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Five Myths About China

November 6, 2013 Topic: EconomicsGlobal Governance Region: China

Five Myths About China

Less economic might than some think—but more military power than some expect.

The third plenum of Chinese Communist Party Congresses is often the time when the country’s rulers introduce major policy shifts. The Eighteenth Party Congress in November and, crucially, implementation over time of policies announced there offers the U.S. an opportunity to reassess China, to see whether top leaders Xi Jinping and Li Keqiang are interested in pursuing reform or will hew to the course of their predecessors.

This opportunity could be wasted if the persistent myths that have long plagued American views of China are not dispelled. The key myths feature overstating Chinese economic prowess and understating clashing security interests between the China and the U.S.

Myth #1: China is well on its way to surpassing the U.S. economically

Reality: China is far from surpassing the U.S. and can do so only if helped by our failures.

This is the generative myth, from which the others flow. In less than a generation, the world economy is supposed to have a new leader. China will purportedly be bigger than the U.S., the first time the American economy has not topped the world in well over a century. This is said to follow just by projecting Chinese and American GDP growth forward.

This is wrong on multiple counts. First, GDP is not nearly as important as commonly thought. It is not a measure of economic well being, it is misleading measure of annual domestic output. It discounts imports, no matter how vital they are, and counts government borrowing as always positive, because only the current year is relevant. Because it is merely an accounting device, changes in GDP do not cause anything—employment, inflation, nothing.

One year of production is not “the economy.” A much superior notion of “the economy” is the stock of national wealth—all the assets we have accumulated over time. The stock of American private wealth in 2012 was about $70 trillion. Using the same methods as with American wealth, the stock of Chinese wealth is $20-25 trillion, through government ownership of assets and control of prices make that a very rough estimate. The absolute size of the gap between the U.S. and China may approach $50 trillion. It would take decades to erase.

Or never. The other part of China passing the U.S. is extrapolation. China’s economic performance from 1945-1978 meant very little to its economic performance from 1979-2012. And 1979-2012 is likely to mean very little to 2013-2046.

One obvious reason is demography. China was a young country with an expanding labor force when market-oriented reform was initiated in 1978. The two factors fed each other: the market found opportunities for all and the raw number of workers pushed the rate of economic expansion higher. Now China is middle-aged and headed quickly toward old. The number of people age 60 or higher is expected to double from 2010 to 2030, past 350 million. Even the most brilliant policies will be less successful under these conditions.

The same is true for physical resources. Relentless demands from urban development and heavy industry have erased arable land, polluted water, and overwhelmed local supply of energy and metals. Imports are available, but China’s own stock of resources has been depleted and water shortages, especially, cast a shadow over sustainability.

Other sources of economic growth are capital and innovation. China reports investment spending $1.5 trillion higher than the amount of investment that actually contributes to annual GDP. Some of that is due to accounting differences but hundreds of billions of dollars are wasted annually. Across a range of sectors, Beijing mandates that state-owned enterprises must lead. This leaves neither them nor the small private firms that might challenge them much incentive to innovate.

America is richer now, will be younger soon, has more in the way of resources, and is more innovative. China will not close the wealth gap unless we squander our advantages with irresponsible fiscal, monetary and regulatory policy.

Myth #2: Having not fought a war since 1979, China’s military hasn’t recognized the important changes caused by high technology.

Reality: The People’s Liberation Army (PLA) is a modern force, emphasizing quality for the past two decades.

The Chinese military has been carefully observing the conflicts of the past two decades, and has focused on improving quality, even as it remains the largest military in the world. To put it simply, this is not your grandfather’s PLA.

Since the end of the first Gulf War in 1991, the Chinese military has been striving to modernize, preparing for what is now termed “local wars under informationized conditions.” Based on their assessments of Operation Desert Shield/Desert Storm, NATO operations in the Balkans, the conflict in Afghanistan, and the march to Baghdad, the PLA understands that the victor in modern warfare is determined by their ability to engage effectively across the land, sea, air, outer space, and cyber-space domains—which in turn requires highly trained forces equipped with advanced weapons, rather than the Mao-era “human waves” of ill-equipped militia.

Consequently, today’s PLA is fielding ever more sophisticated weapons, developing two stealth fighters (the J-20 and J-31), fielding multiple new submarine classes, and commissioning the aircraft carrier Liaoning, making them the first navy in Northeast Asia to possess such a combatant. Meanwhile, China has fielded an array of space systems, including its own satellite navigation system as well as having tested an anti-satellite (ASAT) weapon in 2007. At least some Chinese cyber activities have also now been traced to the PLA, as Mandiant identified Unit 61398 of the Chinese military as “Advanced Persistent Threat-1,” or APT-1.

Even more important, the PLA has been creating its own doctrine, to maximize the effectiveness of these largely indigenously developed systems. China’s military has been emphasizing joint operations, training its forces to operate in the land, sea, air, outer space and cyberspace arenas. It has also paid significant attention to improving the logistical support structures, long a weakness in the PLA, so that it can sustain military operations.

The combination of more sophisticated weapons, indigenously developed doctrine, and more extensive training means that today’s PLA is striving to rely on quality, and not just quantity.

Myth #3: China is engaged in promarket economic reform and rebalancing from investment to consumption.

Reality: China has not engaged in promarket reform since 2005 and has only talked about rebalancing.

For those not paying close attention, China seems to have stayed on the path of economic reform for the past two decades, with perhaps an understandable and wise (in many eyes) exception for government intervention during the financial crisis. More recently, the Chinese government has publicly committed to making consumption the core of the economy.

In fact, the last decade of Chinese economic policy can be broken into three parts. First, roll back the market in favor of the state without anyone noticing. Then roll back the market in favor of the state to global cheers. Conclude by worrying about the harm done by rolling back the market in favor of the state. Beijing presently talks about deemphasizing investment and promoting consumption but has been unable or unwilling to act.

China’s imbalance problem did not always exist, it was created in 2003, when investment growth accelerated. Sustaining this acceleration required investment vehicles, which meant the state had to exert tight control over banks and major corporations. This control was highlighted in 2009, when China ordered state banks to greatly expand lending even while the business environment was deteriorating. Now this defiance of commercial logic is coming home to roost in the form of sharp concerns about debt.

Rebalancing has not even begun. From 2002 to 2012, fixed investment expanded by a factor of 11 while retail sales, a consumption measure, expanded by a factor of 5. By the end of 2012, fixed investment was three quarters again as large as retail sales. In the first half of 2013, investment grew another 20 percent and retail sales grew 12 percent.

The broader reform picture is no better. Beijing does not like competition in the home market (competition in other markets, of course, is a marvelous idea). For coal, gas, oil and petrochemicals, power, telecoms and tobacco, there are a total of 17 enterprises operating nationally, all extremely large and all state-owned. An antimonopoly law is not applied to these firms but is brandished against foreign companies. The government wants other industries to also consolidate on a few large state firms.

China is a large and important economic partner for the U.S., but it has stopped reforming and is not a very good partner.

Myth #4: China will inevitably engage in political reform.

Reality: Not only is the link between economic and political reform weak, but the CCP has little interest in political reform.

It has long been an article of faith that economic growth would inevitably lead to greater political liberty. The assumption was that, as a society became richer, there would be created a middle class that would eventually demand greater ability to chart its own political future, rather than defer authority to an autocratic government.