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.
Overall, while the USSR is the story of a long decay, this quick analysis paints a picture of China as a country that is about to experience a strong economic readjustment, which was long delayed by the stabilizing efforts of the government. As Nassim Taleb explained recently, it is often the case that efforts to reduce volatility overall increase the long term risk of a “black swann”, ie a violent shock, which in the case of China would be a financial crisis triggering a social crisis, which the current communist leadership would find difficult to manage.
It is important to repeat that the objective of this post is not to settle the “Chinese question” definitely. It would take more than such a post and this is only a “back of the envelope”  analog analysis to illustrate the method. At the very least, however, it shows that the Chinese story is certainly not as simple and clear-cut as we are told repeatedly, and that there are real reasons to be concerned about the country’s sustainability over the near future. If only policy analysts, but also journalists and business people can gain a more articulated view of the issue, it will be a good enough result.
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Note: the post was prepared with Milo Jones. We will update it based on feedback until we reach the “perfect” forecast, ie when events have run their course.

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

  1. Pingback: China’s Present, the World’s Future, and the Pretense of Knowledge « Silberzahn & Jones

  2. An overview/update on China’s “fertility implosion” is available here: http://www.newgeography.com/content/002474-six-adults-and-one-child-china

  3. If you want to avoid the ‘shock’ correction of long suppressed change, then you need to actively create mechanisms for smaller adjustment – easing the tension out of the socio-economic ‘rubberband’. Historically, no-one has done this particularly well, but the managed economies have fared worse than the market economies, where pursuit and protection of vested interests has proven a useful mechanism to act as a balance to over-reaction (though not always). In managed, communist countries, there has been no allowance for the populace to have a vested interest, the dictates of centralised control has meant suppression of individual rights. Central powers will always fear letting small, local adjustments take place outside of their control. In mixed economies, where governments have considerable centralised power, yet allow individual freedoms, they are able to create mechanisms which allow the exercise of alternative points of view, thus easing the tensions of control, within a structured context, ie elections, public discourse, artistic expression, professional journalism, interactive media, etc. The role of government is to create a ‘forum’ for such expression and police it to ensure equality, truth and harmony, without actually having a voice in the debate. The danger, especially in smaller, less people-power economies, is the rise of the military diva – Gaddafi (Libya), Saddam (Iraq), Edi Amin (Uganda), Than Shwe (Burma), Pol Pot (Cambodia), Kim Jong-il (North Korea), Mugabe (Zimbabwe), Khamenei (Iran), …the list is endless. The only proven counter to the rise of dictators is to ensure the ‘right’ of these democratic forums and that the central military while strong enough to police the various forums individually, is less powerful than the combined efforts of its people to maintain them. China will avoid the ‘shock’ of an Oriental Spring, either if it can constantly increase its military power to maintain its position of suppression over its own people (already showing signs of being unsustainable). Or, if it has the presence of mind to ‘release’ its grip on its provinces, let go of Tibet, cease its incessant claims over Taiwan, etc and so ensure the ‘Chinese family’ stay together even as they develop individual nuances of what it is to be Chinese. As the Chinese people grow in confidence to take on their role in a democratised nation, the leadership has to accept an increasingly lesser role in how it plays out.

  4. If you’re interested in these questions, don’t miss Guy de Jonquières outstanding summary of the economic, political and foreign policy challenges it faces. See http://www.ecipe.org/chinas-challenges/PDF

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