China’s Catch 22: Communist Party Under Pressure

The party can lose its grip on power if growth stalls but to keep growth up, it will have to relax its grip on power.

China’s leaders face a conundrum. The ruling party’s grip on power may be weakened if there is an economic slowdown but in order for there to be higher growth, the party will have to loosen its grip on power.

In the short term, China’s economy is expected to grow at a slower pace than in previous years because of reduced Western demand. The lack of a full economic recovery in Europe and the United States hurts Chinese manufacturers who simultaneously face aggressive competition from low wage countries in Southeast Asia.

The main structural impediment to healthy economic expansion in years to come is the heavy role that the Chinese state still plays in the economy. Behemoth state-owned enterprises, central planning, a weak judiciary, insufficient protection of private property and intellectual copyrights stand in the way of a free-market economy but are unlikely to be addressed while Beijing is preparing for a generational shift in leadership this year.

Instead of accelerating the liberalization effort that was initiated under Deng Xiaoping in the 1980s, the incumbent administration has attempted to counter reduced growth projections with an expansionary fiscal policy as well as monetary interventions. There is now talk of another stimulus but as Wei Gu writes for Reuters, China is still recovering from the first which included $600 billion in extra public spending in 2009.

The industries that are suffering most now, such as appliances makers, auto companies and equipment makers, are among those that benefited most from the infrastructure investment boom and consumption subsidies in the last round.

Even in communist China, stimulus tends to have a nasty side-effect — nepotism. Money was poured into politically favored industries that therefore had little incentive to boost their competitiveness relative to foreign companies.

These very industries — housing, infrastructure, manufacturing — provide the outward expressions of the success of the Chinese model which underpins the stability of the one-party system. It’s hard to think of China as failing if one sees the skylines of its megalopoles ever expanding and rising.

Therein lies China’s Catch-22. Its leaders depend on economic expansion for legitimacy but if they are to ensure sustainable growth for the long term, they will have to relax their grip on power by breaking the bond between government and its client industries.

As competition from freer economies across East and Southeast Asia increases and Western companies move production back to Europe or the United States because cheap Chinese labor no longer outweighs the added costs of transport, China will have little choice but to reform. The Chinese social contract of unlimited economic expansion in exchange for an unquestioned political monopoly on the part of the Communist Party cannot survive. The question is whether its leaders will recognize that in time.