The End of Risk?

December 2006 Dr. Hans Black

On a recent trip to Beijing I was amazed by the contradictions I found in this supposed communist state. In many ways Beijing today represents a model of what is happening across the country. The city’s most immediate features — the rampant capitalism, the sense of free-for-all, the horrendous pollution and the lack of planning —are those of the country, too. The destruction of cultural heritage in the process of development is equally evident in Tibet and along the Yangtze at the Three Gorges Dam.

The transformation of China has been one of the most dominant stories of the 21st Century. In one way or another, China has profoundly affected nearly every aspect of global economics and politics, from the prices of commodities to American elections. These pages have often discussed China and its astounding economic growth — particularly its short-term sustainability and its effect on the global economy — and our cautious stance has tended to differ markedly from those of the media generally. Yet beyond the immediate concern about China’s ability to maintain its current rate of growth over the near term (11.3 percent in the second quarter of this year) and its increasingly well-documented problem of bad debts, I believe there are other long-lasting and more important consequences of China’s economic growth, both domestically and globally, that I will attempt to highlight below. They illustrate in my view that the modern transformation of China is a storyline that will undoubtedly remain important well into this century.

China today is going through a process of development that we would most closely associate in our own history with the industrial revolution, except that China is doing so in a globalized world, at a much faster pace and on a vastly broader scale than was the case in the West. Beginning with Deng Xiaoping’s decollectivization of agriculture in 1978, China has been undergoing a process of great urbanization, technological modernization and privatization of the economy, all of which is manifesting itself in massive social change.

While the country has witnessed huge changes already, there are still incommensurable challenges to be faced. While reporting focuses on all that is new and modern, it is easy to forget that 42 percent of the population still live on less then $2 a day. Even at current growth rates, the country is decades away from achieving levels of wealth comparable to most of its East-Asian neighbors. This goal will not be aided by the fact that China has a daunting demographic problem created by its one child policy. The country has a bulge of people in middle age but a smaller base of children who one day will have to support them. In effect the country is aging at a rapid rate. By 2050 there will be over 400 million people aged over 60, in a country with virtually the same population as today and which currently has no social security network (there is no longer any free healthcare in China and most people have no pensions). As the refrain goes, the worry is that the country may grow old before it grows rich.

Environment

China faces environmental challenges that dwarf the imagination. The country suffers from widespread air, land and water pollution as well as large-scale soil erosion and deforestation. As the Chinese economy continues to grow, these problems will only get worse. 300 million Chinese currently drink contaminated water, and 5 to 9 (depending on whom you ask) of the 10 cities with the worst air pollution in the world are in China. Although the central government is beginning to recognize the scale of the issue (it has pledged to spend over $125 billion on protecting its environment over the coming five years, much of which will go towards the restoration and protection of drinking water), the basic needs and realities of the country are inescapable. 70 percent of China’s energy production comes from burning coal, resulting in the world’s worst air quality, but because of the Chinese economy’s massive energy needs, new coal-burning power plants are being built continually. There is no real sense of what the long-term effects of this will be, but it would not be unreasonable to suspect the prevalence of cancer and respiratory problems will skyrocket in future generations. Nor is it difficult to foresee the hardships that will ensue; Beijing already faces the prospect of water shortages as its water table has dropped and its surroundings continue their process of desertification. The effect of these environmental problems will not be confined to China either and will progressively affect our world (already, the US EPA estimates that 25 percent of the pollution over Los Angles on any given day comes from China). As the world’s second-largest greenhouse gases emitter, China’s growing emissions will be enough to single-handedly counteract any cuts achieved by the Kyoto Convention countries under the current agreement.

Governance

Of all the changes that China’s transformation has wrought, the spectacular level of corruption and self-interest by party officials today is probably the most dangerous for the regime. Not only is the problem of central importance because of the discontent and distrust such behavior fosters in the public, but also because it ultimately feeds back upon and worsens the others stresses created by China’s development. Localities, for example, routinely ignore environmental regulations from the central government because they run contrary to the interests of those who are usually their local partners in industry and real estate. The problem of bad bank loans, much discussed in Western media, is also very much a story about corruption: those making the loans are more interested in the kickbacks than in the returns (even in the best of circumstances bank loans in China are made for policy reasons rather than economic ones, which helps explain their high failure rate).

Corruption and mismanagement are likely to remain a major problem in China for the foreseeable future because the Chinese state is surprisingly decentralized in many respects. A necessity of both the country’s size and its past as a command economy, control of the economic reins (except at the most macro level) is managed at the local and regional levels. This has been exacerbated by more recent reforms that have given even further power to the lower levels of government. This effectively puts these local governments in competition with each other to attract business and jobs to their respective areas by luring foreign businesses and fostering investment. The result is that they seek to surpass each other with investments in infrastructure, favorable borrowing arrangements with local bank branches, preferential tax treatment and no regulation. Thus while the central government currently wants to reign in lending and investment in order to lower what it sees as unsustainably high growth rates that will likely lead to over-capacity, there is very little incentive for the regional governments to follow suit. So although Chinese leaders insist they want to slow down their economy, it is not clear that they can.

Religion

The huge increase in religion in China is one of the most interesting and under-reported phenomena of modern China’s transformation. The growth of Christianity, particularly, but also of all religions, is indicative of the massive social change afoot. This flourishing of religion, as visible in the countryside as in the cities, has spawned countless local sects and cults that are mostly variants on traditional Christianity. The emphasis on the empowerment of the individual is at odds with the country’s traditional Confucian culture. It is not accidental that the growth of Christianity in China has been tightly tied to the spread of capitalism. The Communist Party’s worries about religion reflect these changes; the government realizes that religion and religious leaders potentially represent another power center beyond their control. This will increasingly be true as the numbers of devout Chinese grow (there are already thought to be 65 million
practicing Christians). The effect of such growth will not just alter the social character of the country but will have long-term implications for its politics.

Economic Structure

The Chinese economic growth of the last couple of decades has been built squarely upon its low-cost manufacturing ability. Yet while a growing proportion of the world’s manufactured goods are produced in China, the relative importance of manufacturing to the services-driven global economy has decreased. Ultimately, China has become the victim of its own manufacturing success. Today, manufacturing is a more competitive market with lower margins — especially outside the most technologically complicated and high-value industries — than it has ever been before. In a world where even technological products are being commoditized with incredible speed, it will be the inventors and marketers who will benefit in the global economy as opposed to the manufacturers. Thus the skill set required of a population in the 21st century, which values innovation and originality most prominently, will be high levels of human capital. Thus for all developing countries where the level of education of the population is relatively low, it will become more and more difficult to cash in on the global economy. For China it has yet to be seen how well it will make the transition to more value-added activities.

In many respects, China today gives the impression of a country blindly pursuing the path to wealth. The danger is that the price it is paying is too high and will not translate into social stability. Neither does there appear to have been much examination by the Chinese themselves of the costs of the initiative they have undertaken. History has also taught us that such profound social change is rarely achieved smoothly and is usually not controllable. Times of transformation tend to disenfranchise indiviCduals, and if too many people feel they are being left behind by China’s modernization, there will be large-scale discontent. There are already signs of this in the growing numbers of riots and demonstrations reported across the country.

Despite the challenges posed, an imminent and smooth transition to democracy as a result of the changes China is undergoing does not appear likely in the medium term. The Communist Party’s power still remains very strong and the veritable revolution the country is experiencing is also having many positive effects, from bringing in new technological skills to creating deep infrastructure. Nonetheless, the answer to a recent Barrons article entitled “What could go wrong with hina?,” which highlighted many of these same issues, would seem to be: a lot.