The Sunday Review

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The end of China's era of growth

OVER the past two decades, China has achieved some of the world's highest rates of economic growth under the authoritarian -- although no longer totalitarian -- rule of the Communist Party.

Steeply rising living standards for the mass of the population, especially in the cities, damped down political and social discontent. There are signs, however, that this era of extraordinary growth has ended, with incalculable consequences for the country's political and social order. The reasons are related not only to the East Asian and global economic crisis, but also to internal economic, social ecological and political problems.

Slowing economic growth presents the state with some fundamental and possibly insoluble dilemmas. Former paramount leader Deng Xiaoping's economic reforms required jettisoning a great part of communist ideology, not just that of Mao Zedong, but even that of Karl Marx. This was especially true after the violent suppression of the "pro-democracy" movement in 1989, when Deng sought to buy off mass discontent by committing the Communist Party and the state to rapid free-enterprise growth and higher living standards.

But the party also tried to keep the loyalty of urban workers and local managerial elites by channelling huge subsidies into loss-making state-owned enterprises (SOEs), which continue to dominate the industrial sector.

At the end of January, the governor of China's Central Bank, Mr Dai Xianglong, admitted for the first time that devaluation is a possibility at some point in the future. Chinese and Western economists are increasingly convinced that a restructuring of the economy and, above all, a cut in these subsidies are essential if China is to avoid a deepening economic crisis, let alone resume fast growth.

This necessity has been accepted in principle by the central government and, especially, by the new Prime Minister Zhu Rongji. But closing or reducing a large number of these SOEs will lead to a vast increase in urban unemployment and might renew the alliance between discontented workers and pro-democracy students. It is also questionable whether the state is strong enough to take steps that would infuriate both ordinary people and many powerful members of the elite, especially in the provinces.

THE FALTERING ECONOMY

BETWEEN 1978 and 1997, China enjoyed an annual average growth rate of 8.2 per cent in terms of gross domestic product. However, there has always been some doubt about the reliability of these figures. The official GDP growth figure for 1998 was 7.8 per cent -- just below the official target of 8 per cent -- but few Western economists believe this to be credible given the impact of East Asia's financial crisis.

Moreover, the boom was not due solely to the introduction of market freedoms and disciplines, the growth of agricultural production, the release of entrepreneurial skills and the inflow of foreign investment and managerial expertise. It was also underpinned by the policies protecting and supporting SOEs.

The central government poured more than 80 per cent of the state banks' financial assets into SOEs to encourage growth. This was regarded as socially and politically essential, since more than 75 per cent of urban households work in the state sector. Even according to official calculations, however, around 20 per cent of these loans are non-performing, and the real figure could be up to three times higher. In other words, most Chinese state banks are technically bankrupt.

Subsidies for urban industry can also be seen as a massive transfer of resources from the countryside where, as of 1997, around 70 per cent of the population lived. This shift deprived the rural economy, and especially the poorer interior provinces, of many of the benefits of economic growth, although agriculture powered much of the economy's development. Thus in 1984, Chinese urban residents comprised only 22 per cent of the population but purchased 40.8 per cent of consumer goods. By 1997, they made up 29.9 per cent of the population and no less than 61.1 per cent of the consumer market.

Parts of the countryside are also increasingly affected by environmental degradation. Among the most serious aspects of this problem are a rising shortage of water for irrigation and severe deforestation, contributing both to massive soil erosion and increased flooding. The great Yangtze floods of last summer are estimated to have wiped up to 1 per cent off the Chinese GDP.

The widening urban-rural income gap decreased rural demand for lower-quality, state-sector goods. Meanwhile, the level of state subsidies to SOEs cannot be sustained without undermining the central budget and currency fatally, leading to the kind of inflation that helped spark the Tiananmen protest.

For the first time in many years, state finances are also being weakened by an outflow of foreign investment. In the first nine months of 1998, approximately US$20 billion (S$33.6 billion) of funds were taken out of China. One reason for this is East Asia's economic crisis -- more than 70 per cent of foreign direct investment in China comes from the Far East -- but a number of Western firms are disappointed with the Chinese consumer market, which is too poor to buy many foreign goods.

On the surface, China's trade figures still look very good: between January and September last year it had a current-account surplus of US$35.3 billion. However, these statistics are dependent on a continuing US consumer boom, and also on America's willingness to keep its markets open to Chinese imports.

Following his appointment on March 17 last year, Prime Minister Zhu Rongji announced that the government would reform the state sector and urban-welfare system radically. The plan is to reduce loans to inefficient SOEs, modify the banking sector significantly, dismiss 30 million state employees over the next three years, raise funds by selling urban public housing and cut medical welfare.

