Managing a Faltering China
 
In Washington and other capitals around the world “the defining geopolitical story of our time is the slow death of U. S. hegemony in favor of a rising China.  Harbingers of Beijing’s ascent are everywhere.  China’s overseas investments span the globe.  The Chinese navy patrols major sea lanes, while the country colonizes the South China Sea in slow-motion.  The government cracks down on dissent at home, while administering a hefty dose of nationalist propaganda around the world.”

Yet, like so much of today’s conventional wisdom, this story does not stand up under scrutiny.

Beijing’s newfound assertiveness looks, at first glance, as the mark of growing power and ambition.  But in fact, it is nothing of the sort.  China’s actions reflect profound unease among the country’s leaders, as they contend with their country’s first sustained economic slowdown in a generation and they can discern no end in sight. China’s economic conditions have steadily worsened since the 2008 financial crisis.  The country’s growth rate has fallen by half and is likely to plunge further in the years ahead, as debt, foreign protectionism, resource depletion, and rapid population aging take their toll.

But while China’s economic woes will make it a less competitive rival in the long term, they make it a greater threat to the United States, today.  Why?  As Michael Beckley recently explained in Foreign Affairs, “When rising powers have suffered such slowdowns in the past, they became more repressive at home and more aggressive abroad.  China seems to be headed down just such a path.”

In March 2007, at the height of a years-long economic boom, then-Premier Wen Jiabao gave an uncharacteristically gloomy press conference.  China’s growth model, Wen warned, had become “unsteady, unbalanced, uncoordinated, and unsustainable.”  The warning was prescient: in the years since, China’s official gross domestic product growth rate has dropped from 15 percent to six percent -  the slowest rate in 30 years.  And China’s economy is now experiencing its longest deceleration of the post-Mao era.

If real, a growth rate of six percent could still be considered spectacular; the U.S. economy was stuck at a rate of around two percent from 2008 to 2016.  But many economists believe that China’s true rate is less than half the official figure.  Moreover, GDP growth does not necessarily translate into greater wealth. If a country spends billions of dollars on infrastructure projects, its GDP will rise.  But if those projects consist of “bridges to nowhere,” the country’s stock of wealth will remain unchanged or even decline.  To accumulate wealth, a country needs to increase its productivity -  a measure that has actually dropped in China over the last decade.  Practically all of China’s GDP growth has resulted from the government’s pumping capital into the economy. Subtract government stimulus spending and China’s economy may not be growing at all, or even shrinking.

The signs of unproductive growth are easy to spot. China has built more than 50 ghost cities -  sprawling metropolises of empty offices, apartments, malls, and airports.  Nationwide, more than 20 percent of homes are vacant. Excess capacity in major industries tops 30 percent: factories sit idle and goods rot in warehouses.  Total losses from all this waste are difficult to calculate, but even China’s government estimates that it blew at least $6 trillion on “ineffective investment” in just five years between 2009 and 2014.  Even worse, China’s debt quadrupled in absolute size over the last ten years and currently exceeds 300 percent of its GDP.  No major country has ever racked up so much debt so fast, in peacetime.
 
Worse still, assets that once propelled China’s economic ascent are fast turning into liabilities.  In the 1990s and early 2000s, the country enjoyed expanding access to foreign markets and technology.  China was nearly self-sufficient in food, water, and energy resources, and it had the greatest demographic dividend in history, with eight working-age adults for every citizen aged 65 or older.  Now China is losing access to foreign markets and technology.  Water has become scarce, and the country is importing more food and energy than any other nation, having decimated its own natural resources.  Thanks to the one-child policy, China is about to experience the worst “aging crisis” in history; it will lose 200 million workers and young consumers and gain 300 million seniors in the course of three decades.  Any country that has accumulated debt lost productivity, or aged at anything close to China’s current clip has slipped to near-zero economic growth for at least a decade.

