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George Magnus

November 3rd, 2020

Has the pandemic emboldened or weakened China in the global system?

0 comments | 24 shares

Estimated reading time: 10 minutes

George Magnus

November 3rd, 2020

Has the pandemic emboldened or weakened China in the global system?

0 comments | 24 shares

Estimated reading time: 10 minutes

If the 2008 financial crisis and aftermath was the time China lost respect for the western economic model, and saw the plates of global power rolling in its direction, the 2020 pandemic and President Trump’s inept handling of it in the United States seem to have presented it with a ‘carpe diem’ moment. Judged by the rhetoric emanating from Beijing this year, the Chinese Communist Party (CCP) seems persuaded that President Xi Jinping’s Chinese Dream of the rejuvenation of the Chinese nation and the ultimate triumph of socialism over capitalism have moved that much closer.

At the recently concluded 5th Plenum of the Central Committee of the CCP – details of which will flow before long and in 2021 – the focus was on the new 14th Five Year Plan (2021-2025) and on the target year of 2035. Halfway between the centenaries of the founding of the CCP in 2021 and of the People’s Republic in 2049, China has changed its ambition from being a ‘moderately prosperous society’ to a ‘high level socialist market economy’. We are not quite sure what that means, most likely, it means joining the ranks of those countries currently in the lower half of the OECD’s income per capita table.

So, think doubling or trebling of income per head over the next 15 years, which implies annual growth of between 4.5 and nearly 9 per cent, and the almost certain re-introduction of GDP-targeting after the COVID hiatus this year, along with more resource-misallocation and debt creation. We will know soon enough, and certainly by the time the 14th FYP emerges next spring.

The suppression of COVID has allowed the CCP the space to both champion its own success, sometimes to the point of gloating, and to think about and plan its own future while most liberal democracies can’t stop fretting about the next phase of the pandemic’s second wave.

China’s success in combatting the pandemic and restoring its economy to a significant extent , however, hasn’t cut much ice with western citizens. A record proportion of people hold negative views of China, according to a Pew Research survey published early in October, covering over 14,000 people in 14 advanced countries. Over 60 per cent also thought China has handled the pandemic poorly, and 78 per cent had no confidence in President Xi Jinping. Notwithstanding negative views about their own leaders, these people just don’t buy the China narrative, focusing instead on China’s lack of transparency over the source and management of the pandemic, its belligerent behaviour, and its diametrically hostile values. Views about China are only slightly less negative in a wide range of Belt and Road countries.

There’s no question that the pandemic has unleashed triumphalism in China and defeatism in the US and Europe. Both seem exaggerated. For now, though, we can assume that, buoyed by its own narrative about history, destiny, economics and the pandemic, the CCP is looking to exploit what it sees as a shift towards a more Sino-centric world, consistent with thoughts of President Xi.

But is it right to do so?

China’s economy is back, but with important caveats beyond the pandemic

If you took a geopolitical snapshot today, following the 5th Plenum and days before the most important US presidential election since FDR beat Herbert Hoover in 1932, China’s temptation to gloat is certainly understandable.

You can see how and why, set against a Western world in pandemic turmoil, and a United States distracted by this divisive election, China’s self-confidence has come to be reflected in bold, sometimes truculent attitudes with respect to its policies and behaviour towards Hong Kong and  Xinjiang within its own borders,  an array of external issues including Taiwan, the South China Sea, and allegations of interference abroad, and a raft of contentious issues including industrial policy, technology and the role of leading firms, such as Huawei.

Aside from periodic, random, regionalised and generally low levels of infection, China has suppressed the pandemic successfully, allowing its economy to stage an impressive V-shaped bounce-back. People, for the most part, do not fear congregating in closed spaces or in hospitality and entertainment venues and transportation systems. By the third quarter, the economy was growing, according to official data, at 4.9 per cent compared with a year ago, and it should register positive growth of about 2-3 percent for 2020 as a whole.

The economic data for China in 2020, as elsewhere, are all over the place. The same will be true of 2021, first as unfavourable base effects in 2020 wash out, and then as the snapback in 2020 isn’t repeated next year.  On this basis, China’s overall GDP growth in 2021 may get back to about 8-9 per cent, exaggerating the strength of the economy exactly as this year’s data have exaggerated its weakness. Nevertheless, in 2021 when the CCP celebrates the centenary of its founding, a growth boost like this will certainly make the party feel quite good about itself and about propagating, as usual, its centrality to China’s past, current and future successes.

