Has China peaked? An exercise in forecasting using Neustadt and May’s History framework

China has long been touted as the next leading power, and for many it seems that the question is no longer if China will overtake the US but when. Recently, however, a number of dissenting opinions have started to be heard. Economists point to the strong imbalances in China’s economy; political analysts observe that the political and social structure is unstable; human right activists warn of increasing censorship and repression, while historians suggest that, like the USSR in the late 80s, China’s communist regime has run its course and is on an unsustainable path. Indeed, “hard landing” stories about China have started to appear, by Roubini or by Gordon Chang.

Like any such debate, or lack of debate (instead, it is a series of proclamations), positions are often taken being selective about facts, based on false analogies, shallow extrapolations, ideology, or just plain ignorance. This is problematic because regardless of what we think about China, the country does matter to us in many ways. What can we do about this, then?

In this post, I’d like to do an exercise: while it is certainly impossible to forecast the future accurately, we can try to bring some rationality to the discussion. For that, I’d like to use Richard Neustadt and Ernest May’s analog framework, which I introduced recently. With this framework, we can analyze each analog situation by noting the similarities, the differences and their implications for the current situation.

The first choice is to select the analogs, ie what we should compare China to. As mentioned above, USSR is the most obvious example, but there could be many others, such as Japan, a country that in the late 80s was also presented as a model right when it was about to enter a twenty-year decline. So let’s proceed with the comparison between China today and the USSR in, say, 1985. According to Neustadt and May’s framework, for each analog, we have to draw a list of similarities and differences, and for each of them, ponder the implications. Then, we can put it all together and draw a conclusion.

A) Similarities between the USSR and China:

• Single party dictatorship, which makes the resolution of social tensions more difficult.
• Communist ideology (often, in both places, more “honored in the breach”)
• Dominance of the State in most economic decisions. Implications: Massive mis-allocation of capital, see for example, ghost towns or empty malls.
• Growing hollowness of ideological core, which leads to moral hazard, corruption and arbitrary decisions. This is more pronounced in China today as the Communist world has already collapsed in the 90s with few exceptions.
• Ethnic tensions
• Questions posed on the validity of official statistics, which renders the evaluation of the country more difficult. This was more pronounced for the USSR than China, but it is important nonetheless.

B) Differences between the USSR and China

• Russia was a closed, backward economy, whereas part of China’s is connected to the world economy with a growing number of multinationals competing on world markets. Economic collapse is unlikely. However, implication of the State makes the emergence of an entrepreneurial economy difficult, leading to a dual economy, with a few national, State-backed champions, and a majority of struggling small businesses.
• The Internet didn’t exist for USSR; in China there is simply the Great Firewall. Despite censorship, information sharing is easier, making the sustaining of the dictatorship more difficult.
• Unlike the USSR at the time, China is now experiencing a demographic turnaround which will soon have an important, negative impact of the availability of cheap labor, which has been the cornerstone of its economic take off since 1978. Given China’s urbanization, it is doubtful that farmers will be able to supply the missing labor (See Milo Jone’s note on China’s urbanization)
• Social tensions: Whereas the USSR’s social body was essentially amorphous, China is experiencing growing social tensions, which lead to numerous demonstrations. Such demonstrations have remained spontaneous and small-scale, locally motivated so far. Their coalescence into a “Jasmine” revolution the type of which was experienced in Tunisia or Egypt is now a distinct possibility.
• Unlike the USSR, China is experiencing a growing investment bubble fueled by cheap, government-sponsored credit, particularly in real estate. Sounds familiar?
• Unlike the USSR, China is heavily dependent on foreign exports and hence on the health of Western economies and in particular the USD exchange rate. Should the USD continue dropping, this would pose a threat to China’s financial stability. However, a reaction of China consisting, say, in a transfer of some of its assets from USD to Euro, would, given the share that China represents in USD assets holding, further depress the USD, hence compounding the problem for China. More on this financial thesis in the book “Uprising”, by George Magnus.
• China imports raw materials and oil, while Russia produced them; as such, China is heavily affected by the current surge in commodities while the USSR would have benefited from it.
• China is not engaged in a long-standing war of attrition in a hostile country, unlike the USSR with Afghanistan. However, the growing military budget, and the suspicion that the Chinese military enjoy growing power within the State are a cause for concern.
• China is about to undergo an important change in leadership (in 2012) where, for the first time, the new leader would not have been groomed by Deng Xiaoping. Hence, he probably will not have the same legitimacy and will be more subject to challenges, either from the sons and daughters of the original revolutionary group, or from the Army, for instance.