Threats to China’s future worsen

Analysis

Major risks to China's future prosperity and political stability can be classified into four categories that highlight how the level of risk varies over time:

• risks that recede once a critical period has passed ('hurdles');
• chronic risks that become acute if not addressed in time ('race against time');
• chronic risks that gradually worsen with time (steady deterioration); and
• highly contingent risks that could materialise at any time -- or not at all ('wildcards').

Hurdles

Major hurdles include politically sensitive anniversaries, the presidency of Donald Trump and the transition to China's next generation of leaders.

Anniversaries

This year contains an unusually large number of politically potent anniversaries:

• the tenth anniversary of ethnic riots in Xinjiang;
• the 20th anniversary of major protests by the Falungong sect in Beijing;
• the 30th anniversary of the 1989 mass protests that culminated in the Tiananmen Square crackdown;
• the 30th anniversary of major protests in Tibet; and
• the 70th anniversary of the founding of the People's Republic of China and the relocation of the Republic of China government to Taiwan.

Anniversaries are often used in Chinese politics to mobilise shows of support for the government -- or opposition to it. Even 'patriotic' popular activism is potentially dangerous; it could turn against a government deemed insufficiently assertive vis-a-vis foreigners. As such, the government may feel the pressure to highlight its patriotic credentials, potentially with risky displays of outward strength.

Trump's term

The Trump administration's policies towards China are the most hawkish of any US administration in recent decades and have hurt China more than Beijing probably expected.

Tariffs have suppressed Chinese exports, scrutiny of Chinese investments has led to a collapse in Chinese acquisitions of US firms and diplomatic lobbying has made US allies wary of procuring from Chinese technology firms.

There are China hawks across the political spectrum in Washington; the feeling that China gains 'unfairly' at US expense is widely shared.

However, another US administration would not likely address this in a manner as confrontational, unpredictable and destabilising as Trump's.

Trump's term in office is limited even if he wins a second term as president. After that, 'regression to the mean' may produce a US administration less willing to accept the risks and costs of taking a hard line, easing the economic pressure on Beijing.

Leadership succession

Further ahead, China will eventually face a leadership transition of its own. If Xi Jinping followed precedent, he would step down in 2022-23 after two terms as Party leader and state president. However, his supporters have removed term limits on the state presidency and he has avoided openly designating a successor, which suggests that he will not (see CHINA: Party Congress raises Xi's prestige and power - October 25, 2017See CHINA: Xi's indefinite rule will have immediate impact - March 2, 2018).

What happens in 2022-23 is, therefore, uncharted territory. It is not a sure thing that Xi will stay on, but he has departed from other customs and unwritten rules of post-Mao politics in a way that suggests he will:

• He has purged the elite.
• He has demolished rival factions and filled the Politburo with his supporters (see CHINA: Lack of successor to Xi could mean instability - November 2, 2017).
• He has concentrated power in his own hands by taking personal control of all the Communist Party's leading committees.
• He has built a personality cult -- the first leader since Mao to do so.

The fact that he has put former senior leaders in jail makes retirement risky for him, as does the fact that his controversial policies have claimed many victims and will have made enemies.

There is a risk that when Xi eventually does retire, or dies, this will leave a vacuum at the heart of China's political machine. His departure could be followed by a battle between those loyal to his legacy and those who at last see an opportunity to reverse what he has done. During this period, policy at home and abroad may become volatile and its trajectory difficult to discern. Even if the outcome is paralysis, that too could be a game-changer if it compromises the government's ability to deal with policy challenges effectively.

Race against time

Chronic risks that look likely to worsen include a high debt burden in the economy, environmental damage, external debt problems created by the Belt and Road Initiative, the middle-income trap, economic disruptions caused by automation and the risk that China's growing power will spur commensurate foreign efforts to check or offset it.

Debt burden

The scale of debt relative to GDP in China's economy has grown very rapidly over the past decade to reach a level many consider unsustainable. Even as GDP growth slowed well into the single digits, credit growth continued in double digits (see CHINA: Debt will deepen slowdown, not trigger collapse - January 27, 2017). A deleveraging campaign since 2015 slowed the growth of credit, but it continued to rise faster than GDP, and since mid-2018 policy has shifted back to stimulus (see CHINA: Policy will return to putting growth first - September 5, 2018 and see CHINA: Monetary policy will rely on banks’ compliance - January 25, 2019).

The longer credit grows faster than GDP, the higher the risk of a financial crisis or, more likely, a protracted slowdown in GDP growth as accumulated bad debts get worked out -- probably not a recession in the technical sense of a contracting economy, but circumstances that will feel like one to many citizens accustomed to years of rapid growth, with large-scale job losses and declining living standards.

This could undermine the 'performance legitimacy' of the Communist Party and force it to rely more on repression and less benign sources of legitimacy such as populism and nationalism.

Environmental tipping point

China's rapid economic growth over the last few decades has come at heavy environmental cost. Water resources are extremely strained, soil and water pollution are rampant, air pollution is the worst in the world, and arable land is scarce and shrinking due to construction and desertification (see CHINA: Loss of farmland puts food security at risk - February 12, 2019).

Environmental damage imposes costs in terms of its effect on human health, food production and foregone development potential.

Environmental damage is often assumed to be linear, but environmental factors interact in a 'system of systems'. Multiple factors could combine to exacerbate each other.

Environmental damage can be prevented and repaired, but this is costly, so China is in a race to become rich enough and institutionally capable enough to achieve this before the cost becomes so high that the damage is for practical purposes irreversible.

Middle-income trap

Labour costs in China are rising. Low-skilled labour-intensive production is leaving China for locations such as Vietnam. US tariffs will intensify this process (see INTERNATIONAL: US-China Huawei dispute risks reprisals - January 29, 2019).