There are, however, reasons to take all this with a healthy dose of skepticism. In the first place, we will get a much clearer idea of the Chinese economy by looking less at the annual comparisons and more at quarterly momentum. As the quarters unfold next year, it’s probable that the tempo of officially recorded GDP growth will slow back to around 1-1.5 per cent per quarter, suggesting annualised growth of around 4-5 per cent.

Moreover, despite China’s V-shaped bounce back, economic recovery has been notable for its split personality: production has been on a tear, while consumption has been lagging, contributing only about 35 per cent of GDP growth in the third quarter, for example.  The consumption contribution to growth should rise again, but bear in mind that there are considerable headwinds, some pre-dating the pandemic such as the relatively low share of wages and salaries and of consumption in GDP, and some exacerbated by it, notably the high level concerns about unemployment and job creation.

The dichotomy between production and consumption is reflected in both a rising trade surplus and re-accelerating debt. The former, as Brad Setser of the Council on Foreign Relations makes clear here, is already playing badly in other major nations. The latter trend, which the government had been trying to encourage after the financial crisis of 2015-16, hasn’t echoed the excesses of 2008/09 and 2014/15. Nevertheless, by September, aggregate financing, a broad indicator of credit expansion, was growing at about 14 per cent over a year ago, the highest rate since 2016. Set against a more or less stagnant GDP, it is already clear that China’s debt to GDP ratio, already exceeding 300 per cent of GDP, ratio will climb by about 15-20 percentage points this year.

In the decade ahead, managing the growth-sapping consequences of a heavy debt load, let alone any financial stability issues, along with depressing economic impact of road ageing, and weak productivity growth will also present China with a big test of its intentions and aspirations.

Coping with the tetchy 2020s, starting with the 5th Plenum

If China’s post-pandemic strutting and diplomatic behaviour have backfired, there is at least an opportunity to address on-going economic issues, and reboot to take on the challenges of technological competition, innovation, and modernity which were the focus of the recent 5th Plenum. At this forum, leaders will have listened to and debated recommendations for the 14th Five Years Plan (2021-2025), and for a still longer-term economic and technology strategy out to the year 2035.

According to the official communique which is more slogan than substance, China will emphasise innovation, modernisation, and scientific and technological self-reliance and self-improvement. To this end, a broad array of activities will be targeted for these favourable outcomes, including

a modern industrial system, a strong domestic market and high-level socialist market economic system, agricultural and rural development, a new-type of urbanisation, the development of cultural undertakings, industries, soft power, green development, improvement in people’s quality of life, the integration of development and security, and accelerated modernisation of national defence and the army.

In good time, these goals will be spelled out in more detail along with, more importantly, policies designed to realise them and we might then draw stronger conclusions as to what is do-able and what isn’t.

Dual circulation strategy

In the macroeconomic space, though, expect to hear more also about ‘dual circulation strategy’, launched by President Xi earlier this year. Circulation is basically the flow of activity comprising supply chains, output, logistics, and consumption. Dual refers to both domestic and an external circulation, but the emphasis is clearly on the former. This is a strategy, in effect, to promote Chinese decoupling, or, to pinch a phrase from the Mao era, ‘autarkic self-sufficiency’, though in the 2020s, it doesn’t mean China pulling up the economic-tech drawbridge to the rest of the world.

We should think of it more as an updated version of ‘rebalancing’, which has been in the public domain since 2007, but which has made only limited progress. Given both domestic and external restraints over economic performance, though, China now needs to pay more attention to domestic production for domestic consumption.

The slogan sounds self-explanatory, but it raises serious questions about what sort of policies are going to be introduced to bolster domestic circulation, while sustaining international circulation. More to the point, what happens, as seems quite likely, if the policies needed for one circulation are incompatible with the other?  China would need a low exchange rate, for example, to remain competitive in world markets, but a high one to boost consumer welfare. It would need low labour costs to underpin export firms, but high wages to support domestically focused companies. Similar discrepancies apply in other macro policies and also in competition and regulatory policies.  See, for example, Michael Pettis, for a fuller discussion about whether the policies required to realise both domestic and international circulation goals are compatible.

But if this is so, then how could the strategy work, given there is zero chance of Xi’s government embracing liberal economic reforms and income and wealth redistribution? The only answer is for the CCP to strive even harder to maintain rigid control over the nation’s economic and political resources, and promote even more strenuously ‘stability, maintenance’ which is not new, and ‘safety’, which is.

