China's economy - is the State's control slipping?

The latest Evergreen Virtual Adviser, a free weekly newsletter, contains a very interesting article by George Magnus titled 'China's Economy:  No collapse, but it's serious, and so are the politics'.  Here's an excerpt from the third part of the article.

What has really set the cat amongst the pigeons this summer is the juxtaposition of a weakening economy, and the cack-handed manner in which the authorities managed the mini-devaluation of the yuan and the frantic attempt and failure to prop up the stock market.

The bottom line is that it is only possible to understand these economic, exchange rate and equity market developments in the context of the campaign waged by President, Xi Jinping to bolster the Communist Party’s authority and control. Specifically, the anti-corruption campaign, and the effective displacement of government ministries by so-called ‘small leading groups’, which are Party agencies, which are anything but small.

The benign view is that to strengthen the Party, increase compliance among cadres in the Party and in SOEs and local governments, and get reforms going to correct the imbalances in the economy, Xi had to amass power and centralise it. There is little question that he and his senior colleagues understand they have to implement deep and meaningful economic reforms to unlock new sources of economic growth and productivity.

The risk, as they know even better, is a loss of control. And they fear this more than anything. President Xi’s anti-corruption campaign is weeding out high profile Party misfits, but simultaneously stifling growth and initiative. It is also making an example of so called ‘tigers’—top Party officials—but it is impossible to go after all the ‘flies’—lower level officials, whose misdemeanours (or worse) have a real effect on peoples’ lives. Think only of the recent appalling chemicals explosion in Tianjin, where 11 local government and port officials have been accused of negligence and a beach of regulations, so far.

Xi has also substituted Party small leading groups for government institutions in broad areas of decision-making, undermining the authority of those charged with implementing reforms, and solidifying opposition among vested interests in the Party, SOEs and local governments. During the recent annual leaders’ get-away in the resort of Beidahe, State media reported that the government was facing resistance to reforms on an unimaginable scale. This expression of frustration was indicative not so much of the determination to press ahead regardless with market-oriented reforms and the creation of inclusive institutions, but of factional struggles and the influence in particular of retired leaders and senior Party officials. To all intents and purposes, meaningful reforms of SOEs, and local government finance functions and structures, and a retreat of the State from the commanding heights to make way for the private sector and markets, had already run aground. So, the latest developments are not promising, and may imply that those most enthusiastic about reforms are now on the back foot.

This is what markets and commentators may finally have realised.

There's much more at the link.  It makes very interesting reading.  Recommended.

As if to confirm Mr. Magnus' perspective, Jeremy Warner had this to say in the Telegraph.

When in trouble, shoot the messenger. This time-honoured approach to dealing with unwelcome news was much in evidence in China this week when nearly 200 people were rounded up and criminally charged with spreading “false” rumours about the stock market and the economy, or otherwise profiting from their travails.

. . .

China was meant to have embraced free market reform, yet these latest actions suggest an altogether different approach. Roughly summarised, it amounts to: “Reform good, but woe betide the free market if it doesn’t do what the high command wants it to.” When the stock market was going up, the Chinese authorities were perfectly happy to tolerate what to virtually all Western observers looked like a dangerously speculative bubble, vaingloriously believing it to be a fair reflection of the wondrous successes of the Chinese economy.

The first rule of stock market investment – that share prices can go down as well as up – seems to have been almost wholly forgotten in the scramble for instant riches. When, inevitably, the stock market crashed, the authorities threw the kitchen sink at the problem, but they failed to halt the carnage. This was an even ruder awakening – for it demonstrated to an already disillusioned public that policy-makers were no longer in control of events. Perhaps they hadn’t noticed, but there are today more Chinese with stock trading accounts – some 90 million – than there are members of the Communist Party – “just” 80 million. In any case, powerless before the storm, the authorities have instead turned to scapegoating.

. . .

It is reckoned that China needs to create some 20 million jobs a year just to keep pace with employment demand as the population shifts from land to town, eight million of them in high-end professions to cater for the country’s burgeoning output of graduates. China’s modernisation has created a monster which it is struggling to feed.

As the export-growth story waned, China compensated by unleashing a massive investment boom, which internal demand is now struggling to keep up with, rendering many of the country’s shiny new constructs uneconomic and overburdened with bad debts.

The Chinese leadership looks to growth in consumption and service industries to plug the gap, but these new sources of demand can’t do so without further free-market reform, which in turn requires further loosening of the shackles of political control. Without growth, the Communist Party loses its political legitimacy, yet the old growth model is broken, and to achieve a new one, the authorities must cede the very power and influence that sustains them. Rumour-mongering journalists and short-selling speculators can only be blamed for so long.

Again, more at the link.

I'm watching China's foreign policy very closely at the moment.  Historically, when things got difficult in terms of the Communist Party's domestic policies, it tried to divert the attention of its people to external 'threats'.  What did we see just this past week?

• A massive military parade, displaying many of China's new high-tech weapons, with great emphasis on its 'carrier-killer' missile;
• An overtly anti-American propaganda video showing Chinese forces destroying a carrier task force and an air base on an island that suspiciously resembles Okinawa;
• And an ostentatious visit by five Chinese naval vessels to the Bering Sea, off the coast of Alaska, just as President Obama visited that state.

I think all those elements combined look very much like an attempt to deflect the attention of China's people from its internal economic woes.  Will it work?  I'm not sure it will . . . many Chinese are a lot better educated these days, and much more economically savvy.  I guess we'll have to wait and see.

Peter