China - Paper Tiger?

Okay, here is an interesting argument that China will not become a superpower anytime soon; rather, China’s government will lose its authority and China will devolve into a group of different, competing regions backed by foreign powers.

the following was written by George Friedman, in his book “The Next 100 Years: A Forecast for the 21st century”.

Zeppelin: After reading through it all, does it agree or disagree with your own experiences in China?

China is gambling at the beginning of the twenty-first century that it can carry out an indefinite balancing act. The assumption is that it will be able to gradually shift resources away from the wealthier coastal regions toward the interior without meeting resistance from the coast and without encountering restlessness in the interior. Beijing wants to keep the various parts of China happy and is doing everything in its power to achieve that end.

Underlying this is another serious, and more threatening, problem. China appears to be a capitalist country with private property, banks, and all the other accoutrements of capitalism. But it is not truly capitalist in the sense that the markets do not determine capital allocation. Who you know counts for much more than whether you have a good business plan. Between Asian systems of family and social ties and the communist systems of political relationships, loans have been given out for a host of reasons, none of them having much to do with the merits of the business. As a result, not surprisingly, a remarkably large number of these have gone bad – “nonperforming”, in the jargon of banking. The amount is estimated at somewhere between $600 billion and $900 billion, or between a quarter and a third of China’s GDP, a staggering amount.

These bad debts are being managed through very high growth rates driven by low-cost exports. The world has a huge appetite for cheap exports, and the cash coming in from them keeps businesses with huge debts afloat. But the lower china sets its prices, the less profit there is in them. Profitless exports drive a giant churning of the economic engine without actually getting it anywhere. Think of it as a business that makes money by selling products at or below cost. A huge amount of cash flows into the business but it flows out just as fast.

China is Japan on steroids. It is not only an Asian state that values social relations above economic discipline but a communist state that allocates money politically and manipulates economic data. It is also a state in which equity holders – demanding profits – are less important than bankers and government officials, who demand cash. Both economies rely heavily on exports, both have staggeringly high growth rates, and both face collapse when the growth rate begins even to barely slow. Japan’s bad debt rate around 1990 was, by my estimate, about 20 percent of GDP. China’s, under the most conservative estimate, is about 25 percent – and I would argue the number is closer to 40 percent. But even 25 percent is staggeringly high.
China’s economy appears healthy and vibrant, and if you look only at how fast the economy is growing, it is breathtaking. Growth is only one factor to examine, however. The more important question is whether such growth is profitable. Much of China’s growth is very real, and it generates the money necessary to keep the banks satisfied. But this growth really does not strengthen the economy. And if and when it slacks off, for example because of a recession in the United States, the entire structure could crumble very fast.

China has expanded extraordinarily for the last thirty years. The idea that such growth rates can be sustained indefinitely or permanently violates basic principles of economics. At some point the business cycle, culling weak business, must rear its ugly head – and it will. At some point a simple lack of skilled labor will halt continued growth. There are structural limits to growth, and China is reaching them.

The problem for China is political. China is held together by money, not ideology. When there is an economic downturn and the money stops rolling in, not only will the banking system spasm, but the entire fabric of Chinese society will shudder. Loyalty in China is either bought or coerced. Without available money, only coercion remains. Business slowdowns can generally lead to instability because they lead to business failure and unemployment. In a country where poverty is endemic and unemployment widespread, the added pressure of an economic downturn will result in political instability.

Recall how China split into coastal and interior regions between the British intrusion and Mao’s triumph. Businesses on the coast, prosperous from foreign trade and investment, gravitated to their foreign interests, trying to break free from the central government. They drew in European imperialists – and American – who had financial interests in China. Today’s situation is potentially the same. A businessman in Shanghai has interests in common with Los Angeles, New York, and London. In fact, he makes far more money from these relationships than he does from Beijing. As Beijing tries to clamp down on him, not only will he want to break free of its control, but he will try to draw in foreign powers to protect his and their interests. In the meantime, the much poorer people in the interior of the country will be either trying to move to the coastal cities or pressuring Beijing to tax the coast and give them money. Beijing, caught in the middle, either weakens and loses control or clamps down so hard that it moves back to a Maoist enclosure of the country. The critical question is which outcome is more likely.

The Chinese regime rests on two pillars. One is the vast bureaucracy that operates China. The second is the military-security complex that enforces the will of the state and the Communist Party. A third pillar, the ideological principles of the Communist Party, has now disappeared. Egalitarianism, selflessness, and service to the people are now archaic values, preached but not believed by or practiced by the Chinese people.

State, party, and security apparati are as affected by the decline in ideology as the rest of society. Communist party officials have been the personal beneficiaries of the new order. If the regime were to try to bring the coastal regions under control, it is hard to imagine the apparatus being particularly aggressive, as it is part of the same system that enriched those regions. In the nineteenth century the same problem emerged when government officials along the coast didn’t want to enforce Beijing’s edicts. They were on the side of doing business with foreigners.

If there is indeed a serious economic crisis, the central government will have to find a substitute ideology for communism. If people are to sacrifice, it must be for something they believe in – and if the Chinese cannot believe in communism, they can still believe in China. The Chinese government will attempt to limit disintegration by increasing nationalism and the natural companion of nationalism, xenophobia. Historically, China has a deep distrust of foreigners, and the party will need to blame someone for economic devastation. As Mao blamed foreigners for China’s weakness and poverty, the party will again blame foreigners for China’s economic problems.