New safeties

Safety has been articulated before regarding environmental protection, and energy, including the development of new and green energy sources. Now though, there are also new areas where safety has become essential: technology, food and jobs.

In the wake of the evolving adversarial relationship with the US and the West, China is giving technology a status that was once reserved for the development of the atomic bomb.

Semiconductors, for example, lies at the heart of all advanced technologies. Competence and self-sufficiency have been sought in China for 30 years, but even now it can only meet just over a quarter of its needs, and then only at the low end of the fabrication spectrum. It is heavily reliant therefore on imports, the annual cost of which exceeds that for crude oil.

More important even than the US actions against TikTok and WeChat, and the threat to delist Chinese firms from US stock exchanges, is Washington’s ban on chip sales to Huawei and its affiliate HiSilicon, China’s largest chip designer, as well as the restrictions imposed on US companies’ supplying China’s most advanced chip-maker, Semiconductor Manufacturing International Corporation (SMIC). These mean that China has to go all out to develop its own high end chips.

Yet this is not that easy, and certainly more than a question of money, over $50 billion of which has been thrown at the sector in recent years but so far with only limited success. There is no easy substitute for experience, talent and know-how in which the US, Taiwan, Germany, South Korea and Japan still excel.

Food safety is also a recently added goal, with up to about a third of some agricultural products having to be imported, including from the US mid-west. Xi has said that China must ‘adopt a crisis mentality towards food safety’.  Production of grain has been put at the heart of this concern, along with new experiments in collectivised farming in some provinces.

Employment safety is also of paramount importance, especially after the pandemic, which shook the foundations of China’s labour market and may have pushed unemployment up to about 20 per cent for a while. Job creation has in fact been a top policy concern since the start of 2019, along with the deteriorating prospects for many of China’s annual throughput of almost 9 million graduates, many of whom face a tough and restricted job market. The leadership, borrowing another Maoist tool, has urged millions of high school and university graduates to go to the countryside ‘to learn from the masses’.

Greater resistance

In the coming decade, China is going to find not only mounting economic challenges at home but also that the global system is far more fractious and challenging than in years gone by when it comes to trade, foreign investment, technology sharing and matters of national security. This much we know already, but a Biden presidency could exacerbate things for China further if the US set about rebuilding or forming new alliances, assuring Asian allies they were allies in more than name, and possibly re-committing to the now awkwardly named Comprehensive and Progressive Agreement for Trans-Pacific Partnership.

Moreover, it hasn’t gone un-noticed that China wasn’t the only country to have succeeded in suppressing COVID. South Korea, Taiwan, and Japan, for example – all democracies – give the lie to the view that authoritarian governance is or was the key to pandemic management. In addition to the earlier mentioned Pew survey findings of rising distrust of China in advanced economies, pushback has also emerged across the BRI with a spate of corruption scandals and political controversies in several countries including Malaysia, Myanmar, Sri Lanka, Bangladesh, Pakistan, Kyrgyzstan, Kazakhstan, Kenya, Tanzania, the Czech Republic, Italy, Australia and the Maldives. In some, anti-China political parties have come to power, while in others, charges, rightly or wrongly, of new colonialism, or debt diplomacy have been made. Whatever the reality, it’s likely that poor governance and incompetence figure more prominently than deliberate policies, the sting of criticism is present.

2020 has drained goodwill towards China and accelerated significantly the negative ways in which Chinese power, coercive diplomacy, influence and interference are perceived in important countries around the world. More and more, an adversarial commercial relationship is being viewed, on both sides, as a ‘cold war’, in which contiguous borders have been displaced by governance, values and standards.

China’s rise and status in the global system is not pre-ordained. Neither is American decline. How this all evolves and on what terms is down to the type of engagement Xi Jinping may want, if any, but perhaps even more importantly now, it is down to the next US president.

This article gives the views of the authors, and not the position of the China Foresight Forum, LSE IDEAS, nor The London School of Economics and Political Science.

About the author

George Magnus

George Magnus is Research Associate at the China Centre, Oxford University, School of Oriental and African Studies, and a member of the China Foresight Forum. George was the Chief Economist, and then Senior Economic Adviser at UBS Investment Bank from 1995-2016. He had previously worked as the Chief Economist at SG Warburg (1987-1995), and before that at Laurie Milbank/Chase Securities, Bank of America and Lloyds Bank.

Posted In: Economics and Finance

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