The Magazine

Thirty Years of Reform in China

Economic collapse may soon bring political crisis.

Dec 22, 2008, Vol. 14, No. 14 • By GORDON G. CHANG
Widget tooltip
Single Page Print Larger Text Smaller Text Alerts

As Beijing celebrates the 30th anniversary of its reform era this month--generally considered to have begun with the accession of Deng Xiaoping--the dominant narrative in the world is that this is China's century. This perception is almost entirely based on the country's roaring economy, which has, according to official statistics, averaged 9.8 percent annual growth during the period.

Yet at this very moment the Chinese economy is moving from expansion to contraction and decelerating rapidly. In 2007, China's gross domestic product grew by an astounding 11.9 percent. In the first quarter of this year, growth was 10.6 percent. Second quarter: 10.1 percent. Third quarter: 9.0. This quarter, analysts expect 5.8 percent growth. If the trend continues--and there is every reason to believe it will--next year the Chinese economy will expand by one or two percent--or maybe not at all. China is experiencing a greater and faster economic slide than almost any other country this year.

Why is this happening? First, -China's growth has been extraordinarily rapid; 2007 was the fifth straight year of double-digit growth. When we look back at recent history, the last two half-decades of such fast expansion both ended in downturns, a mild one at the end of the last decade and a severe one after Tiananmen. Second, spending for the Olympics, which provided a large stimulus, will no longer help. Third, China's export-led economy is vulnerable to weakening consumer sentiment across the globe--especially in the United States.

Last year, sales to America accounted for all but $5.9 billion of the country's overall trade surplus of $262.2 billion. A weak U.S. economy has already been a factor in the closure in the first half of 2008 of about 67,000 factories, many of them in the country's export powerhouse, the Pearl River Delta in Guangdong province. In October, electricity output fell for the first time in almost four years. In November, growth in industrial output fell to a 13-year low, and the value of Chinese exports fell for the first time in more than 7 years.

Beijing, in short, has been relentlessly pursuing an economic model that is particularly ill-suited to a faltering global economy. The textbook remedy, economists say, would be for the central government to stimulate internal consumption to take up the slack. Yet consumption's role in the economy has been sliding, dropping from its historical average of about 60 percent to 35 percent today, undoubtedly the lowest rate in the world. The steps Beijing has taken to stimulate exports--like holding down the value of its currency--inevitably discourage consumption. And it will take years for Chinese technocrats to reorient their economy once they make the decision to do so.

That leaves investment to create growth. China's State Council, the central government's cabinet, last month said it would spend $586 billion over 9 calendar quarters on 10 major areas. Despite the initial global fanfare greeting the announcement, the program seems unlikely to reverse the economic downtrend. For one thing, the program is not big enough--only about a quarter of the spending is not already contemplated in the current five-year plan. For another, the new package, by concentrating on the long-term building of infrastructure, will not have much effect until 2010 or maybe even 2011. Pump priming loses its effectiveness over time, and this plan is merely the latest installment in a 10-year fiscal stimulus campaign begun by former premier Zhu Rongji. Only 1 percent of the $586 billion will go to desperately needed social services. The Chinese economy will thus remain heavily dependent on exports and investment--and be unsustainable in the long run.

Despite the seriousness of the situation they face, China's leaders seem unable to break from their old way of doing things. China's economy has progressed about as far as it can within its existing political framework. Further reform would threaten the power of the Communist party. A true market economy requires (among much else) the rule of law, which means constricting the power of government. Because such limitations on power are incompatible with the party's ambitions to continue to dominate society, the country cannot make much more progress toward them.

Technocrats promoted fast growth, and fast growth has created dislocations, such as bad bank loans, unfunded social welfare obligations, a degraded environment, and rampant corruption. These problems have not posed serious threats because increases in economic output in past years have masked them. But as growth slows, the dislocations are becoming too big to ignore--and probably too big to solve.