavily on cheap labor. External pressures are also mounting on China’s economy; now more than ever, the West sees China’s growth as a threat. The Chinese export economy suffers from renewed hostility, trade wars, and even suspicion over the COVID-19 pandemic’s origin. All of these discouraging factors beg the question: what can China do about its economy? The reality is that the country has only one option: to place emphasis on domestic consumption and to shrink the export industries. This would transition the country’s economy closer to those of wealthy importers, such as the United States. However, increasing domestic consumption necessitates a stronger, wealthier middle class and more support for businesses; it requires freer financial institutions. Lastly, China needs a cutting-edge innovation sector that can compete with other global producers. Yet China’s authoritarian system, which suffers from wasteful government spending, corrupt elite interests, and impediments to technological growth, will most likely prevent all endeavors to transition to a domestic consumption economy. 1 W orld Bank, “China Overview.” 2 World Bank, “GDP Growth (Annual %) 2 The Decline of the Export Economy China’s economic model is extremely unique. The term that describes China best, ‘state capitalism,’ appears to be an oxymoron. The authoritarian central government coexists with a thriving market economy, a combination that appears to possess the best of two worlds: capitalist productivity and authoritarian supervision. Instead of following the Western liberal model, China believes that it has carved a new path to success. Furthermore, the country markets its state capitalism as a viable and attractive alternative to democratic capitalism. The only proof China needs is its existence: it is one of the world’s largest economies and its sphere of influence grows as each day passes. The Chinese Communist Party, or the CCP, has virtually complete control of the Chinese government. The CCP maintains its legitimacy by ensuring economic growth, which placates the Chinese population to some extent. Therefore, one of the CCP’s highest priorities is to continue economic growth and to avoid stagnation. However, in recent years China’s economy has experienced a notable slowdown. China’s GDP growth had averaged about 10 percent for many decades; in past years, annual GDP growth has slowed from a peak of 14 percent in 2004 to a low of just 6 percent in 2019. 3 This significant drop can be attributed to the now-outdated export model on which China built its fortune. Three reasons stand out for why the Chinese export sector is in decline: an incoming demographic crisis, rising wages, and external hostility. The availability of cheap labor in China decreases every year due to negative demographic trends that have plagued the country since the notorious ‘One-Child Policy’ was enacted in 1980. 4 The policy limited the number of children a couple could legally have to just one. Even after Beijing reversed the policy in late 2015, many 3 W orld Bank, “GDP Growth (Annual %)” 4 D as and N’Diaye, “End of Cheap Labor.” 3 families chose not to have a second child due to economic concerns, and rising prices around the country have left swaths of Chinese couples behind. The country’s overall birth rate declined dramatically after the enactment of the one-child policy, and the current Chinese fertility rate in 2020 is approximately 1.69 children per woman.5 Experts predict that annual Chinese population growth will continue to decline in the next few decades to the point that there soon will not be enough workers to support the aging population. 6 Also, China’s economic boom has rapidly increased worker wages, and as a consequence, many companies are outsourcing to cheaper locations such as Sri Lanka. 7 Finally, more countries in the U.S.-led coalition are taking a harder stance on China. Notably, the ongoing trade war with the U.S. adds the extra burden of tariffs on imported Chinese goods. The only remedy to a declining export economy is to transition to an economy driven by internal consumption and innovation. Recognizing the necessity of this transition, the CCP has recently unveiled a new ‘dual circulation’ economic strategy which is part of the party’s 14th Five-Year-Plan. The plan emphasizes the transition to a domestic consumption economy aimed to boost the growing middle class of roughly 400 million Chinese. More concretely, the CCP wants to lessen dependence on imports and raise per-capita GDP to match moderately developed countries such as South Korea or Israel. The plan also highlights domestic technological development as an important objective. 8 However, the feasibility of this strategy should be called into question. Given the political environment and authoritarianism prevalent in China, the plan’s ambitious goals to transition the economy will most likely never come to fruition. 5 World Bank, “Fertility Rate.” 6 M yers, Wu, and Fu, “China’s Looming Crisis.” 7 Y an, “Made in China.” 8 S utter and Sutherland, “China’s 14th Five-Year Plan.” 4 Authoritarian Barriers: Wasteful spending, SOEs, and the Elite Officialdom To transition to a domestic consumption economy, the CCP must emphasize domestic growth by allocating resources towards productive businesses and beneficial developments. However, the inefficient authoritarian nature of the CCP and its state-owned enterprises (SOEs) could impede any effort to transition. Effective resource allocation is not one of the CCP’s strengths; the party has a long record of wasteful expenditures. Although the CCP has attempted to stimulate domestic consumption and productivity by increasing internal spending, much of that spending has been wasted on useless infrastructure and clunky SOEs, rather than private enterprises and the middle class.9 Structural overinvestment plagues Chinese housing and infrastructure developments. 10 Most ghost towns formed when people moved out, but China’s ghost cities formed when no one moved in. A nationwide study in 2017 based on the China Household Finance Survey found that approximately 22.4 percent of homes in China are unoccupied; in comparison, the U.S. home vacancy rate in the same year was just 12.7 percent. 11 Regional airports and highways are also underutilized, and many Chinese provinces that borrowed huge sums of money to pay for these projects are now in severe debt.1 2 We can look towards China’s fragile real estate bubble as a partial explanation for the high vacancy rate; government-led property developers in China believe that the demand will keep going up, which will certainly not be true once the bubble bursts. The government-driven housing bubble severely hurts the average Chinese consumer. Recently, economists at Moody’s Analytics pointed out that Chinese disposable income has grown at about 10 percent annually for the past six years while household debt has grown at 9 F isher, “China’s Authoritarianism Is Dooming.” 10 M atsangou, “China’s Transitioning Economy.” 11 B lazyte, “Infographic.” 12 B uckley, “China’s New Bridges.” 5 about double the rate, and much of that debt is related to housing. The low disposable income suggests that even if Beijing transitioned China to a domestic consumption economy, consumers would not have enough to spend. 13 China’s excessive infrastructure construction vastly increases debt every year; Chris Buckley from the New York Times writes that “the cost-benefit ratio of each new mile of asphalt drops sharply.” Even worse, Oxford professor Atif Ansar examined 65 Chinese highway and rail projects in a study and found that less than a third were productive.1 4 Most of these projects are supervised on the local level, meaning that local officials have the largest stake in infrastructure. Why would officials take the risk to fund projects that are not worth their price tag? Three reasons stand out. First, officials can receive millions of dollars in various benefits for giving out contracts to certain companies, also known as bribery. They get away undetected because China possesses neither a financial disclosure system nor an effective anti-corruption practice.1 5 Second, officials can receive career benefits for building large projects, even if the projects are not economical. Third, government backing ensures that the construction companies and the local government will not default nor go bankrupt even when they are deeply in debt. 16 Simple economics shows us that supplying a service does not ensure demand. Rather than boost the middle class and businesses, the CCP wastes money on largely useless infrastructure, proving its incompetence in transitioning to a domestic consumption economy. The CCP also controls Chinese SOEs, which are a distinctive part of the Chinese economy. 17 Although SOEs have brought many jobs to the country, they are undoubtedly inefficient. SOEs, by definition, are led by the CCP and their top priority is to serve the party. 13 Cheng, “China Can No Longer.” 14 Buckley, “China’s New Bridges.” 15 C hen, “Too Long a Wait.” 16 B uckley, “China’s New Bridges.” 17 G uluzade, “China’s State-Owned Companies.” 6 This means that they have to operate under special policy burdens which can lead to contradicting objectives, hiring of redundant workers, and other wasteful consequences.