China’s Economic Dark Side Part II

ICangles Investment Post…

China’s economic successes are well known. Less so is the case around the immense challenges the country faces in remaining on a path of progress. These challenges go beyond an over-reliance on exports, the high likelihood of an export led development model faltering during the transition from an export-focused to more consumer-focused economy, a sizable real estate market bubble and significant levels of low credit quality debt in the financial system, as mentioned in my previous post on China’s Economic Dark Side. In addition the money created in relation to China’s holdings of foreign debt represents a substantial liability and inflation risk, as articulated in my earlier post “Big Risks on Central Bank Balance Sheets”. What is more, China’s economic challenges extend to societal issues to such an extent that the country’s history of periodic periods of revolutionary implosions may very well repeat.

Raising the specter of upheaval in China might seem alarmist, especially given the country’s recent economic success, but it is actually a possibility that China’s own leadership has admitted to being concerned about. Recently, Chinese premier Wen Jiabao cited the risk of descending into another Cultural Revolution, which is being increasingly reminisced, as driving the need for political reforms. In the same speech he also foreshadowed the ouster of Bo Xilai, one of China’s most powerful politicians. Certainly, the Bo Xilai scandal puts a spotlight on the pattern of a strong central government that has strengthened China, but done so by disproportionately strengthening some regions over others, and now faces challenges to its authority from the very diffusion of power to regional actors created by economic success.

Maybe this time will be different. But there is good reason to think it will not. For starters the legitimacy of China’s government rests largely on delivering prosperity. An economic crisis would not only unleash destabilizing forces, but would at the same time undermine the government’s very claim to legitimacy critical to managing such forces. Obviously, China is not a democracy deriving its legitimacy from the consent of the governed with proven mechanisms to remove unpopular leaders. But neither is China’s government truly Communist any longer, with claims to legitimacy derived from seeking a classless society. China’s government is in fact a form of fascism with strong feudal undertones.  One party rule with government-business partnerships functioning in a quasi market economy and featuring nationalistic claims to legitimacy is actually a form of fascism. Were China’s central government to hold most of the power this label alone would describe its government. But the diffusion of power from the center to the regions and spread out in unofficial patronage systems of groups, linked by personal relationships, familial ties and exercising power with little constrains other than custom, is so prevalent as to increasingly resemble a modern form of feudalism.

China’s government is seen as legitimate largely because it has successfully delivered economic growth and improved living standards, although the average annual income remains under $4,000. This makes the government uniquely vulnerable to instability due to an economic crisis. Neither the election ballot, shared ideology or the rule of law administered by an independent judiciary exist as safety valves to release societal pressure in the event of a severe economic downturn. And as the feudal characteristics of Chinese society become more apparent with the diffusion of power from the center it is also clear that the peasants are getting increasingly restless. To quote an editorial in the Wall Street Journal, “For 2006, China’s Academy of Social Sciences reported the eruption of about 60,000 “mass group incidents,” an official euphemism for demonstrations of public anger involving at least 50 people. In 2007, the number jumped to 80,000. Though such figures are no longer published, a leak put the number for 2008 at 127,000. Today, it is almost certainly higher.”

One estimate puts the number of recent so-called annual mass incidents, which sometimes turn violent, at 180,000, with most of them linked to land grabs by developers and political corruption. Even with economic growth the number of disturbances has grown, as a wealthy connected class enriches itself often through the corrupt, arbitrary and sometimes brutal use of state power, creating rising levels of income inequality in the process. Although some of these protests stem from rural peasants fighting land seizures an increasing number are coming from the 150 to 240 million migrant workers, who are hard hit by inflation, earn only about $250 a month and living in the underground economy, with no legal status to residence or public services, find their interactions with the state to be largely repressive in nature.

Yet while a restless underclass may be the dry tinder of revolution, they are not the spark. And clearly critical mass has not yet been reached in China, where despite growing unrest that is often violent in nature, the government remains in firm control. However, the spark often comes from a destabilizing event, such as an economic crisis, which displaces educated members of the middle class—the type of people who write manifestos, know how to organize movements and articulate ideologies. Avoiding the occurrence of such a spark, igniting the fire of revolutionary unrest is of such a concern to China’s government that it is both their highest priority and an increasing worry given the risk of economic difficulties in the future.

In my earlier post I reviewed many of the economic factors making such a crisis likely in the future, so I will not go over them again. Instead, I will highlight some of the very destabilizing demographic trends unfolding in China, which could contribute to turning an economic crisis into a political one. For starters China’s labor population will soon peak, with the ratio of retirees to workers rising from 39 percent in 2011 to 46 percent in 2025. Thus, demographic aging trends, which helped drive growth will increasingly become a headwind slowing economic growth, as workers become retirees in a country increasingly beret of social safety nets. On the bright side for the government, retirees tend not to lead revolutions, even when sentenced to destitution. Unfortunately, their sons might as young, unemployed and unmarried men do, and China is gaining an exceptionally large pool of this most combustible of demographics due to its one-child policy.

Government policies, forcing families to have only one child, had the unintended consequence of creating an enormous gender imbalance, through selective abortions and infanticide, in a country where boys are more valued than girls for reasons, which include their role in taking care of their parents in an increasingly uncertain old age. The Chinese Academy of Social Sciences estimates that by 2020 China will have 20 to 30 million more marriage age men than women and one in five Chinese men will be unable to find a wife—the equivalent of the entire young male population in the United States. The consequences will not be good, and include increased crime and the greater likelihood of war or revolution, such as China’s Taiping Rebellion where sex imbalances may have played a role. It will be the poorest men who are not able to find a wife. For these men without the hope for or stabilizing anchor of family, they will have little to lose in taking actions others would hesitate to embrace. In other words the dry tinder of China’s underclass is going to get a lot drier with the passage of each year.

There is also another destabilizing and unforeseen consequence of China’s one child policy. Many well off families have spoiled their single child, showering them often him with lavish attention. The government is concerned that these little emperors lack strong moral character. Such concerns are well warranted. While at the low end of the income ladder China has millions of men who will never be able to marry and have a family, at the upper reaches of society there are increasing numbers of narcissists feeling entitled to conspicuous perks, such as police departments flaunting luxury automobiles. It’s a perfect recipe for disaster–a society where the powerful are inclined to increasingly abuse their power and pay little heed to the disadvantaged, as more and more of these little emperors move into positions of power and where the poor increasingly have little to lose in lashing out at real injustices.

All of this doesn’t mean that China will not continue down the path of economic progress. But it does mean a very large bump in the road could be ahead. But a bump in the road to economic modernity might be the best case. Economic progress could stall out or even reverse. China’s government actors will surely have a significant impact in how events transpire. Yet, in any of these scenarios the prospect for significant political upheaval, ignited by an economic crisis and taking on a scale and scope few imagine today, is extremely likely to unfold over the coming years. In more dire scenarios such a crisis could occur over an extended period of time and pose significant risk to the global supply chain, economy and stability. It’s a possibility unlikely to transpire this year or the next, but the potential for a spark from an economic crisis striking China’s dry tinder of social instability is poised to grow.


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