China must pander to its rising middle class to see off this crisis

 
Neil Dwane
President Xi has been clear that he wants to create the “Chinese dream” (Source: Getty)
China has emerged as the world’s second largest economy, with its growth breaking every record, even surpassing that seen in Germany and Japan after the end of World War Two. Since 2010, China has represented over 50 per cent of the world’s incremental GDP growth, with its fortunes carrying enormous implications for international investors and the global economy.
Many visitors to China’s dynamic cities would no longer see it as an “emerging market”. But the reality is that it is facing one of its most arduous economic challenges yet, as it rebalances away from the manufacturing of property and products.
Eventually, all emerging economies have to break through the low income ceiling and create a middle income economy that offers a significant widening and sharing of the economic benefits from the wealth created. This won’t be easy – the US and Europe took decades to achieve it and, to date, not that many Asian economies have succeeded.
So can China make it? It has the size of its economy on its side and the benefit of strength in numbers from its large population. Yet the challenge is also immense.
Industrial economic rebalancing will lead to a need to improve the levels of education and skills in the workforce to cater for new service industries and technologies. Sheer numbers will not be enough to move the dial – what China needs is its own innovative culture.
While it has successfully created its own social media and related online market industries, the largest part of the economy is still dominated by State Owned Enterprises (SOE) that run, control and influence the major industries and sectors.
The political environment, encompassing everything from anti-corruption policies to regional politics, remains delicate. And the environmental cost of China’s growth has been high, with tremendous loss of agricultural land, water and river damage, as well as related healthcare and food security issues.
China has a relatively undeveloped “traditional medicine” healthcare system, which ensures that modern medicines are expensive. Although personal taxation is not a great burden on the populace, China needs to find a balance between better health, welfare and pension safety nets for its population, which will age quickly from now on, managing the resulting pressures on the economy in the shorter term as dependencies rise.
Ultimately, rebalancing towards services will necessitate the emergence of a real middle class. Education standards are rising, and in the internet age so are opportunities, but it remains crucial that the Communist Party allows a society with more freedoms and choices to evolve.
History shows that middle class evolutions come entwined with greater personal freedoms, stronger legal systems and free movement of capital. China has, we believe, understood that its economic business model must evolve towards services – in 2015 they may contribute about 50 per cent of GDP – but the ability of these companies to access capital has been hampered by the SOEs and their relationships to the big banks and local governments through a centrally-planned economy.
The power of the Party is also being increasingly concentrated in the hands of President Xi and, as such, “key man” risk may evolve. He has been clear that he wants to create the “Chinese dream” by producing more equal opportunities. Capital outflows suggest some do not share his enthusiasm for this new direction, however, so challenges to his authority could emerge if the economy stalls or the restructuring loses purpose.
But the outlook may be better than it seems. Ironically, there is a greater chance that a determination to stay in power will encourage or force both Xi and the Communist Party to make many of the right decisions, simply because economic success is the greatest validation of the Party’s right to rule.
Further, China still has a great wealth of talent and the capacity to sustain its development momentum, while the US is showing how hard it is to restart an economic behemoth twice the size.
China has access to large amounts of capital and could attract much more from its diaspora, as well as international investors, as it forges freer markets. Its reliance on government-backed debt can be adjusted over time and its vast hoard of domestic savings put to better use, with a concurrent implementation of basic health and pension safety nets.
The “great rejuvenation of the Chinese people” has become a stated aim of Xi. A strong and assertive China could be seen as a threat to all in the region and to the US’s global power. Paradoxically, however, a weaker or failing China could actually be more of a threat to the region and to the resolution of global issues, simply because China wouldn’t have the domestic self-confidence to respond and react.
So in a world enduring another year of financial repression, where growth is fragile and political vacuums leave little room for longer-term restructuring policies, China has a better chance of remodelling its economy than most. This, of course, will force many in Asia to change too, with their carriages hooked to the Chinese locomotive. This should be positive for the next regional engine, India, which has much to learn to fulfil its potential as another global growth driver.
The easy yards may have been run in the last 25 years, but China still seems capable of being a positive force for the world’s economy for the next 25 years, albeit in a different, distinctly Chinese, way.

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