As Beckley explains, “When fast-growing great powers like China run out of economic steam, they typically do not mellow out.  Rather, they become prickly and aggressive.  Rapid growth has fueled their ambitions, raised their citizens’ expectations, and unnerved their rivals.  Suddenly, stagnation dashes those ambitions and expectations while giving enemies a chance to pounce.  Fearful of unrest, leaders crackdown on domestic dissent.  They search feverishly for ways to restore steady growth and keep internal opposition and foreign predation at bay.  Expansion presents one such opportunity -  a chance to seek new sources of wealth, rally the nation around the ruling regime, and ward off rival powers.”

Historical precedents are numerous.  Over the past 150 years, nearly a dozen great powers experienced rapid economic growth followed by long slowdowns.  None accepted the “new normal” quietly.

-   S. growth plummeted in the late nineteenth century, and Washington reacted by violently suppressing labor strikes at home while pumping investment and exports into Latin America and East Asia, annexing territory there and building a gigantic navy to protect its far-flung assets.

-   Russia, too, had a late-nineteenth-century slowdown. The Tsar responded by consolidating his authority, building the Trans-Siberian Railway, and occupying parts of Korea and Manchuria.

-   Japan and Germany suffered economic crises during the interwar year and both countries turned to authoritarianism and went on rampages to seize resources and smash foreign rivals.

-   France had a postwar boom that fizzled in the 1970s: the French government then tried to reconstitute its economic sphere of influence in Africa, deploying 14,000 troops in its former colonies and embarking on a dozen military interventions there over the next two decades. And

-   As recently as 2009, world oil prices collapsed, which led a stagnating Russia to pressure its neighbors to join a regional trade bloc. A few years later, that campaign of coercion spurred Ukraine’s “Maidan revolution” and Russia’s annexation of Crimea.

The question, then, is not whether a struggling “rising power” will try to expand abroad, but what form that expansion will take. The answer depends in part on the structure of the global economy.  How open foreign markets are?  And How safe international trade routes are?  If circumstances allow it, a slowing great power might be able to rejuvenate its economy through peaceful trade and investment, as Japan tried to do after its postwar economic miracle came to an end in the 1970s.  If that path is closed, however, then the country in question may have to push its way into foreign markets or secure critical resources by force -  as Japan did in the 1930s.

Like so many trends rooted in demography and human behavior, this one can be influenced by technology but remains largely irreversible.  How will China handle the coming slump?  How will the U. S. and EU respond?  The answers will shape the global reality in the 2020s and beyond.

Given this trend, we offer the following forecasts for your consideration.

First, the era of hyper-globalization that enabled China’s extraordinary rise is over.

While the global economy is still more open today than prior to the 21st century, a global rise in protectionism, as well as the bilateral trade war with the United States, increasingly threatens China’s access to foreign markets and resources.  China’s “free ride” at the expense of American and EU producers is over.  China will be forced to play by international rules or be cut-off from the global economy.  Multi-national corporations are already responding by rerouting an increasing portion of their supply-chains around China.

Second, China will double down on mercantilist expansion in an effort to keep the domestic economy from collapsing.

The structure of a country’s home economy inevitably shapes its response to a slowdown.  The Chinese government owns many of the country’s major firms, and those firms substantially influence the state.  For this reason, the government will go to great lengths to shield these companies from foreign competition and help them conquer overseas markets when profits dry up at home.  A state-led economy like China’s will not liberalize during a slowdown.  Doing so would require eliminating subsidies and protections for state-favored firms; such reforms risk instigating a surge in bankruptcies, unemployment, and popular resentment. Liberalization of China’s economy would also disrupt the crony-capitalist networks that the regime depends on for survival.  Regimes like China’s inevitably will double-down on mercantilist expansion, using money and muscle to carve out exclusive economic zones abroad and divert popular anger toward foreign enemies.

Third, China will ramp up domestic repression and control.

