China’s Great Stagnation

China’s economy is stalling. The most likely economic scenario over the course of the next decade is not high growth or an economic collapse, but stagnation. American policymakers need to pay attention.

China’s economy is stalling. The most likely economic scenario over the course of the next decade is not high growth or an economic collapse, but stagnation. If this occurs, the Chinese Communist Party (CCP) will have difficulty sustaining its ambitious national development and strategic plans. In particular, Beijing will not be able to avoid a more serious “guns v. butter” tradeoff.

This has sharp implications for American policy. Most importantly, while the US certainly has its own structural problems, it is far wealthier and more powerful than China, and that gap may actually grow or at least hold, rather than shrink. The dominant Sino-US relations paradigm of a declining power managing a rising power is inaccurate. A truer depiction of the Sino-American relationship is that China is a capable great power seeking to compete with US primacy in Asia, much as Russia has become a US rival in Europe and the Middle East, while Iran challenges American interests in the Persian Gulf. To attribute to China the capability to “overtake” the US or compete with it globally—or to describe the power dynamics as a “power transition” from Washington to Beijing—is at best premature.

Because the bilateral relationship contains cooperative elements, it would be better for American interests for China to return to market-based reforms, both to spur global economic growth and to stabilize Sino-American relations. However, this is unlikely in the medium term. And given the combustible mix in China of less stability at home and foreign policy adventurism abroad, Washington needs to more strongly resist destabilizing Chinese actions. It should reorient US strategy based on the long-term leverage created by likely Chinese stagnation and the enduring power gap.

China’s Economic Future:

There are three views of China’s economic trajectory: (1) it is slowing, but also transforming into a healthier and very large economy; (2) it is stagnating; or (3) a true economic crisis is inevitable in the not-too-distant future. The preponderance of evidence is for stagnation.

Both the China (still) rising and crash scenarios are fundamentally flawed. While their ranks thin and their version of success is watered down every year, there are still “bulls” who see China as a future economic success story. This view is based not on current analysis but on a combination of history—the People’s Republic of China (PRC) in 1978 and 1992 did indeed rise under worse circumstances—and the ensuing faith that pro-market reform will either be chosen by the Communist Party or be forced upon it.

Reform forced on the party by some sort of crisis may indeed be the best hope, since the party voluntarily choosing pro-market reform at this point is highly unlikely. The much-hyped 2013 Third Plenary session did not in fact offer a sound set of reform proposals. For example, it promoted cooperation between the public and private sectors when the exact opposite is needed. Unsurprisingly, no net progress toward the market has been made since. And few bulls would be able to endorse the economy purely on the basis of the present explosion of debt, weakening demographics, depleted natural resources, and other objective indicators.

The economic and financial crash argument has a more specific problem: it mistakenly treats the troubled Chinese financial system as similar to the American system. Commercial financial systems in rich countries may be only as strong as their weakest link, but Chinese finance is dominated by the state. Its primary function is to serve state interests, not to make money. Noncommercial financial systems are only as weak as their strongest link because governments can, without legal or political delay, order the strongest institutions to save the weakest. The cost, of course, is an enormous amount of waste.

Neither Preeminence nor Collapse - The Stagnation Case:

To understand why stagnation is likely, first consider other countries. While the categories are not well-defined, far more economies rise out of poverty than become truly rich. This is sometimes referred to as the middle-income trap.

In the postwar era, the most impressive economic success stories are in East Asia, which bodes well. However, in comparison with the world as a whole, Japan became rich before World War II, and much of its growth during 1946–1990 was a return to the status quo. Hong Kong and Singapore are mere cities, while Taiwan’s population is about the same as Shanghai’s. The structure of these microeconomies is fundamentally different than China’s economy, and they hardly demonstrate that the PRC can become rich.