Tense times in Beijing

August 24, 2015

These are difficult times for the ruling elites in Beijing. China is at the beginning of a profound restructuring of its economy and is being forced to let go of the high growth model that has sustained it for the last couple of decades (see this article). This restructuring involves ending dependence on investments and exports to drive growth, and a shift to a much greater role of domestic consumption in the Chinese economy. This transition to a consumption led economy is a complex and potentially destabilising process, it will involve deep changes to the current financial and banking system, almost certainly a downgrading of the role, and special financial privileges, of state owned enterprises and the easing of central control of many aspects of Chinese economic life. The wealth and power of a significant proportion of the Chinese elite is bound up with precisely those sections of the old economy, particularly the state owned enterprises, that will contract as part of a transition to a different sort of economy. At the same time the ruling elite and the leadership block must relinquish control of important parts of the economy and markets, a process that is deeply unnerving. And this entire complex and difficult transition has to be managed in a way that does not cause the economy to crash into a depression which could lead to political destabilisation.

The country is now going through a crisis of transition, unparalleled since Deng Xiaoping defeated the Gang of Four and set out to break with the economic system of the Mao era and develop a new model of economic development. The signs are that it is not going so well. Maintaining and renewing the authority and primacy of the Communist Party during and after the transition to a new economic model, the pursuit of often contentious reforms, financial liberalisation and rebalancing the economy while trying to sustain an unrealistic rate of growth are complex and mutually incompatible goals.

Deng’s task in a pre-industrial society without a middle class and social media was, in many ways, easier than that confronting the current leadership. Deng was determined to avoid the concentration of power in one individual, and so he empowered government bodies and ministers, especially the State Council and the prime minister, and encouraged openness and a consensus-driven political model. In a sense Deng stabilised life for the Chinese Communist Party bureaucracy in much the same way that Breshnev did in the Soviet Union. This worked well enough until the 21st century, but has gradually atrophied as the party succumbed to corruption, as social tensions resulting from the fast growth model have grown, and as the economy has built up high levels of debt, overcapacity and an addiction to misallocated and credit-fuelled investment.

Communist Party leader Xi Jinping has been trying to loosen central economic control and allow the gentle decline of the old investment heavy growth model but has responded clumsily when, for example, the stock market or exchange rate has moved in the wrong direction, The leadership poured vast resources into trying to prop up the stock market only to see it crash again in recent days. The latest announcement, that Chinese local government pension funds will now be allowed, and in fact encouraged, to invest their several hundred billions of funds in the stock market is the latest desperate and dangerous measure to try to stop the market slide. The stock market crash is a profound political problem for the leadership because of the large number of small investors who are watching their saving being wiped out and who believed that they were protected by the government. This has caused wide spread anger and has made the government look clumsy and powerless.

While some reforms have made progress, many important ones affecting the role of the state in the economy and the introduction of market mechanisms have suffered from dilution and the opposition of vested interests. The clampdown on civil society, media, legal and non-governmental institutions has not helped. A strong central authority, perversely, has stifled important reforms, removed authority and accountability from those institutions responsible for carrying them out and produced conflicted decision-making.

From the beginning of his leadership Xi Jinping tried to strengthen the centralised power and authority of his ruling bloc and has been accumulating more power than any leader since Mao, consistently emphasising the Leninist need for “party purity” to avoid the fate of the Soviet Communist party. Among his first policies was an extralegal anti-corruption campaign that continues to this day. He has usurped the authority of government institutions by establishing party bodies, known as “small leading groups”, that are more numerous than ministries and hold sway over the most important functions of the state.

Recently the inner party struggles appear to be coming to a head just as the economy enters a dangerously unstable period and the high growth model falters. According to a source in Beijing close to China’s top leadership, Chinese Communist Party leader Xi Jinping has made his first significant move against the former Party boss, and his chief rival, Jiang Zemin. The source said that Jiang and his two sons have been “placed under control,” meaning that their freedom of movement has been temporarily restricted. This follows the arrest of Zhou Yongkang, a former security chief, who was convicted of abuse of power, accepting bribes and revealing state secrets. He was sentenced to life in prison following a secret trial on May 22. The takedown of Zhou was widely acknowledged to be among the most significant political purges in recent Chinese history but the move against Jiang Zemin is even a bigger.

