There’s a ticking time bomb within China’s financial system in the form of huge debt-to-GDP ratio of 260%, caused by government spending to fuel its growth.



London: Let’s be frank. The People’s Republic of China (PRC) is not a communist country. Communism is an ideology of economic equality through the elimination of private property. One glance at the inequality in Chinese cities and the countryside will prove that China is not communist. China is communist in name only (CINO). Yet CINO is working, as the 70th anniversary parade earlier this month so clearly illustrated.

In a mere 40 years, the PRC has astonishingly created one of the biggest bourgeoisie in history. Although this month celebrated the 70th birthday of the PRC, the first 30 years were wasted under Mao Zedong as he enforced the disastrous Great Leap Forward in a fruitless effort to catch up with the West. It was only during the reign of Mao’s successor, Deng Xiaoping, the “Architect of modern China”, that China was opened to foreign investment and the global market, policies that are credited with developing China into one of the fastest-growing economies in the world.

Now the world’s second-largest economy is expanding at its slowest pace since the early 1990s. Investors are getting nervous. The weakening in the domestic economy and the deteriorating external environment, including a global slowdown and the US-China tensions have contributed to China’s economic problems. The official data paints an increasingly cloudy outlook. Chinese exports fell in August by 1% year on year, with a huge 16% drop to the US, a clear sign that the dispute is hurting bilateral trade. The only pockets of growth are in housing construction and spending in the services sector.

In addition there’s a ticking time bomb within the nation’s financial system in the form of the huge debt-to-GDP ratio of 260%, caused by massive government spending to fuel its spectacular growth. Banks are state-funded and owned and it’s the government that sets interest rates and approves loans. Banks pay low interest rates on deposits, which means that they lend cheaply to state-owned businesses. As a result, banks have channelled government funds to an unknown number of projects that may not be profitable.

Bank loans are about 30% of the economy, and it is estimated that a third of these may be “off-balance sheet”, loans that aren’t regulated. If interest rates rise, if growth slows too fast or if the government cuts back on the stimulus, these loans will probably default, pricking the asset bubble, reminiscent of 2008. Fortunately, Beijing has recognised these dangers and earlier this year announced plans to boost spending and cut billions of dollars in taxes in an effort to support the economy. It has also moved to provide a liquidity boost by reducing the amount of cash banks must hold in reserve. The aim is for the economy to be less dependent on investment and exports and to increase the role for spending by consumers. These moves may succeed, but the three decades when the annual growth rates were 10% are long gone.

A second major threat to China’s future is its aging population and damaging demographic profile, self-inflicted by its former one-child policy. China’s population will peak at 1.44 billion in 2029 before entering an unstoppable decline. The country will then enter an era of negative population growth. Fewer people means less domestic consumption and therefore rapidly slowing economic growth. The ratio of young to old will be dramatically imbalanced by the rising ranks of the elderly, putting unprecedented weight on the ties that hold society together. Although there was an 8% bump in births in 2016, mainly due to women who had waited years to have a second child after the one-child policy was relaxed, births dropped 3.5% the following year. China is in a classic “middle income trap”, when rapidly developing economies stagnate as incomes reach median level and the emerging middle class start having fewer babies. Chinese women are prioritising careers and stable home life over raising children, especially as the costs of living and education soar.

The third existential threat to the Chinese government is the lack of individual liberty. In addition to a huge middle-class, the extraordinary growth over the past 30 years has created a class of ultra-rich professionals, all of whom want more individual liberties. Yet under President Xi Jinping individual liberty is decreasing. In the past decade investment in domestic security, including policing and surveillance, has rapidly increased. In 2017, spending on external defence amounted to just over 1,000 billion Yuan; that on domestic security was more than 1,200 billion Yuan. Xi clearly fears internal dissent more than the external threat!

This is a huge price to keep the country stable and governable. That the authorities currently encounter little resistance to its increased repression and blunt propaganda may indicate that it occupies a position of strength. But equally its willingness to use repression, even at the risk of encountering resistance, is a clear sign of heightened anxiety. For an undemocratic political regime, to manage a society which will increasingly demand democracy is an unnervingly tall order. Something will have to give.

It was possible to argue for a decade up to the 2008 Beijing Olympics that an element of freedom was appearing in China. The combination of economic reforms and proliferating new media appeared to be permitting citizens more personal autonomy and freedom of expression. This began to change almost the moment the competitors and visitors to the Games departed. Then, three years later when the Chinese leaders saw the overthrow of autocracies during the Arab Spring, a neurosis developed among them about secret plots and uprisings, so that this last decade has seen the end of meaningful debate of almost any kind.

Few Western analysts see any dramatic change in Chinese democracy while Xi Jinping is in power. He has tightened restrictions over civil society and ideological discourse, while calling for further socialist market economic reforms. Xi is 66 and is the first Chinese leader to be born after the Second World War. Recent changes to the Constitution allow him to stay in power for the rest of his life. Chinese leaders tend to live long lives (a predecessor, Jiang Zemin is 93), so Xi could be in power for the next 25 years. Nevertheless, the present leadership will almost certainly be the last one capable of governing China with a reasonable degree of authority and stability in the absence of democratisation.

An autocratic system is liable to make itself dangerously vulnerable when it undertakes reform, because of the lack of institutions and civic skills. These will need to be developed over the next decade before any move to democracy takes place. Russia gave the world a text-book example of the danger of reform without institutions in 1991 when Yeltsin tried to change from autocracy to democracy in double-quick time. Yeltsin’s “shock therapy” resulted in too much shock and not enough therapy and the country quickly reverted to Putinocracy, autocracy of a different kind.

If China fails to answer the call of democracy during the remainder of Xi’s reign, it may well fail as a State. Precedence is mixed. Under Deng Xiaoping there was a form of “authoritarian adaption”, which reformed agriculture and unleashed entrepreneurship. This was extended under Jiang Zemin when China joined the World Trade Organization. A market economy was officially enshrined and state owned enterprises were reformed. Hu Jintao and Wen Jiabao reformed social security. All this created new benefits and beneficiaries while imposing few costs on established interests. The problem then was that there was little potential for further evolution within China’s authoritarian framework. The easy reforms had already been launched and a self-strengthening framework equilibrium of stagnation was slowly being formed, hard to break without some major economic, social or international shock.

But shock is the last thing China needs. While few want to reverse the reforms that have already taken place which have led to the spectacular growth over the past 30 years, many in the bureaucracy and the elite would be happy with the perpetuation of the status quo. But the reforms to date have created a quasi-democratic society without a complementary democratic form of civil government. This mismatch will eventually require that the state democratises in order to preserve its legitimacy.

There is no surer recipe for a major legitimation crisis than to prolong by repression a mismatch between a quasi-democratic society and an undemocratic political regime. The ongoing crisis in Hong Kong should be a wake-up call to Beijing. Beyond reasonable doubt, it illustrates that a nondemocratic entity is the Achilles heel of an otherwise strong and rising China. President Xi Jinping, El Duce of the CINO PRC, should take note.

John Dobson is a former British diplomat to Moscow and worked in UK Prime Minister John Major’s Office between 1995 and 1998.


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