China’s strengths and ambitions have been eye-catching.  What of its weaknesses and fears?  These, too, are striking.[1]

China’s economic progress rests on three pillars.  First, a rapid industrialization that required moving hundreds of millions of peasants out of low-productivity rural agriculture into higher-productivity urban factory work.  Second, engagement with the global capitalist economy to draw upon Western investment and expertise while selling China’s products abroad.  Third, the move from a centrally-planned economy to something more like a market economy.

This approach produced significant benefits for China.  China joined the World Trade Organization (WTO) in 2001.  This opened many markets to Chinese goods on advantageous terms.  Moreover, China pursued neo-mercantilist policies aimed to boost exports while restricting imports.  These included manipulating exchange rates for currency, subsidizing Chinese producers to lower their prices on world markets, and raising all sorts of non-tariff barriers to Western imports.  By 2010, China’s exports amounted to almost 25 percent of the world’s trade.

Then, in 2008, the Great Recession began.  World economic growth—and trade—slowed down.  China’s problem: how to keep everyone working so that political dissent did not arise?  China’s solution: invest in the domestic economy by providing a lot of credit.  This meant cheap loans to businesses to build things.  Trouble is, there’s investment and then there’s “investment.”  The Chinese government poured money into all sorts of make-work projects: construction and infrastructure (roads and bridges, high-speed rail) were favored targets for government largesse.

What are the results?  China over-built, over-invested, and over-borrowed.  Chinese debt has ballooned, about half of it is in real-estate.  Many industries suffer from excess capacity, while much of the building spree has produced empty buildings.  China’s economy isn’t growing at the fantastic rates of the first decade of the century; profit margins have fallen to low levels compared to Western economies; many companies can’t earn enough to service their debts and about 20 percent of it is non-performing.

Other problems are policy-driven, but not specifically financial in nature.  First, the one-child policy launched in the 1970s is now beginning to produce a demographic trap.  The labor force will start to shrink while the number of retirees will grow.  When America faces this problem, one solution is immigration.  Can China find immigrants?  How would the Chinese respond to immigrants from Southeast Asia?  From South Asia?  From Africa?  Can the Chinese substitute robots and artificial intelligence for human labor?

Second, Xi Jinping’s instinct is to clamp down on all forms of freedom as disruptive.  His “Belt and Road” plan is fascinating, but it is essentially a top-down government plan that is insulated from market considerations.  His pursuit of a “surveillance state” and his insistence on joint party-enterprise decision-making for the state-owned enterprises is likely to be “stifling in terms of creativity and disruption.”

Combine a gigantic asset bubble with a global economic slowdown and a not-agile government and what do you get?  Trouble for all, and not just for the Chinese.

[1] George Magnus, Red Flags: Why Xi’s China Is in Jeopardy (2018).