Is China Unstoppable?

Art by Julianna Brion

The backdrop to the now-deeper US trade conflict with the Chinese is a strong fear in Washington that China will supplant America as the leading economic power.

In terms of gross domestic product (GDP), China ($14.2 trillion) is on track to overtake the US ($21.3 trillion) by the end of the next decade, says the Center for Economics and Business Research.

China has transformed itself from a primitive land depending on farming into an industrial colossus, the second-largest economy in the world, after that of the US. It has done this by melding the dominance of a Marxist autocracy with a capitalist culture that’s home to burgeoning privately held companies.

As befits a Communist dictatorship, the underlying credo of Chinese economic ascension is collective action. Private companies live under a cloud of government repression. And state-owned enterprises (SOEs) are the favored children of the nation’s regime, even though the bulk of the growth comes from the private sector.

China has some headwinds that will hinder its progress to becoming No. 1. A big one: Its economic growth rate is decelerating. In 2010, the rate was in double digits. This year, the projection is 6.3%, down from 2018’s 6.6%. And by 2024, it should slow to 5.5%. 

Let’s assess the Chinese economy’s pros and cons:

China’s Problems

Move to a consumer economy. China rose to prominence as the world’s factory floor, an export machine that churned out goods of increasing sophistication with battalions of low-cost workers.

Now, with more and more people moving into the middle class, that is changing, as the nation seeks to become more of a consumer-driven society like the US. One reason for the shift is that China then would be less vulnerable in a trade dispute. Exports in the first quarter were 18% of GDP, down from 36% in 2006. Private consumption is almost 40% of the economy, up from 35% in 2011, CEIC data shows. In the US, the consumption share is 67%.

The downside, in the view of many China experts, is that exports are the lifeblood of its economy, and that monopolistic companies encouraged by the state can’t replace the drive of shipping goods overseas.

By Capital Economics’ estimate, rapid productivity growth isn’t possible unaccompanied by double-digit exports growth. China’s exports growth has fallen to the single-digit range for several years, long before the trade war. It was 9% last year. Meanwhile, productivity increases have ebbed to 6.7% in 2019 from 13.7% in 2007.

Big debt, top-down strategy, waste, and inefficiency. Despite the planned transition toward a more consumer-centric society, the ill effects of past economy-building efforts linger. Like towering debt.  At 303% of GDP, China’s overall debt—government, corporate, and household—is every bit as large as those of the US and other Western powers, the Institute of International Finance finds. Debt is not necessarily a bad thing, as it enables societies to afford needed expansions, provided that the borrowing is not simply wasted.

The problem is that China’s heavy investment has not often been deployed efficiently. Many of its huge infrastructure build-outs, for example, had little utility, resulting in vast ghost cities where few lived, and highways and bridges to nowhere. Companies often are barred from choosing foreign components, even if these are superior to the homegrown alternatives. China’s return on capital plunged to 8.4% in 2017, from 19% in 2007, research firm Gavekal Dragonomics said.

And the Chinese private sector has at times been forced to struggle for capital, as state-controlled banks tilted toward SOEs. Private business’ share of sales has dipped about 5 percentage points since 2016, while the state-owned segment rose by around the same amount, Goldman Sachs researchers indicated.

An additional problem, as many China critics have stated, is the basic top-down nature of Chinese society, where the government is all-powerful and punishes anyone breaking ranks, and where political favoritism often intrudes in who is allowed to succeed.

The notion of a Chinese Steve Jobs or Bill Gates seems far-fetched. Conformity doesn’t usually foster the independent thinking that leads to world-changing advances. “With the state so involved in the economy, it’s a hindrance to creativity,” said Jim McDonald, chief investment strategist at Northern Trust.

Meddling with private businesses. Chinese authorities have jailed a number of the nation’s business leaders, in a crackdown on supposed corruption. For instance, Wu Xiaohui, the former chairman of insurance giant Anbang Group, has been sentenced to 18 years for fraud and embezzlement worth more than $12 billion.

The onetime head of wireless company China Mobile, the former chairman of Huarong Asset Management, and the chief of online giant Alibaba’s streaming service are among those booted from their jobs and either convicted or placed under investigation.

This executive roundup risks a chilling effect on China’s vibrant private sector. “A lot of entrepreneurs are fearful,” said Northern Trust’s McDonald, with suspicions that the arrests are for political reasons. The anti-corruption campaign has drawn suspicion that Xi has used it as a cover to cement his power, deposing opponents and rewarding allies. Likely, a Chinese Jobs or Gates would end up doing time.

Numerous critics in the West have noted that the Chinese legal system is an instrument of the ruling Communist Party, and courts are not meant to defend individual rights. The perpetuation of the party hierarchy, riding high over an obedient populace and business class,  is the foremost priority. Removal of term limits for China’s president last year meant that Xi Jinping is its maximum leader for life.

