Tuesday 25 October 2016

Jonathan Fenby: Trapped under the Great Fall of China

We will all be winners if Beijing bows to market forces, but China faces a choice between top-down control and dynamic capitalism, writes Jonathan Fenby

Jonathan Fenby

Published 29/08/2015 | 02:30

Investors react as they look at computer screens showing stock information at a brokerage house in Fuyang, Anhui province, China
Investors react as they look at computer screens showing stock information at a brokerage house in Fuyang, Anhui province, China

For 35 years, China has played a Marxist-Leninist-capitalist game. Following the model laid down by Deng Xiaoping when he launched partial economic reform at the end of the 70s, it has tried to use market forces to introduce reform, while retaining the top-down control beloved of Communist parties.

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Now the time is fast approaching when the leadership in Beijing has to make a choice, or risk being caught in a middle-development trap that would thwart its ambitions to rival the United States on the world stage.

Its decision will have a global impact, including on Europe; if China becomes more economically liberal and open, it will be good for exporters to the world's second-biggest economy. If the Communist leadership fails to reform, it could make the People's Republic a more awkward partner that is less able to contribute to the growth the world needs.

Whatever happens, we have to brace ourselves for a period of slower growth from the economy that had been seen as the main source of global expansion.

This week's interest rate cut by the People's Bank of China was a sticking plaster solution, rather than the kind of reform the country really needs.

The Deng-era formula of cheap labour, cheap capital and strong exports has lost its validity as wages have risen, money has become more expensive and foreign demand is not what it used to be. But the trouble with thoroughgoing reform, which is required if China is to move to a new stage of economic development, is that it would upset the structures on which the Communist Party rests.

The tension has been evident in the recent convulsion of Chinese stock markets, which set off an unwarranted global panic at the start of the week. The Beijing government had decided, sensibly given its commitment to financial reform, that companies should be encouraged to raise capital by issuing shares instead of relying on borrowing and increasing the country's debt mountain. The result was boom turning into a bubble, which led to an inevitable crunch, helped along by short sellers.

The authorities stepped in to try to prop up prices. But the slump this week showed the limits of that as investors, most of them individuals rather than institutions, took fright. Now the authorities seem to have changed tack again and are ready to let the market find its own level - something they should have done in the first place. The uncertainty bred by this switching policy approach has chipped away at the leadership's reputation for competent economic management. This is a risky position: it needs that reputation to instil the public confidence in its ability to deliver economic results that gives it the legitimacy it lacks from the ballot box.

The decision last week to make China's currency, the renminbi, more subject to market forces was another example of the limits to reform that the government and Communist Party are ready to accept. After the initial drop, strong intervention put a floor below the renminbi - the devaluation that spooked markets after the announcement will, clearly, be closely controlled with the backing of China's huge foreign exchange reserves.

But the stakes go much deeper than the performance of China's stock markets, which have always been quite marginal to the overall health of the nation.

The real economy is where the tug-of-war between economic modernisation and political power is being fought - and the signs so far are that the latter is winning. That risks putting a dampener on progress in the medium to long-term, even if it protects the Leninist system for the time being.

When it acknowledged the need for economic reform - with no mention of political change - at a top-level party meeting at the end of 2013, the leadership said it wanted to "harness the dynamic forces of the market" to bring out modernisation. But it added that the aim was to increase the dominance of the state. Nearly two years later, the paradox that this encapsulates is becoming ever more apparent. Xi Jinping, the most powerful Chinese leader since Deng, has this year increased the grip of the political power apparatus with a catch-all national security law, the detention of human rights lawyers, stringent new regulations for foreign NGOs and a series of ideological pronouncements warning against Western values. His approach makes it unlikely that he will relinquish control over the economy, however strong the arguments of reformers.

The bottom line is to strengthen the party and avoid change, which could lead to a Gorbachev-style meltdown.

The time for a choice is approaching but the betting must be that it will be for a preservation of the system rather than the structural change China needs. That will shape not only China's future but also us all given the country's global weight.

Jonathan Fenby is author of 'Will China Dominate the 21st Century?'

©The Daily Telegraph


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