by Jonathan Brookfield
Dean Stavridis sees economic difficulties within the People’s Republic of China (PRC) as constituting one of the five biggest risks to the world in the near term. I agree that the PRC serves as the locus of a number of risks for the world and that its economy contains several weaknesses. That said, I think there are more than just economic risks present, and while I see the risks as manageable in the short-term, over a longer period, I agree that the risks may turn out to be significant.
From a global perspective, I see three major risks stemming from activities in the PRC.
First, an economic slowdown in the PRC could have significant effects on several economies around the world. PRC infrastructure spending and property development has sustained strong demand in building materials and basic commodities. To the degree that capital spending in such areas has been undertaken with the expectation that future demand will resemble recent past trends, we may see less economic activity in some resource rich economies, certain companies may find their balance sheets under pressure, and oversupply may lead to a noticeable decline in the prices of some commodities. In fact, this story has already begun to play out. The PRC’s real economic growth rate in the third quarter was 7.3 percent year on year, down from an annual growth rate of 10.4 percent in 2010. Meanwhile, copper prices are down 7 percent over the past year and down over 30 percent since the end of 2010.
Second, simultaneous weakness in the PRC’s financial sector, government finances, and overall economy, could potentially lead to a decision in Beijing to begin to use the country’s foreign exchange reserves to bolster its domestic economy. While some see this choice as unrealistic, believing it would lead to a kind of mutually assured economic destruction, such an analysis seems too sanguine. Yes, the U.S. dollar would weaken and PRC exports would suffer, but the actions of a drowning man can be hard to predict, and as 2009 demonstrated, in the short-term, well-resourced governments have ways to cope with turbulent export markets.
Finally, the most catastrophic risk, potentially, is that somehow the U.S. and PRC get involved in a military conflict. In a serious incident, it is not inconceivable that the U.S. could lose an aircraft carrier. How things might unfold after that is hard to predict.
While the last two risks are dramatic in terms of potential impact, the likelihood of their coming to pass still seems small. What seems unlikely today, however, is unfortunately not impossible. The American financial crisis of fall 2008 marked an important turning point in the economic trajectory of the PRC, as economic growth moved rapidly from being export-led to being a credit-enabled, investment-led phenomenon. If Carl Walter and Fraser Howie’s Red Capitalism is right, non-performing loans and poor asset quality continues to plague the PRC’s financial sector. If the estimates in Michael Pettis’ book, Avoiding the Fall, are right, the true level of total government debt in the PRC is somewhere in the range of eighty to 120 percent of GDP (as opposed to the more widely observed figure of 15 percent of GDP for net public debt). Add in a weak global economy, and one could imagine a perfect storm that might cause some in Beijing to seek succor from the roughly $4 trillion USD in foreign exchange reserves the country now holds.
As far as paths to a military conflict are concerned, one can imagine at least three: first, Beijing might try to channel domestic discontent away from itself by creating an international incident; second, to enhance his domestic legitimacy and position as leader, President Xi Jinping might adopt a foreign policy of aggressive nationalism that ultimately seeks to give the U.S. or one of its perceived proxies a bloody nose in order to demonstrate the PRC’s strength; third, having noticed the gains resulting from aggressive external action (e.g. Vietnam, the Philippines, the United States, or Japan), Beijing finally goes too far and ends up in a fight with the U.S. that it didn’t really intend to get into. Certainly, an economic slowdown could be a major source of domestic discontent, and widespread economic distress could increase the likelihood of Xi engaging in an aggressive nationalism or looking for advantages wherever they might be found.
On the bright side, in terms of economic risks, the PRC has resources, and Beijing still has a number of policy options available. For example, as far as local government finances are concerned, Beijing seems to be loosening restrictions on debt issuance by local governments. Allowing local governments to collect a property tax could also go a long way toward improving their finances. As for growing the economy, the required reserve ratio for major banks in the PRC is around 20 percent, which provides some scope for easing. While such policies are not necessarily in the long-term interest of the country, the point is that Beijing still has options. In the short-term, the PRC’s economy should be fine.
The further one gazes into the future, however, the less certain things become. Could extreme economic distress and perceptions of economic inequality in China lead to a dramatic change in government? It wouldn’t be the first time. It should be kept in mind, however, that while the focus of this piece has been on the PRC and some of its economic weaknesses, a number of economies around the world are in bad shape. In Europe, the weakness of Greece, Portugal, Italy, and Spain has been a concern for years. As far as emerging markets go, Turkey, South Africa, Brazil, Indonesia, and India have collectively been dubbed the “fragile five,” and if one extends an analysis of current accounts and budget deficits to the developed world, weakness can be observed in the United Kingdom (current account deficit of 4.2 percent of GDP, budget deficit of 4.5 percent of GDP), Japan (budget deficit of 8 percent of GDP), and the United States (current account deficit of 2.5 percent, budget deficit of 2.8 percent). Sometimes timing is everything, and if, in the land of the blind, the one-eyed man is king, flaws need not be a barrier to leadership.
About the Author
Jonathan Brookfield is an Associate Professor of Strategic Management and International Business at the Fletcher School of Law and Diplomacy at Tufts University and an Associate in Research at the Fairbank Center for Chinese Studies at Harvard. His research covers politics, economics, and business strategy in Asia, and he is currently working on a project that examines different varieties of capitalism in the region.