By the end of 1998, up to 20 million public-sector workers had been laid off or given early retirement. The Ministry of Labour warned last month that some 16 million Chinese will be unable to find work this year.

Such policies have changed urban income levels and consumer behaviour dramatically. A September 1998 opinion poll revealed that only 23 per cent of respondents experienced income growth that year, while 76 per cent said their income had not changed or had fallen. Financial constraints are also resulting in the late payment of wages to state workers.

'CRONY CAPITALISM'

UNDER communism, and to a considerable extent up until the present, the state has guaranteed urban workers an "iron rice bowl" in terms of employment and social welfare. This was a major contrast to the situation in the countryside, where the state controlled peasants' daily life strictly, but offered few extra job opportunities and minimal social benefits.

Consequently, peasants embraced the market economy without hesitation, since they had little to lose and much to gain from their new economic freedom. Most urban dwellers, however, are beneficiaries of the welfare system and thus have good reason to fear change.

So too do many members of the Chinese elite -- not only the old communist elite, but also many new businessmen, insofar as the two groups can be separated. Over the past two decades, and especially during the 1990s, there has been a growth of powerful networks of "crony capitalism".

These mainly involve Communist Party and state elites, but also include new entrepreneurs, overseas Chinese businessmen and, in some areas, organised-crime bosses. The wealth of the industrial, trade, real-estate and other companies that they control depends on protection from senior officials and access to soft loans from the state banking system. These local cliques use the police to defend themselves against public protest.

The interests of these elites and of many Chinese workers therefore coincide when it comes to resisting serious reform of SOEs and, even more so, of the banking sector. The dependence of so many private businesses on corrupt official connections also casts doubt on the belief that privatisation will necessarily lead to increased economic efficiency.

Paradoxically, the promised cuts in the bureaucracy are helping, at least in the short term, to increase corruption. As more officials recognise the future danger and lose confidence in their political careers, they take every possible opportunity to transfer public assets into their own pockets. Widespread and obvious official corruption, as well as rapidly increasing social differentiation, heightens popular discontent. A 1998 estimate by Chinese economist He Qinglian suggests that 20 per cent of the population owns around 50 per cent of China's national wealth, while barely 4 per cent is held by the poorest fifth.

Increased elite corruption is in part a result of moral confusion stemming from the virtual abandonment of communist ideals without the introduction of either democratic controls or a new ethical system. Theft and illegality are also being fuelled by the growing desire for Western luxury items and lifestyles, which very few officials or state managers can afford by legal means. As such attitudes and behaviour spread among officials and their children, it is increasingly difficult for the central state to impose its will, especially given the close-knit, mutually protective nature of provincial elites and their business allies.

START OF A NEW CYCLE?

PUBLIC anger at corruption and growing hardship is already producing an increasing number of demonstrations and strikes, although so far these have been local, disorganised and on a fairly small scale. On Jan 8, thousands of peasants protested at high taxes and official corruption near Changsha in the southern province of Hunan. Also in January, large-scale peasant protests were reported from Shanxi and Jiangsu provinces. Last year, distress associated with the Yangtze floods led to more than 130 attacks on government offices, food stores, officials and policemen.

Equally important, Chinese intellectuals are beginning ever more fiercely to criticise corruption and crime. They are being encouraged to do so by central officials, including both those who want stronger reforms and those who dream of restoring communist values. However, the process of public complaint and criticism could easily spiral out of control and once again threaten the state. The number of dissidents prepared to risk imprisonment to press for democracy is small but appears to be growing fast. An attempt by dissidents to create a public opposition movement, the China Democratic Party, led to around 30 arrests last summer.

Even most reformist officials do not accept the dissidents' argument that greater democracy is necessary to control corruption and crime, and to mobilise support for economic reform. They remember all too well that former Soviet President Mikhail Gorbachev's political liberalisation led to an explosion of crime, economic catastrophe and the collapse of the state itself. They hope to preserve state power through a mixture of intelligent macro-economic management, selective repression of dissent and harsh exemplary punishment of some leading officials and criminals.

Compared to their counterparts in Moscow, the men at the very top of the Chinese system are much more able, even more ruthless, and, in many cases, more honest and patriotic. They represent a much older and stronger state tradition, and over the past two decades, they have increased China's wealth greatly. But in so doing, they have knocked away the moral basis of communist rule and weakened the Communist Party gravely. If the economic foundations fail as well, the Chinese state will be in serious danger.

[The International Institute for Strategic Studies (IISS) is a London-based think-tank. This article is part of a series on strategic issues published monthly by the institute.]

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