Since there will be substantial confrontations with foreign states on economic issues – they will be defending their economic interests in China – playing the nationalist card will come easily. The idea of China as a great power will substitute for the lost ideology of communism. Disputes will help bolster the position of the Chinese government. By blaming foreigners for problems and confronting foreign governments diplomatically and with growing military power, the Chinese will generate public support for the regime. This is most likely to take place in the 2010s.

The most natural confrontation would be with Japan and/or the United States, both historical enemies with whom smoldering disputes already exist. Russia is unlikely to be treated as an enemy. However, the probability of a military confrontation with the Japanese or the Americans is limited. It would be difficult for the Chinese to engage either country aggressively. The Chinese have a weak navy that could not survive a confrontation with the United States. Therefore, invading Taiwan might be tempting in theory but is not likely to happen. China does not have the naval power to force its way across the Taiwan Strait, and certainly not the ability to protect convoys shuttling supplies to Taiwanese battlefields. China is not going to develop a naval capacity that can challenge the United States within a decade. It takes a long time to build a navy.

China, then, has three possible future paths. In the first, it continues to grow at astronomical rates indefinitely. No country as ever done that, and China is not likely to be an exception. The extraordinary growth of the past thirty years has created huge imbalances and inefficiencies in China’s economy that will have to be corrected. At some point China will have to go through the kind of wrenching readjustment that the rest of Asia already has undergone.

A second possible path is the recentralization of China, where the conflicting interests that will emerge and compete following an economic slowdown are controlled by a strong central government that imposes order and restricts regions’ room to maneuver. This scenario is more probable than the first, but the fact that the apparatus of the central government is filled with people whose own interests oppose centralization would make this difficult to pull off. The government can’t necessarily rely on its own people to enforce the rules. Nationalism is the only tool they have to hold things together.

A third possibility is that under the stress of an economic downturn, China fragments along traditional regional lines, while the central government weakens and becomes less powerful. Traditionally, this is a more plausible scenario in China – and one that will benefit the wealthier classes as well as foreign investors. It will leave China in the position it was in prior to Mao, with regional competition and perhaps even conflict and a central government struggling to maintain control. If we accept the that China’s economy will have to undergo a readjustment at some point, and that this will generate serious tension, as it would in any country, then this third outcome fits most closely with reality and with Chinese history.

A very real future for China is its old nightmare - a country divided among competing regional leaders, foreign powers taking advantageof the situation to create regions where they can define economic rules to their advantage, and a central government trying to hold it all together but failing.

Meh. Anyone can make a nice story using simple generalities.

That is true, assuming the generalities are false. His points seem pretty potent.

The biggest generality is probably that if the Chinese government lost its ability to make people rich, all the bureacrats and other government officials would leave in droves and the Chinese people would not support it… However, from what zeppelin has said in his other posts, this seems not that far a stretch.

A story is a story. As long as it hasn’t happened, it isn’t reality. Its not because someone says something that rings well with how people like to see things that its how things are.

Not to backseat mod or anything, but this really could have been posted in the other thread. Don’t know why it deserves its own thread.

anyway, I dont’ really disagree with anything the author describes, though I think the description of a paper tiger is perhaps a bit over the top. Plenty of Asian tiger economies have gone through similar phases as China. Complete and utter disaster did not ensue as a result: in fact, when the asian tiger economies slowed down, a slow process toward liberalization and democritization has generally occurred. It happened in Japan, South Korea, Taiwan, and now even Singapore is starting to open up as things slow down. The author seems to want to say “look at what happened to Japan - disaster is coming in China!” Japan did not have a “disaster” when the bubble burst though. It is still the second largest economy in the world, and the second largest consumer. It has invested heavily in its own infrastructure and social safety nets since the bubble burst in the 1990’s, so even if it’s not as crazily rich as it was, it is still a stable, healthy society. As I said, similar processes of events have happened in other Asian countries as well.

I agree that China will become more regional. It already has become greatly more regional. I do not think the country will break up into civil war, but regional and local governments (who are already) experimenting with democratic-style local elections are already asserting more political and economic self-determinism. Check out this article:

zhejiang province has always been a center of business and trade. It lies on the southeastern coast of the country, where trade has always flourished. When Mao clamped down on these activities, a lot of them went underground, and the largest private banking system in China developed. Even after Mao’s death, the government spent two decades trying to crackdown on this system, because it wanted to control capital from the center. It never worked, and now the government is giving in, legitimizing the system, and even using it as a model for other regions to develop capital infrastructure. This is going to be the future.

If someone wants to just tack the posts in this thread onto ‘ticking time bomb’, go right ahead.

I don’t think Friedman is arguing that there will be overt civil war, or a breakdown in society… but rather, that the “regionalism” in China will hamstring its ability to act as a superpower. That’s what he meant by ‘Paper Tiger’ - that China will not be able to challenge the U.S. as a military or even economic superpower, because each region will have conflicting interests and will be looking out for itself, hurting the ability of China to act as a unified nation. So fears about China taking over the world or even challenging the U.S. are over-inflated.

As for the comparison with Japan… the idea is that Japan is a very different society than China. Japan had “political discipline” that China doesn’t - as Friedman points out, China’s political unity is based mostly on money, so when the money stops pouring in, the political discipline evaporates, leading to the regionalism.