Scott Kennedy, Deputy head of the China Studies Program at the American Center for Strategic and International Studies (CSIS, Freeman Chair in China Studies) studies the global economy “number two” from the position of political economy.

According to the analyst, which he expressed in one of his recent reports on Chinese reforms, China’s economic performance over the past four decades is as impressive as the Great Wall. Since the late 1970s, China has grown faster than any other country in history. But just as the Great Wall was not as effective as it is usually assumed, the foundation of China’s economy, according to an American expert, is weak. Due to the size of the PRC and its integration into global production networks, one thing is for sure: as the Chinese economy moves, so does the world economy. In addition, the danger of a failure of the Chinese economy is of enormous importance not only for the PRC, but also for the United States and everyone else.

From the late 1970s until 2010, China’s real economic growth averaged more than nine percent, but since then it has declined significantly, and amounted to 6.7 percent in 2016. But more worrying than the decline in growth is the collapse of productivity. The entire growth of the PRC is now achieved by mobilizing more money and labor, and not by improving human capital or technology. Now it takes three times more capital to create one unit of economic growth than in 2008. The result was a jump in debt, which now amounts to at least 280 percent of GDP, and which can overcome the 300 percent mark by the end of the year.

China has three strategies to stop this trend. The first is to reduce the size of the old economy by reducing capacity in the heavy industrial sector, which is dominated by sluggish state-owned enterprises, including steel and aluminum. The second is the expansion of the new economy by supporting high-value-added services and advanced technologies. And the third is to reform the financial system of local authorities, while strengthening the control of new financial instruments, such as capital management. The basic indicators reflect the economic restructuring; the services sector now occupies more than half of the economy, high-tech production is expanding rapidly, and the issuance of new loans is proceeding at a slow pace. But despite these efforts, productivity is still declining.

The reason for the problems, according to the expert, is the large-scale intervention of the state. In 2013, Chinese President Xi Jinping promised that the market would play a crucial role in the allocation of resources. But, in fact, the KP and government officials have increased, not decreased, their role in the economy due to industrial policy and mercantilism, and the closure of factories and the reduction of production are now the sphere of competence of politicians, not businessmen.

Under the “Made in China 2025” plan and other similar initiatives, billions of dollars, if not trillions, are being thrown into strategic industries, starting with semiconductors, and ending with artificial intelligence. That is why almost two dozen Chinese provinces are simultaneously investing in the production of memory chips. Companies and research institutes are registering useless patents in record numbers, because they get paid by officials for it. And government lending is still freely distributed to high-priority projects across the country, which is why the economy grew by 6.9 percent in the first quarter of 2017, despite the barely noticeable enthusiasm of the private sector.

The era of economic reform and openness, initiated by Deng Xiaoping in 1978, was built on the basis of gradual liberalization at home and greater openness to the outside world, although with the proviso that the monopoly of the Communist Party would not be threatened.

S. Kennedy recalls that under President Jiang Zemin and Prime Minister Zhu Rongji, China joined the World Trade Organization at the end of 2001 in order to use globalization to liberalize the Chinese economy and increase its efficiency. This commitment weakened under the next leader, President Hu Jintao, but he was weak and was influenced by conservative and liberal forces, which led to policies that jumped from one goal and tactics to another.

According to an American analyst, Chinese President Xi Jinping not only does not believe in the strength of the market, but he is much more influential than his predecessors. Despite the promises of reforms he made in 2013, he has always been an unreliable liberal, and as soon as the clouds gathered over the housing sector in 2014, Xi resorted to intervention and moved money to the stock market the following year. The sudden collapse of the Shanghai and Shenzhen stock exchanges that summer led to embarrassing measures that led to additional intervention. Reform now means not the development of market relations, but the strengthening of the state.

Certain elements of foreign industry take advantage of the Beijing state capitalist approach. Thank you, because American companies that sell consumer durable goods, services, transport goods and construction equipment are quite successful in China. But a growing number of foreign manufacturers-especially those at the top of the value chain-are now finding targets on their backs, placed there by China’s industrial policy bosses.

One study of think tanks after another shows that foreign companies feel less welcome in the Chinese market. Experience shows that even getting a “small piece from the big Chinese pie” brings significant income, and China’s statement that it maintains mutually beneficial relations with the world is now ironically understood as the principle of “only China wins” (China wins, China wins).

However, if the ” China Corporation “(as American experts often like to call it due to the collective style of state leadership, similar to the boards of directors in corporations) continues to compete and win illegally, everything will eventually end in a loss, especially for China. Its economy cannot continue to operate on a “high-calorie diet of industrial policy incentives”. It will become more difficult to maintain the global competitive environment and commercial models of industries, even if they operate far outside of China, despite the bottomless financing from Chinese sources. And all this can lead to macroeconomic instability and instability of the world.

There are several ways to completely change this trajectory, but they are all unlikely. Some believe that Xi may now deliberately act as a conservative nationalist in order to consolidate his power and implement a program of liberalization later, perhaps after the 19th Party Congress. This is probably a little more than a dream, but most likely we will see Xi, with whom we will have to live. Most likely, during the second term, he will carry out state intervention with a vengeance, rather than show himself as a true liberal.

The economic crisis may also present Xi with an inevitable choice, but China has many ways to avoid a full-scale crisis; it boasts huge savings and has virtually no external debt. Even in the event of a crisis, perhaps as a result of a chain reaction associated with a collapse in housing prices and a default on bonds and other financial instruments, it is unclear how Xi would react. The Asian financial crisis of 1998 is instructive. Kim Dae-jung of South Korea destroyed several of the country’s leading conglomerates and banks and liberalized the economy. In contrast, Malaysian Prime Minister Mahathir Mohamad introduced capital controls and increased state participation in the economy. Si is more like the latter.

According to experts, he leaves external influence as the last way to stimulate economic liberalization and more balanced relations with the rest of the world. Unfortunately, the Trump administration threw away the best tool to encourage China to change when it abandoned the Trans-Pacific Partnership, an agreement that would have lowered barriers to trade in goods, agricultural goods and services, and created completely new rules governing the activities of state-owned enterprises, e-commerce, investment and public procurement.

If we look at China as an outsider, then it needs to be reformed in accordance with the conditions in the world, so that it does not fall into a dead end along with the world economy. It is unlikely that similar bilateral agreements between the United States and individual TPP states will be as effective, although other multilateral and regional deals are being negotiated – such as the WTO Agreement on Environmental Goods and the Asian Regional Comprehensive Economic Partnership – Beijing has enough leverage to ensure that such agreements have restrictive concessions.

Given the little domestic pressure and the lack of significant multilateral or regional instruments, the entire burden seems to be placed on the negotiations between the US and China. President Trump spoke about a bad game during the election campaign, but softened his tone and has since refrained from calling China a currency manipulator. At the Mar-a-Lago summit in April, Trump and Xi agreed to a 100-day negotiation period in order to make progress in restoring balance between the two powers.

Chinese officials believe that they have tamed Trump and can avoid large fines by making symbolic steps to reduce the trade surplus-perhaps by buying more American beef, fossil fuels and Boeing. Given the need for China’s help on the issue of North Korea, it is quite possible that it will be easy to negotiate with Trump. However, due to its long-standing complaints about unfair trade and the arrival of American Trade Representative Robert Lighthizer, it is equally likely that Washington will insist that China demonstrate a real commitment to limit its industrial policy.

It seems that there is a lack of prejudice-free decision-making on both sides of the Pacific, and China’s inability to return to the reformist path could cause irreparable damage not only to its own economy, but also to the liberal international order, and could put the two superpowers on the path of a trade war.


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