China’s Export Economy and Global Demand Slowdown

Something that my international business law students often have trouble grasping is that the Chinese economy remains enormously dependent upon exports to the rest of the world and to the US in particular.  On account of so much attention, often in undergraduate political science classes and elsewhere, I suspect, to the “rise of China and India,” my students, and perhaps the broader public as well, have a misplaced sense  of the size of China’s economy and its dependence upon American demand.  In very rough terms, China’s economy, well over a billion people, is on the order of $3 trillion in nominal GDP … while the US economy, or the EU economy as a whole, is each around $13 trillion.   There are all sorts of different ways of measuring the relative size of economies – purchasing power parity (on which China goes up to around $7 trillion), etc. – but in rough orders of approximatiion, the story is the same.  The point is that when demand falters, even modestly (on a historical basis) in the US and Europe, the consequences for China’s economy are leveraged.

Hence the kinds of difficulties spelled out in this Washington Post article from November 3, 2008.  It describes the swift effects of downward demand on Chinese factories and enterprises (since that article appeared, China has moved directly to bail-out mode and to sustain demand domestically through its vast currency reserves, and joining coordinated interest rate actions with central banks worldwide):

The economic devastation has been worst in the industrial centers of southern China, areas that had thrived in recent decades by producing the electronics, clothing, toys and furniture that fill retail stores in the United States.

With export orders falling because of the global slowdown and rising raw material and labor costs, more than 68,000 small companies nationwide collapsed in the first half of 2008 and about 2.5 million jobs in the Pearl River Delta region may be lost by the end of the year, according to government and industry estimates.

Moreover, when people in the West talk about the inexorable rise of China as a political power, they tend to assume a stable growth rate of 10% a year, and political stability that is equally certain.  That might turn out to be true – the world must hope for a China that becomes more prosperous, is able to draw its population into the modern workforce with rising wages and standards of living, and one that becomes more politically open and stable as well.  But it is worth bearing in mind that the transformation of China politically and economically is, in historical terms, five minutes old – a few decades.  The political legitimacy of the Chinese government is like a tiger by the tail – a function of providing a steadily and visibly rising standard of living, and a frank appeal to Chinese nationalism and, really, a certain form of ethnic chauvinism.  

What happens if the engine of rising living standards falters?  The inexorable rise of China narrative typically fails to addresss the questions of institutional governance – a global economic power with huge dependence upon corruption and limited rule of law, or for that matter systemic weaknesses of the banking and financial services system that make the current difficulties in the United States and Europe frankly modest by comparison.  What happens given the demographic facts of an aging population – as the demographer Nicholas Eberstadt has said many times, the question is whether China will grow old before it grows rich.  

These are all enormous question marks around the “inexorable” rise of China, and it seems to me premature to announce the political outcomes of such great unknowns.  Rural dissatisfaction has long been a problem of stability for the Chinese government, and a large nexus of its repression.  But as the WP observes, the current economic problems raise the possibility of urban factory workers also making political trouble:

When Chong Yik Toy Co. went bankrupt, the bosses fled without meeting their payroll and angry workers took to the streets in protest. Less than 72 hours later, the local government came to the rescue.

Armed with bags full of cash totaling half a million dollars, accountants began distributing the money so the 900 former employees would have something to get by on. The Chinese officials who made the emergency payments on Oct. 21 called it an “advance,” part of a “back-pay insurance fund.”

But the reality was obvious to everyone: It was a government bailout.

In the initial weeks of the global financial crisis, Chinese officials resolutely declared that they were not significantly affected. But now, as factory closings, dire corporate earnings reports and stock market losses continue to mount, the Communist Party’s confidence has changed to another feeling entirely: fear.

For the first time in the 30 years since China began its capitalist transformation, there is a perception that the economy is in real trouble. And for the Communist Party, the crisis is not just an economic one, but a political one. The government’s response offers a glimpse into its still ambiguous relationship with capitalism — relatively hands-off in good times, but quick to intervene directly at the first signs of a downturn in order to prevent popular unrest.

Just as one ought not to buy too quickly into the “inexorable rise” narrative, one should resist as well assuming that there will be permanent repercussions from the current crisis.  It is just too soon to tell.  However, it is worth noting something that Francis Fukuyama observed in a short book that deserved much more notice than it got in 2004, on nation building and economic development.  It is that for some governments, and China being one, the problem is paradoxically one of too weak a central state (btw, I recommend Fukuyama’s new book on Latin America and economic growth and development).  

This seems paradoxical if not flat out false for a Communist regime of naked authoritarianism.  Quite so, Fukyama says.  But it is also true – and more relevant in current circumstances – that many of the problems of repression and regulation are on account of the fact that, within the things that a central government ought to regulate, the Chinese government lacks the power to do them, or even to control local government in the rest of the country.  A vast amount of stuff is decentralized to provincial and local government structures, which are themselves simply beds of cronyism and rentseeking and corruption.  Successful democratic capitalist states, Fukuyama says, are characterized not by weak states, but instead by states that are at once very strong – but within carefully circumscribed subject matters.  About that, I think, he is quite correct.

Update.  Not everyone agrees.  See Jeff D. Opdyke’s column in the Wall Street Journal, “Death Knell of Decoupling Rings Hollow,” Monday, Nov. 10, 2008, C1.  He quotes Peter Schiff, president of Euro Pacific Capital:

“Everyone thinks the U.S. is the engine, but it’s the caboose just being pulled along. China and the others are healthy economies that foolishly loaned us their surplus capital that we squandered. But that doesn’t reflect on the local economies. They’re still intact. The factories are still there, the work ethic is still there, and they’re not entirely dependent on the U.S. for their own growth.”

While there is something to that, of course, I think it overlooks the institutional, governance, and political risks in making assumptions about China in particular.