China must upgrade its economy by developing more advanced, higher-skill industries supported by a strong domestic consumer market, otherwise unemployment will rise and incomes and living standards will stagnate.

Automation

The widespread application of recent breakthroughs in artificial intelligence is expected to automate many job functions currently performed by humans. Algorithms are expected to perform routine functions both more cheaply and to higher and more consistent quality standards. China's education and vocational training systems will need to adapt in order to reskill the workforce before automation causes mass redundancy (see INTERNATIONAL: Digital economy needs new skills - January 16, 2019).

Belt and Road debt trap

The Belt and Road Initiative involves funding infrastructure construction in developing countries in the expectation that this will unlock economic growth potential that will then generate the tax revenue needed for the host government to repay the debt.

If the investment projects do not yield the expected returns, or the host economies do not develop fast enough, the non-performing loans could become a burden on China's financial system.

Containment coalition

For the past four decades China's economic, technological and military capabilities have risen rapidly, but have lagged sufficiently far behind those of the pre-eminent world power -- the United States -- that Washington and its allies did not consider it an urgent threat to the established international order.

However, the gap has now narrowed enough that Washington regards China as a challenge to US economic and military pre-eminence. It is taking steps to curtail China's 'rise' and is encouraging allies to do likewise.

This was seen first in the 'Asia pivot' and Trans-Pacific Partnership of the Obama administration and now in the much more openly hostile China policies of the Trump administration.

Policies to 'contain' China threaten to prevent it ever achieving parity in living standards or military capabilities unless it can first reach the point where its continued development does not require the continued cooperation of the United States and its allies.

Steady deterioration

Certain risks will gradually worsen with time, either inevitably or if China continues on its current course. The former include demographic ageing and generational change. The latter include the consequences of intensified political repression under Xi.

Demographic ageing

China's population is ageing rapidly at a much lower income level than elsewhere in the world. The workforce is shrinking, and the dependency ratio (the number of people of non-working age that must be supported by each worker) is rising. The abolition of the one-child policy has failed to raise the birth rate to the degree hoped, and it will anyway be nearly two decades until the first of the additional children enter the workforce (see CHINA: Gains from one-child policy's end may not last - December 29, 2017).

The cost of pensions and health-related costs (direct and indirect) of a large proportion of elderly in the population will impose a burden on the fiscal system (see CHINA: Beijing will drag feet on urgent pension reform - April 24, 2019). This will reduce the government's ability to fund key policies that sustain the political system, including fiscal stimulus, industrial policy and the apparatus of political repression.

Cultural and generational change

Cultural and generational change will affect politics as new cohorts with very different formative experiences gradually rise to positions of power.

As the generation that remembers the Cultural Revolution passes, its successors may be less inclined to put social stability first. At the popular level, this may mean less willingness to accept authoritarian rule as a necessary evil for keeping chaos at bay. At the elite level, it may mean a leadership less concerned about the fragility of the political system at home. Possible consequences include political reforms at home that have unpredictable and potentially destabilising outcomes and less risk-averse foreign policy in asserting China's interests abroad.

In the 1990s, nationalistic (particularly anti-Japanese) propaganda was greatly stepped up in response to the 1989 democracy movement. As positions of power are filled by generations raised during this and subsequent periods, the nationalistic views they imbibed during their formative years will colour their outlook and foreign policy preferences at least to some extent.

There may also be risks associated with the coming pre-eminence of the 'one-child policy' generations. Psychological research, and certainly popular perceptions, suggest that people born as only children during this period are more inclined on average to display anti-social personality traits. If true, this could have insidious effects.

Censorship and repression

The climate of ideological repression under Xi's government shows no sign of slackening and will have long-run effects.

Academia and the think tank sphere are being purged of content, individuals and institutions deemed heterodox, creating an intellectual monoculture that could stifle creative thinking about policy problems.

This, combined with a studied reluctance among officials and scholars to dissent from 'politically correct' views, increases the risk of the leadership receiving poor policy advice and formulating badly judged policies as a result.

The risk of intellectual self-handicapping may worsen further in the future due to a purge of foreign ideas and teaching materials from schools and universities, which is depriving future generations of intellectual diversity.

Meanwhile, contact between officials and their foreign counterparts or researchers is become more controlled and restricted (see CHINA: Gains from one-child policy's end may not last - December 29, 2017). This leads to the attenuation of personal networks through which foreign governments come, over time, to understand Beijing's intentions. This will leave foreign governments no choice but to assume the worst in interpreting Beijing's behaviour.

Wildcards

Plausible but contingent events that could occur more or less at any time include international crises, and an elite backlash against XI.

International crisis

Beijing's territorial disputes with its neighbours, its pushback against the US military's activities in its region and the growing scale of Chinese investments and personnel overseas create ample opportunities for diplomatic or security-related incidents that, if handled ineptly, could escalate into a serious international confrontation.

Elite backlash

There is much in what Xi has done for Party members to disagree with -- his repressive policies in general and his harsh treatment of other politicians and Party members in particular, the 'power grab' in which he has seized control of the key committees that run the country, the personality cult with echoes of Mao Zedong, the removal of term limits and apparent positioning to become 'leader for life'. There are signs, too, of discontent with his signature Belt and Road Initiative, with complaints that money is being wasted overseas that would be better spent at home. Xi's replacement of collective leadership with one-man rule also makes it harder for him to evade blame if signature policies fail.

The Party elite keeps its disagreements tightly under wraps as a matter of policy, but disagreements exist. Xi has purged enemies and promoted allies, but alliances need not be permanent.

It is plausible that Xi might be challenged by a coalition within the Party's Central Committee -- probably not ousted, but forced to compromise, lower his profile, retreat from controversial policies and retire in accordance with precedent after two terms.