The trade war with the US. In spite of the political rhetoric on both sides of this question, the tariff clash with the world’s sole superpower is beginning to hurt Chinese growth, although hardly to a catastrophic extent.

By the International Monetary Fund’s calculations, the trade war plus global economic slowing should shave a tenth of a percentage point from China’s growth rate this year and in 2020. And that’s after accounting for Beijing’s latest stimulus program, aimed at offsetting US trade sanctions.

China’s Advantages

Superior, if slowing, growth rate. The math is simple. Right now, even though growth is slowing, China has an expansion rate that’s triple that of the US. Even if China’s growth rate slips to 5.5% in coming years, the American rate likely will stay around 2%. All things being equal, that spells China overtaking the US over the coming decade.

The US could “get its act together and increase economic growth,” said David Dollar, a senior fellow at the Brookings Institution, “but we so far are failing to do so.” China still benefits from the phenomenon known as “convergence,” which means that poorer economics in per-capita terms tend to grow faster than established nations like the US. “China would have to slow down to 2%, even with the US,” he added. “And that’s not going to happen.” 

Smarter stimulus strategy. The enormous stimulus packages Beijing launched to overcome past difficulties, such as the 2008-09 financial crisis, when it spent a sum equal to 13% of its GDP, are things of the past. That campaign was heavy on often wasteful infrastructure building.

China is shucking that approach, with the emphasis on tax cuts, and just a fraction is going toward construction of roads and rail tracks. So the new strategy, which amounts to a mere 2% of the economy, is more in keeping with a country that wants to tilt its economy toward services. Another benefit is that it won’t balloon debt.

Focused national purpose. “The Chinese authoritarian-capitalist model wasn’t supposed to survive in a global free market, let alone thrive,” wrote Ian Bremmer, president of Eurasia Group, a research and consulting firm. Under the Chinese hybrid strategy, enormous national funding is marshaled toward giving China the edge, especially in technology. Example: China is directing its national resources to becoming the global leader in artificial intelligence (AI).

Winning the AI contest will require a national commitment akin to the US’s Manhattan Project to build an atomic bomb or the race to the moon against the Soviets. “China is the better bet to win if the decisive factor is depth of commitment to a single goal and the depth of pockets in pursuing it,” Bremmer asserted. Washington has not dedicated the capital to triumph, he contended, and thus “is not in the race.”

The US doesn’t have a company that can compete with China’s smartphone giant Huawei, a study by the University of Pennsylvania’s Wharton School concluded. What that means is China has a strong focus on 5G wireless technology. Although US companies spend the largest amount on research and development, their Chinese counterparts are catching up and spending at a higher rate.

Exceptions to the authoritarian model inhibiting enterprise. “Some say there are no real private companies in China because the government always is in the background,” observed Ginny Chong, senior portfolio manager at Mondrian Investment Partners. Yet, despite the collectivist mentality and the political meddling, she continued, the heavy hand of government has not totally been an inhibiting force to innovative thinking.

Private Chinese businesses have prospered—to be sure, often with the help of Beijing. “Spurts of innovation occur,” Chong said. One area, she noted, is pharmaceuticals, where China’s drug makers used to be content to turn out generics and me-too versions of existing medicines from elsewhere. Now, however, the nation’s drug companies have embarked on a quest to turn out their own breakthrough nostrums. And that development, she said, has attracted expatriate  Chinese pharma scientists to come home.

Retail giant Alibaba, data and search provider Baidu, social network Tencent, and appliance maker Haier have all mounted innovation-fueled challenges to foreign multinationals, the MIT Sloan Management Review pointed out. Thousands of innovative Chinese companies, the journal maintained, “are quietly disrupting numerous industries, overtaking incumbents, and developing new products and new business models.”

Japan as a Template

At one time, another Asian nation was growing very fast and seemed assured of overtaking the US. That would be Japan in the 1980s, when it was the second-largest economy and the subject of much American hand-wringing.

Well, things didn’t quite turn out well for Japan, whose growth stalled in the 1990s. Only recently has it been able to nudge growth up, although many problems still exist. Thanks to an aging population and overweening debt, Japan has endured stalled growth since the 1990s.

Will China suffer the same fate as Japan? “Other than that they are both in Asia, China is quite different,” said Phil Torres, global co-head of emerging markets at Aegon Asset Management. “The debt in Japan was in the private sector.” Indeed, in China, the debt is loaded onto the SOEs and the local governments.

China is unlikely to develop into Japan. The question is whether it will develop into the United States and overshadow the rest of the world. There’s a decent chance it will.

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