By Lawrence Katzenstein for Global Risk Insights
The recent precipitous drop in the value of Chinese equity markets, and its link to underlying and broadly held concerns about the Chinese economy, compels serious analysis. China is now too large and too integrated into the global economy to suffer failure without ramifications for its major trading partners.
Some optimists, who think that the nearly $4 trillion in China’s foreign exchange reserves will offer options, are also concerned that mounting debt may reach capacity in spite of these reserves. In fact, it is telling that the deepest devaluation of the Chinese markets was estimated at $3 trillion, or a level nearly as high as the reserves themselves.
Small wonder that the unprecedented levels of intervention through both suspension of trading and massive purchases of stocks were eventually abandoned in favor of prosecuting inside traders and short sellers, even if some of the trading was part of the normal operations of hedge funds.
The solution to China’s problems will not be found by attracting additional capital through stock markets. In fact, because many stocks, like China Telecom/Mobile or major Chinese commercial banks, were derived from the most profitable sections of state-owned industries restructured into stand-alone entities to attract capital, it is unclear whether they should have attracted major investment in the first place.
At the heart of the problem is the political will in China to abandon unprofitable state-owned enterprises (SOEs), and write down their debts, rather than evergreen their existing loans with new ones. This process is designed to help pay existing debt and obscure problems rather than solve them.
In fact, China’s economic problems are primarily political economy problems rather than purely economic ones. The leadership faces both foreign and domestic insecurities deeply embedded in China’s national identity that are probably more manageable than they may realize.
Setting realistic national goals, while being true to the nation’s past, should not be a hard sell domestically or internationally. This may draw from the socialism of Kautsky and Bernstein rather than that of Marx or Mao, but it is certainly consistent with the goals of a nominally socialist party.
Assuring adequate state-provided pensions, unemployment benefits, and healthcare to primary sector workers and others not covered by work in SOEs would go a long way toward preventing mass anti-government protests or disorder during SOE restructuring, market corrections, or economic downturns. The government would not be under constant pressure to keep annual GDP growth rates high out of fear of social strife.
In fact, U.S. policy makers during the Great Recession found that unemployment insurance helped the economy by raising consumption over what it would have been had the unemployed been left destitute.
An economically secure populace would also be less open to potentially disruptive populism that has been advanced by Bo Xilai and others. It would also eliminate the need to advance Chinese nationalism at the level that has been inculcated in schools since the Tiananmen Square protests.
China could continue to advance Chinese culture and Chinese interests internationally as is befitting for a rising great power. But it doesn’t have to be so big and noisy about doing so. It is generally accepted that China was the original center of power and culture in the region, so there is no real need for provocative acts like have seen in the East and South China Seas.
The reduced threats at home and abroad will facilitate the restructuring now necessary for China’s wellbeing and growth. Xi Jinping’s Chinese Dream initiatives have already reduced corruption and corporate price fixing, sometimes at the expense of high party officials or “tigers.”
Following through on economic reforms that will privatize stronger SOEs with proceeds from these sales going to pay down China’s massive debt. The restructuring or elimination of unproductive state assets will displace some high party officials, but the best of these can be rewarded with posts in the new enterprises.
Allowing the renminbi to be convertible and traded on global currency exchanges may raise rather than lower its value as China’s economy stabilizes. However, this will only increase the value of the paychecks of China’s poorest earners, albeit at the expense of the most affluent in coastal cities.
At the end of the day, Xi Jinping must continue challenging powerful party officials and networks for the good of his country.