5 February 2016

China: The Golden Chains Weaken

January 31, 2016: For most of 2015 the biggest threat from China was economic. The Chinese economy was behaving unpredictably and that was a concern for most of the world because China now has the second largest economy on the planet. But because of mismanagement and corruption the Chinese economy was slowing down. That was obvious because China has become one of the largest customers for raw materials, manufactured goods and much else. Those orders were shrinking and many of the foreign suppliers were in trouble. Naturally people (inside and outside China) wanted to know what was going on and, not for the first time, it was noticed that the official economic statistics did not add up. In part this was because the government was still using a lot of communist era economic measuring techniques invented in the Soviet Union. The Soviets measured the economy mainly by counting production (of manufactured goods, raw materials, food) and not much else. This method gave a very inaccurate view of economic performance and was one reason why the Soviet Union collapsed in 1991. China never completely got rid of all these flawed .communist era methods. They got away with this because since the 1980s their communist command economy has replaced with a free market model and the resulting growth has been spectacular. 

But now the bad economic data matters. Western economists have long been aware of this problem but have been unable to convince their governments that pressuring the Chinese to use modern measuring methods was important. For example in 2014 the Chinese government predicted 7.5 percent GDP growth in 2015 but actual growth (using accurate measurement) was closer to four percent. In 2014 many investors, Chinese and foreign, feared GDP growth might fall to five percent in 2015 but the Chinese government insisted it would be seven percent or more. Since 2010 more Chinese officials have acknowledged there is a measurement problem but found senior leadership unwilling to do something as dramatic as revising years of inaccurate official data. The senior leaders preferred to try and ignore the real numbers. 

That has become much more difficult because there is openly available (to foreigners and Chinese) economic data that is accurate and can be combined to produce more accurate measurements of things like GDP and productivity. To do this economists and business analysts use things like electricity production, railroad traffic and similar data that cannot be manipulated by local officials to make their city or province look more successful. Using this approach it was discovered that Chinese GDP has not been growing steadily at near ten percent a year for decades. Chinese officials do eventually (months or years later) get more accurate data and while Chinese GDP has actually been steadily growing over the last three decades the annual growth has actually varied from 5-11 percent. Chinese official policy was to keep everyone calm by issuing less variable annual growth rates. In short, the official numbers were doctored in addition to using inadequate Soviet era tools. 

Many financial exerts inside and outside China fear that all this official manipulation of economic data (an ancient practice in China) is masking some serious economic problems that could go sideways at any time and cause a banking crises that would paralyze the economy for a while and cause political chaos inside China and beyond. It’s very much a crouching tiger and hidden dragon. This is an ancient phrase warning that behind seeming success and talent lurks the possibility of imminent disaster. Chinese are ever mindful of this sort of thing. The realistic Chinese economy measurements indicate continuing declining productivity and GDP growth. Worst case is that in a year or so GDP growth halts or even goes negative by one or two percent a year. This means more unemployment and less income per person in China. While Chinese leaders prefer to talk about external threats (like the United States or neighboring countries fighting back as China claims their territory) the biggest threats to China have, over thousands of years, usually been internal. Chinese leaders fear this the most because historically the most common cause of Chinese leaders losing their jobs (and usually their heads) was rebellion or civil war. In the 1970s the new (post hard core communist) leadership decided they could buy their way out of trouble and since the 1980s that has worked. But now the Big Bribe (of the entire Chinese population) is in trouble and it is uncertain how the crises will be resolved (explosively or quietly). When the golden chains no longer restrain the Chinese population, what will happen? 

The Chinese stock market crash, which got more media attention than the bad economic data problem, is still underway. Average stock values are back to where they were in late 2014. The official government assessment is that the stock market collapse has nothing to do with the economy. There is some truth to that but to the large number (over 100 million) of Chinese who have suffered from the sharp fall in stock prices, all the bad economic news seems to mush together with whatever is wrong with the stock market. Then there is the devaluation of the yuan (the Chinese currency) impacts all Chinese because that means it takes more yuan to buy a dollar, the main currency for international trade. That means it costs Chinese more (over ten percent more so far) to pay for imports. The Chinese government does not have enough cash to strop this devaluation, despite all the government pronouncements that everything is fine. 