China’s recent behavior is a textbook response to economic insecurity. Back in the 1990s and the early years of this century, when the country’s economy was booming, China loosened political controls and announced to the world that its “peaceful rise,” would be pursued through economic integration and friendly diplomatic relations.  Compare the situation today: labor protests are on the rise, elites have been moving their money and children out of the country en masse, and the government has outlawed the reporting of negative economic news. President Xi Jinping has given multiple internal speeches warning party members of the potential for a Soviet-style collapse.  Furthermore, the government has doubled internal security spending over the past decade, creating the most advanced propaganda, censorship, and surveillance systems in history.  It has detained one million Uighurs in internment camps and concentrated power in the hands of a “dictator for life.”  State propaganda blames setbacks, such as the 2015 stock market collapse and the 2019 Hong Kong protests, on Western meddling.  These are not the actions of a confident superpower.

Fourth, China will increasingly invest in the mechanisms for projecting power abroad.

On the military front, it launched more new warships over the past decade than the whole British navy operates it and flooded major sea lanes in Asia with hundreds of government vessels and aircraft.  It has built military outposts across the South China Sea and frequently resorts to sanctions, ship-ramming, and aerial intercepts in territorial disputes with its neighbors. 

Fifth, the United States will counter Chinese commercial, diplomatic and military threats by leveraging its inherent advantages.

When the country’s leaders cannot rely on rapid growth to bolster their domestic legitimacy and international clout, they will be all the more eager to squelch dissent, burnish their nationalist credentials, and boost the economy by any means necessary.  Rampant espionage, unfair trade practices, naval clashes in the East and South China Seas, and a war over Taiwan are only the most obvious risks that a desperate and flailing China will pose.  U. S. statecraft will seek to contain these risks without causing China to lash out in the process.  To that end, Washington will have to deter Chinese aggression, assuage China’s insecurities, and insulate the United States from blowback should deterrence and reassurance fail. The inherent tension among these objectives will make the task a very difficult one.  The right initiatives could help it strike the proper balance.  And,

Sixth, Hong Kong will serve the first big test of whether China can deal with the new realities.

Given the geopolitical and commercial realities, the Trends editors believe that the State Department has already warned Xi that the cost of military intervention will be capital flight, brain drain and the end of Hong Kong’s preferential trade status, as well as any hopes of a satisfactory bi-lateral trade deal.  Specifically, if he launches a crackdown in Hong Kong, then the United States will repeal the Hong Kong Policy Act, largely eliminating the rationale for nearly 1,400 U. S. businesses to operate in Hong Kong.  The United States will also welcome Hongkongers as refugees from the most economically vibrant city on Earth; these hard-working, creative, entrepreneurial people are precisely the kind of immigrants Trump has said he wants to come into our country.  Xi also knows that China would face massive tariffs and international sanctions that could send its economy into full contraction causing the kind of instability and protests on the mainland that the Communist Party of China wants to avoid at all costs.  In short, a military operation, even if it succeeded, would be a Pyrrhic victory.  The question now is, “How does China put the “Hong Kong genie,” back in the bottle?”

References
1. October 22, 2019.  Derek Scissors.  Is the U. S. economy pulling away from China?

https://www.aei.org/foreign-and-defense-policy/is-the-us-economy-pulling-away-from-chinas/

 
2. Bloomberg Opinion.July 23, 2019.  Hal Brands.  Every president since Reagan was wrong about China’s destiny.

https://www.bloomberg.com/opinion/articles/2019-07-23/every-president-since-reagan-was-wrong-about-china-s-destiny

3. Foreign Affairs.October 28, 2019.  Michael Beckley.  The United States Should Fear a Faltering China.

https://www.foreignaffairs.com/articles/china/2019-10-28/united-states-should-fear-faltering-china

4. Foreign Affairs.September 21, 2019.  Michael Beckley.  Stop Obsessing About China.

https://www.foreignaffairs.com/articles/china/2018-09-21/stop-obsessing-about-china

5. The Washington Post.Mark Thiessen.  August 19, 2019.  China does not have the upper hand in Hong Kong. Trump does. 

https://www.washingtonpost.com/opinions/2019/08/15/china-does-not-have-upper-hand-hong-kong-trump-does/

6. The Hill.  08/14/19.  GARY SCHMITT.  Europe faces a security threat from the rise in Chinese military power.

https://thehill.com/opinion/international/457399-europe-faces-security-threat-from-the-rise-in-chinese-military-power