China’s economy depends on its politics

The news that China’s gross domestic product grew 7.5 percent from April to June ― down from 7.7 percent in the first quarter ― has provoked fewer gasps of horror than one might have expected. Chinese officials have been talking down the importance of the number for days. The mainland economy might ultimately grow 7 percent this year instead of at its usual double-digit rate, they’ve hinted. Nothing to worry about.

These officials, from Prime Minister Li Keqiang on down, are speaking to two audiences: the global financial elite, and the tens of thousands of junior officials who administer Communist rule in China. Top leaders like Li understand that the Chinese economy needs to slow down. Too much money is flowing into unproductive investments ― ghost apartment blocks empty of residents, mills churning out steel that no one wants ― and local officials, striving to meet high GDP growth targets, are often to blame. By implying that such targets are no longer sacrosanct, Li means to encourage a focus on the quality rather than the quantity of growth.

He’s hoping to engineer a “soft landing’’ for China’s jumbo-jet economy, a gliding slowdown in which consumption, not misdirected investment and white-elephant projects, becomes the primary driver of growth. The effort is laudable and long overdue. Unless Beijing pushes ahead with political as well as market reforms, however, it is doomed to failure.

All those officials out in the provinces are receiving mixed messages. For years they’ve been judged on their ability to meet the official growth targets; not surprisingly, most of them did so. While some falsified figures outright, many others funneled cheap credit to state-owned companies and crony developers. Since the 2008 financial crisis, credit has ballooned to an estimated 173 percent of GDP from 115 percent. This, party leaders have declared, must stop.

Yet local officials continue to be judged by something else ― their ability to maintain stability. On any given day there are 500 “mass incidents” in China (an official term, elastically defined). Authorities often try to buy peace with payoffs, or by sanctioning make-work projects to keep protesters employed and quiescent.

Li acknowledges that his reforms will cause pain when projects are canceled and inefficient enterprises shuttered. Yet the government has provided no new means for ordinary Chinese to vent their grievances ― quite the contrary. Thousands of online censors are policing social networks like Sina Weibo more intensely than ever. Efforts to promote greater democracy at the village and county level have stalled. Legal reforms that allowed people some hope of pursuing their claims in court have been slowed and in some cases reversed.

Chinese President Xi Jinping seems to believe that the party can recapture the affection of the masses by intensifying its ideological commitment. Xi has launched a Maoist-style “mass line’’ campaign to eliminate “formalism, bureaucratism and hedonism and extravagance.’’ If that fails, local officials can always rely on batons. China spends more on internal security than it does on external defense.

Top leaders show signs of realizing that this can’t go on. Li recently encouraged Politburo members to read Alexis de Tocqueville on the French Revolution, notes Minxin Pei, a China scholar at Claremont McKenna College. Faced with mobs at the gates, local officials are only too likely to turn the credit back on, adding to the nearly $2 trillion in debt that local governments are estimated to have accumulated.

Xi and Li must rebalance their efforts at reform. They have talked about imposing market discipline on lending decisions, by allowing interest rates to rise, for instance. The recent tightening of credit conditions, now partly reversed, was presumably a clumsy attempt to do just that. Broader social reforms are needed as well. Relaxing household-registration restrictions (hukou) would normalize the position of China’s 250 million migrant workers and encourage them to spend more of their savings; former World Bank China director Yukon Huang believes that alone could boost consumption as a share of GDP by 2 to 3 percentage points. A stronger social safety net would also lessen the need to save.

Just as critically, leaders in Beijing need to bolster the discipline of democratic accountability. A freer press would challenge the vested interests that are sure to resist Beijing’s newly decreed sobriety. Only empowered and legitimate courts will convince Chinese that their grievances will get a fair hearing.

Ultimately, the vote alone can create a truly effective safety valve for citizens’ mounting frustrations. For years Beijing has bought stability with economic progress. Now that the country faces years of painful de-leveraging, its people cannot be expected to meekly accept that the party has their best interests at heart. Even the Study Times, a newspaper run by the Central Party School, warned last week that Xi’s mass-line campaign was “not an effective substitute that can realize the function of democracy.’’

Western investment analysts have been reassuring their clients that China isn’t about to crash, that its leaders retain enough control to oversee much-needed reforms. The truth is, if Xi and Li are to succeed, they will have to surrender some of that control to their people.

(Bloomberg)