Jiang Zemin was the leader of the Chinese Communist Party from 1989 to 2002. He stayed on as head of the military for another two years, and didn’t relinquish all military posts for a year after that. During his years in office and as he was departing, Jiang installed a series of cronies in key posts, some of whom ran their own fiefdoms outside the control of the formal leadership.

This parallel power structure encompassed the security apparatus, under the rule of Luo Gan, and the recently imprisoned Zhou Yongkang, who expanded it into a massive apparatus with an annual budget of $120 billion, larger than that of the military.

Much of the focus of Xi Jinping’s purge of the Communist Party over the last two and a half years has been about uprooting this political network and removing the Jiang Zemin holdovers one at a time. It has been accompanied by well-timed leaks to the press, and tantalising reports and remarks by officials who have hinted about far-reaching political conspiracies that went to the top of the regime.

That Jiang Zemin was the ultimate godfather behind the political machinery that Xi Jinping sought to dismantle was widely understood in political circles in China, but had not been explicitly brought to the fore until an editorial in People’s Daily, the Party’s mouthpiece, on August 10th. The newspaper on that date published a barbed criticism of former leaders who interfere in the affairs of their successors, preventing them from “rolling up their sleeves and doing bold work.” It also complained of leaders who, “being unhappy to retire … do everything they can to extend their power.”

The pace of events has accelerated during August. Encouragement of the stock market was supposed to be a key part of the reform process by switching to a more market driven and efficient mechanism for the allocation capital investment in China. But after an initial exuberant, and officially encouraged, bull run the market has crashed spectacularly prompting massive, and what likes futile, intervention led by the central government to try to prop up the share prices. After initially appearing to stabilise the market has now crashed once again, this time driving down markets across the globe. Caught between its roles as cheerleader and regulator, the government has shown a lack of trust in the very market forces it sought to introduce.

This month’s mini-devaluation of the renminbi was explained officially as an incremental change to China’s financial liberalisation, designed to help the currency’s admission later this year to the International Monetary Funds’s accounting unit, the Special Drawing Rights. Yet the action was communicated poorly at best. Again, the authorities have been conflicted, torn between a strong renminbi policy to help rebalance the economy, and a softer one to respond to weakening growth. Economic statistics this summer, especially for exports, manufacturing and investment, were disappointing, underscoring that weaker performance for the past four years has become impervious to stimulus measures.

An indicator of the slow down in the Chinese economy has come from the automotive sector. During the first half of 2015, the aggregate utilization rate of 23 significant car-making joint ventures— China requires foreign companies to build cars with local partners—fell below 100% for the first time, averaging 94.3% utilization versus 107.4% a year earlier, according to a study by Sanford C. Bernstein. Plants are able to exceed 100% capacity utilisation by adding extra work shifts to meet high demand.

Perhaps the biggest part of the challenge for the Chinese elite will be its ability to manage employment, a much more politically sensitive indicator than GDP. The official unemployment rate, supposedly about 4 per cent over many years, is a fiction. Many Chinese labour market analysts believe that the jobless rate may be even higher than the 6.3 per cent estimated by the International Labour Organisation and that it is rising. The faltering property sector is causing a decline in investment in labour-intensive construction, and the loss of a job is very challenging for the many workers who are not eligible for unemployment benefits because they are unofficial migrants from the rural areas and thus lack urban registration status under the Hukou system. If the economy seriously falters then unemployment could rise significantly, which would not not only deepen the downturn but also unleash a great deal of dangerous social tension. The deal that underpinned the legitimacy of the system in China has always been pretty straightforward, if everyone stays out of politics and lets the ruling elite rule unchallenged then living stands will steadily rise and everyone will be better off. If the elite cannot deliver rising living standards, or a significant proportion of the population finds itself actually worse off, then the second part of of the deal, letting the elites rule unchallenged, may also be in question.

China’s economic transition was always going to be difficult, but developments this year suggest that things are not going according to plan. The centralisation of power is proving to be a double-edged sword for reform, the anti-corruption campaign is choking off initiative and growth. The country is now going through a crisis of transition, unparalleled since Deng Xiaoping and the economy cannot be kept on an unrealistic expansionary path by unending stimulus. The time for accepting a permanently lower growth rate is drawing closer. It will test the legitimacy and reform appetite of China’s leaders in ways that will determine the country’s prospects for years to come.

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