The economic problems, especially unemployment and bad treatment of many workers and led to more public demonstrations calling for labor unions and other reforms. For the government the scariest unrest is the labor strike, which is illegal in China. Yet in there were over 2,700 of them in 2015, which was nearly twice as many as in 2014. Workers want more money, safety and job security. Independent (of government control) labor unions are illegal in China and workers have been creative in finding ways around that restriction to organize opposition. The government admits that there are over two million official labor disputes a year and that is increasing as well. China does have labor unions but these are government controlled and meant to keep workers in line and prevent strikes (unless the government wants them). None of the angry workers wants to risk jail by openly participating in what the government could call “illegal union activities.” So there have been more and more “spontaneous” and “leaderless” work stoppages and walkouts. In some cases workers will threaten management, without using a representative or “workers’ committee” to deliver the threat. All this is of great concern to the government. After all, China is still, in theory and practice, a communist police state. So it is embarrassing and scary when all that power proves incapable to keeping workers in line, quiet and on the job. The workers use cell phones and the Internet in creative ways, getting around government electronic surveillance. This provides workers with a safe way to communicate, maintain morale, and organize more labor actions. There are often repercussions anyway. Strike leaders will be sought more aggressively and punished. Efforts to block use of cell phones and the internet to support such forbidden activities (strikes) will accelerate. But despite all this additional effort the state security agencies still tend to come up empty. The workers are winning and becoming bolder. 

The government started the year by reminding everyone that the anti-corruption campaign would not only continue but intensify. In the past only lower ranking party members were prosecuted but by 2015 it became clear that if the corrupt senior party members were not shut down the widespread corruption would survive. So prosecutors are told no one was immune and throughout 2015 some of the most senior government and Chinese Communist Party officials were being prosecuted. This is unprecedented and if the investigators are allowed to prosecute all they find to be dirty there will be a lot of new faces in the partly leadership by the end of 2016. 

Apparently senior officials were also quietly told that if they resigned, admitted their transgressions and made restitution they would be left alone. The biggest impact of the anti-corruption effort is in the state controlled enterprises. These account for over 20 percent of GDP and even more jobs. These operations make far less profit than privately owned firms and are seen as a form of make-work to keep unemployment down. Worse, these inefficient firms are often run by very corrupt and inept officials and not allowed to go bankrupt. The reforms are supposed to make the state owned firms more competitive as well as becoming subject to bankruptcy. With a looming labor shortage the government feels it can survive a lot of these state owned firms going bankrupt and disappearing. 

There are some other problems as well. The state owned firms have a disproportionate number of corrupt managers and so many are being prosecuted that some of these firms complain about a crises in management. That’s because state-owned firms did not attract the best managers in the first place and with all the corruption-related arrests it is difficult for many firms to find competent replacements. In addition a management job in a state owned firm, especially at a senior level, does not enhance the reputation of a manager seeking the greater opportunities in the more dynamic and profitable independent (of state control) firms. Given the current situation it is also seen as dangerous to take a job in an organization that had been run by corrupt managers, because many more corrupt managers may still be there and that could lead to replacement executives being entangled in further investigations and get prosecuted as well. 

While all these corruption prosecutions seem to be directed at people who are guilty the government releases few details of exactly what they did wrong. Some of the transgressions are known because the officials are living in mansions or country estates that they could never afford on their state salary. The government does not censor much of the reporting on this, which are often accompanied by real estate experts providing the market value of these properties. Then there are the expensive cars, jewelry and other visible valuables that there is a known market value for. Apparently the government does not want Chinese to know how extensive the stealing has been in precise terms. It is apparently a very large chunk of the GDP. 

Meanwhile China continues to insist that it owns the South China Sea despite what anyone else in the neighborhood believes or international treaties say. The neighbors (especially Taiwan, Vietnam and the Philippines) continue to protest and build up their much smaller air and naval forces. Many Filipinos doubt that the United States would stand fast if China pushed hard. There are no signs that China is going to back down when it comes to its many territorial claims on neighbors. 

On January 6th North Korea conducted a successful test of what they claimed was a fusion (H-Bomb) nuclear weapon. This was condemned by the United States, Russia, China, South Korea and just about everyone else. China and Russia both agree that North Korea having nukes is a bad thing but China is more concerned about this than Russia or anyone else. While China refused to impose the strict sanctions on North Korea that the United States was calling for, the Chinese have been increasing forceful in their criticism of North Korea. For example trade with North Korea declined 15 percent in 2015 and China is openly (in the state controlled media) telling North Korea that continued work on its nuclear and ballistic weapons program means North Korea can no longer depend on support from China if North Korea gets involved in a war. China could cut off all trade, which would cause a major economic crisis in North Korea. While that trade only amounts to about five billion dollars a year, it is over 70 percent of North Korean foreign trade. There has also been a reduction in trade between China and South Korea. But that trade is more than a hundred times larger than the North Korea-China trade and the drop is all economic (the stalled Chinese economy). This is much less of a problem in the south than in the north where the reduction in Chinese trade is a matter of life or death for many. An even bigger problem is that China has not shipped any petroleum products to North Korea for two years. There has been some smuggling, but China has been the major source of oil for North Korea since the 1990s this cutoff has been a big problem. Officially the North Koreans have not backed off because of these Chinese moves. Unofficially there have been a lot of secret negotiations going on between North Korea and China. Meanwhile American military commanders in the Pacific have gone on record that the United States considers North Korea, not China, the biggest military threat in the region.

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