Tuesday, February 3, 2009

China Enters A New And 'Interesting' Phase

Making observations about geopolitics is often hazardous even for the seasoned analyst - events have a way of intervening in the most embarrassing ways. As we have seen with the economic crisis, a small number of economists did accurately warn about the coming meltdown and were roundly ignored by those in power, who universally said that there was no chance of a recession until the economy was already capsizing.

This is not to blame anyone for this state of affairs. Hindsight is a splendid thing, and when trying to operate in real time, one has to deal with human systems which are (too) complex and inter-dependent, wherein any move is usually met by a quick and often unexpected counter-move or a gambit to exploit an inadvertent opening. Natural eco-systems are not very different most of the time.

The above preamble is a kind of disclaimer. Despite the likelihood of being wrong in prognosis, there are some big picture items that we just have to try to diagnose and discuss even if we don't have the complete picture or anywhere near. One of these is the situation in China. There are several nations that have a disproportionate effect on the world, and China has become one of them. China has been a famous enigma for a few thousand years and it doesn't look as if that will be changing any time soon.

Until recently, it has become the done thing to say that the Chinese economic miracle will carry it through to being the largest economy in the world, and that along with the rising India and a possibly resurgent Japan, the centre of the world will keep shifting towards the East and South Asia. It is possible that this is what will play out, but it might happen in unexpected ways or not all.

The economic crash has taken China by surprise, as it has every other country. The reduction in economic activity is causing a huge increase in unemployment, which is not easy to cope with in any country (neither for those without jobs nor those trying to govern), but in China the situation is rather more tricky, because every year it has to absorb six to eight million new migrant rural workers into the eastern industrial and heavily urbanised part of China.

It is said that every percentage point of Chinese growth (per year) creates about a million jobs. One can readily see why it is necessary for China to grow at a rate in excess of 8% per year. Anything less risks social destabilisation. However, China's growth is showing signs of falling below this number (leaving aside the question of whether the growth figure may be exaggerated).

Signalling that all is definitely not well with the Chinese industrial machine, some 20 million of the roughly 130 million migrant workers are now reported unemployed. This number does not show up in official unemployment statistics because migrant workers are not counted. There is little question that such a huge number of displaced unemployed people showing up in the poverty-stricken villages of China has the potential to cause trouble.

The Chinese leadership is only too painfully aware of the situation and is trying to introduce policies to stabilize and reverse the economic decline. They are doing this for a number of reasons including the fact that they don't want to see social order break down (which government does?) and they also see signs that the economic miracle has promoted the regions too much leading to an age-old problem of local and potentially uncontrollable power bases developing.

It is therefore imperative that the Chinese economic stimulus, now underway for two months, work quickly and effectively. Specifically in response to the rural migrant worker problem, the measures include subsidies and training programmes, and encouraging the formation of new small businesses, though there is little optimism that the latter will have much traction in the poorest, most cash-starved areas, at least in the short term.

Rural health care systems are being proposed, and much more boldly, China has just announced that it will spend $123 billion to provide universal health care within two years instead of eleven. This in itself could relieve a lot of potential social and economic tension (as it might in America, were it ever to be tried).

The economic stimulus package is also going to spend massively on constructing new inter-city rail lines - $88 billion is proposed, with $44 billion having already been spent last year. If China were able to power these trains with renewable electricity instead of coal or imported diesel, it would have moved a long way to having a sustainable transport system. Given Chinese expansion in wind and solar PV, such an idea cannot be ruled out.

The Chinese leadership knows there is plenty of trouble with the country, but they are certainly taking vigorous action. There are signs of incoherence and conflicting policy aims, but China has weathered these before. With the petroleum price now fallen so far from last year, however temporarily, and waning industrial activity, China is importing less oil even as it builds its own new strategic petroleum reserves.

There are many other problems besides those mentioned here and the stimulus and other policies may not all work as intended. But for the world, the consequences of China's new path may be easier to grasp, however unwelcome in some quarters, because whether China succeeds or not, it looks like it will start pulling back from the heavy emphasis on global export trade as it concentrates on domestic development. It should be noted that it is unlikely to pull back from its need to import oil, especially if the domestic stimulus works.

A withdrawing China would have some interesting effects to put it mildly, and one of the most interesting would be if China starts liquidating its holdings of US treasuries just when America needs China - and anyone else - to start buying even more. China has withdrawn from the world before, but this does not appear to be what China is planning now, rather a refocusing on domestic issues and infrastructure, not least because it does not wish to emulate the kinds of collapse that the economies of Japan or the Asian Tigers underwent after growing too fast.

It is a trite and now cliched saying, but China really does look as if it is heading into 'interesting times', with both danger and opportunity in its own future and in its relations with the rest of the world. As a broad brush stroke, that much at least is not too hazardous an observation. The unfolding details may be another matter.

Sources: NYT, WSJ, Reuters, FT, Stratfor: Baker Friedman, CIA, P&C

No comments: