September 2015 - China: Learning to sail by braving the seas

During the military parade on September 3rd in Beijing to mark the 70th anniversary of WWII victory over Japan, President Xi Jinping wore a buttoned-collar jacket that reminded the Chinese public of the one worn by Sun Yat Sen, the Republic’s founder and a great modernizer.
Xi Jinping has a gift for sound bites, and his term of office began with talk of the ‘Chinese Dream’: ‘I believe that the Chinese Dream is the great rejuvenation of the Chinese nation.’ His ambition is to restore China to a position of regional and military dominance, and to provide the Chinese with a stable and ‘moderately well-off’ society. This concept of a ‘Chinese Dream’ might appear at first sight to be modelled on the shimmering success story of the USA, but it is in fact the title of a book by Colonel Liu Mingfu. A patriot in the progressive, anti-Japanese tradition of Sun Yat Sen, Mingfu believes that China must modernise if it is to surpass the United States. After over three decades of catching up (1978-2014), during which time GDP grew 22-fold, per capita income by a factor of 15 and output from 3% to 25% of American GDP (in purchasing power parity), China is on the threshold of a new era of modernisation. It has now attained the standard of living enjoyed by South Koreans around 1980; achieving the goal of a ‘moderately well-off’ society would mean a further increase (from the current situation of 21% of the standard of living in the United States, or the equivalent of 1951 Japan).
In May 2014 Xi Jinping persuaded the Central Economic Work Conference to agree to a ‘new normal’ concept of economic development. Put plainly, this implies a slower long-term growth rate (4-6% rather than 7-10%), and moving from ‘Made in China’ (the workshop of the world, with 60% of exports attributable to foreign firms) to ‘Made by China’ by 2025 through R&D, innovation and product upgrades, a greater focus on services, and a greener economy. The challenge will be to manage the transition between these different systems of growth, using the domestic market, major infrastructure projects and regional development to drive up living standards and maintain social stability, which is the regime’s core concern.
The challenges are huge. The country is plagued by yawning social inequality, so fighting corruption is a must. Air and water pollution and soil contamination have reached unprecedented levels, and the situation is worsening as regulations go unheeded. State oligopolies are reluctant to pay tax. As wages rise, people are saving more than is desirable, and feeding a real-estate bubble in a country where urbanisation (780 million city-dwellers, 224 million of whom have no residence permit) is one of the main drivers of growth. The financial markets are booming with little oversight, local authorities and companies are over-indebted, and there has been over-investment in industrial capacity in around a dozen sectors (steel, cement, aluminium, naval shipyards, solar panels, wind turbines) where streamlining would destroy jobs and threaten social stability.
The IMF estimates that China has over-invested the equivalent of 10% of its GDP, and says that this over-capacity will hinder the country’s transition to a new growth model. The state is encouraging companies to redirect this capacity towards exports, and this is the motive behind its projected ‘New Silk Roads’. Last but not least, the Chinese authorities see their main challenge as managing relations between the government and the market properly. During the summer of 2015, the Politburo Standing Committee of the Communist Party decided on a double devaluation of the yuan to prop up falling exports, coupled with massive interventions in financial markets. Is a freer market – one of the vectors of the ‘new normal’ – compatible with a greater concentration of political power?
China is not dependent on the global economy; its success in catching up with the rest of the developed world demonstrates the opposite. However, its transition towards a system based increasingly on endogenous growth is having a profound impact on countries that produce raw materials, as well as challenging European businesses to adjust to this changing economic landscape. The United States may be an enduring source of fascination for the Chinese, but the European Union is still a point of reference and an essential partner. On his most recent visit to Brussels, the Chinese Prime Minister committed his country to supporting the Euro, which Beijing regards as the reserve currency of a multipolar world.
Both the Chinese and the Europeans will need to ‘learn to sail by braving the seas’.

Michel Foucher
Former ambassador
Senior Advisor

Option Finance N°1332