Challenges behind the Chinese anniversary

On Tuesday, China will be marking the 70th anniversary of the founding of the People's Republic, with the Communist Party commemorating an impressive journey from a poverty-stricken least-developed country to its current standing as the second-largest economy in the world. But with China now contending with a political and economic watershed, there's the risk of rain on the parades.

By Peter Toft, Senior Analyst, EKF

The new China was proclaimed by Chairman Mao on 1 October 1949 following three years of bloody civil war, and China's path to prosperity started out as a disaster. Because Mao launched a programme of hyperindustrialisation in which market forces were eliminated, agriculture was collectivised, wages were paid in worthless points, farmers were forced to neglect their fields and melt down their implements to fuel the country's steel production. Collectivisation, expropriation and a lack of monetary incentives sent agricultural production into heavy decline. Mao's ’Great Leap Forward’ ended in a vast national tragedy, with between 30 and 46 million Chinese dying of starvation.

The fiasco undermined Mao's power, and more moderate forces managed to take control of the party and start rolling back the direst elements of the planned economy. Mao retaliated by mobilising radical factions of the party and fanatical students in an attempt to regain power. The result was the Cultural Revolution of 1966. This cost the lives of another million Chinese and cleansing of the brightest minds, who were branded enemies of the people. While the Cultural Revolution did not start waning until 1972, Mao, increasingly frail with advancing age, retained symbolic power over the Party right up until his death in 1976.

Economic Growth

GDP in 1978 (2019 USD): USD 179bn

GDP in 2018 (2019 USD): USD 13,600bn

GDP growth for the year compared with previous year

1978: 11.1%

2018: 6.6%

GDP per capita in 1978 (2019 USD):    USD 307

GDP per capita in 2018 (2010 USD): USD 7,755

China's share of the global economy

1978: 1.74%

2018: 15.86%

Source: The World Bank

Economic renaissance

Deng Xiaoping's reformist communists won the power struggle in the wake of the passing of Mao, and in 1978, the seeds had been sown for China's economic renaissance, with the semi-privatisation of its agricultural sector, focus on light industry, open-door foreign trade policy and modern defence programme.

The foundation was a large and low-cost labour force and the creation of special economic zones to promote a Japanese- and Korean-style protected export industry. However, the economic boom was only possible because Mao, in spite of the many atrocities, had succeeded in uniting China as a centralised state. He largely eliminated illiteracy and entered into a cooperation with the US in 1972 during the Cold War era, following a severe Sino-Soviet split.

From the 1980s to the 2000s, development was rapid. Manufacturing switched from simple low-wage production to technology-intensive production within IT, machinery and shipping, and, with average annual growth rates of up to 10 per cent, the Chinese economy rocketed to become the second-largest globally.

Persisting with a sunk cost fallacy, China has also attempted to channel its immense industrial overcapacity into "The New Silk Road"

Meanwhile, the upturn in the value chain spelled tougher labour and wage requirements, making it more profitable to relocate labour-intensive manufacturing to countries cheaper than China. In addition, the high growth rate was achieved at the expensive of the environment.

The limitation of the growth model

The global financial crisis also impacted China. Exports declined, and in an attempt to get the wheels turning, China eased its credit restrictions and invested heavily in national construction projects with doubtful returns, given the limits to how many 'bridges leading nowhere' the system can bear. This was a contributory factor in the accumulation of a massive debt of 250% of GDP.

Persisting with a sunk cost fallacy, China has also attempted to channel its immense industrial overcapacity into "The New Silk Road" – a colossal venture to link China with large parts of Asia, East Africa and Europe.

For China, the Silk Road is also about geopolitics, of securing trade routes, marketing and insourcing of commodities. But the Silk Road may prove a costly venture, as many of the countries along its route are so indebted that they will scarcely all be able to repay their loans, and the losses risk delaying China's further economic development. The trade war with the USA further complicates this, and exposes the weakness of China's existing growth model in its reliance on export-led growth.

The colossal economic expansion has also created deep societal disparities. China is now among the countries with the greatest inequality, with several of its regions marginalised from the progress that has benefited Eastern China the most, while a rust belt has emerged in the heavily industrialised north, and Western China still has least-developed status. Another legacy of China's past is a persistent feudalism, which makes eligibility for welfare benefits contingent on birthplace. If people move to the city, they have no entitlement to urban state-funded schooling and health care. This locks a substantial segment of the Chinese population in poverty-stricken rural districts, and means that the labour market fails to get hands to where they are needed most.

More market, less state?

China's astonishing economic development is based on cheap labour, protectionism and forced technology transfer from foreign companies that sought to invest in China. But if China is to overcome the ongoing economic challenges and reap the full potential of the inventiveness, economic efficiency and long-term stable growth that only free market economies have proved capable of achieving, more market reforms will be called for.

Population

Life expectancy

1978: 65.9 years

2018: 76.4 years


Source: The World Bank

One crucial step in that direction will be a reform of the banking sector, which serves political interests in being predominantly under state ownership and favouring loans to low-margin state enterprises and projects.

Far more favourable and equitable terms must be created for private enterprises and entrepreneurs if the Chinese economy is to continue to improve. For that to happen, the Chinese Communist Party will also have to be willing to relinquish its hold on the economy in favour of market forces. This would also entail loss of economic and political control, which is not exactly high on the Party wishlist.

The Party's actions in the time leading up to the next anniversary will thus determine whether China can realise its dream of becoming the most advanced economy in the world.

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