Xi should draw up a new so­cial con­tract for China

“How he might tackle them and what room for ma­noeu­vre he has within China's sys­tem of col­lec­tive lead­er­ship will be the sub­ject of next week's col­umn. Here, let's con­fine our­selves to ex­am­in­ing what kind of China he will in­herit.”

The Pak Banker - - Front Page - David Pilling

Afew weeks ago, Xi Jin­ping, the man who will shortly be­come China's next pres­i­dent, dis­ap­peared. Per­haps he was get­ting cold feet. That is not a very likely ex­pla­na­tion for Xi's 13-day van­ish­ing act. Far more likely, he was ill or fight­ing a be­hind-the-scenes bat­tle over the re­main­ing slots on the Polit­buro's all-pow­er­ful stand­ing com­mit­tee. But he would not be hu­man if he had not paused to con­tem­plate the enor­mity of the task be­fore him.

Do­mes­ti­cally not to men­tion in­ter­na­tion­ally, where China's re­la­tions with Ja­pan have strained to snap­ping point Xi faces ex­traor­di­nar­ily com­plex pol­icy chal­lenges. How he might tackle them and what room for ma­noeu­vre he has within China's sys­tem of col­lec­tive lead­er­ship will be the sub­ject of next week's col­umn. Here, let's con­fine our­selves to ex­am­in­ing what kind of China he will in­herit.

Eco­nom­i­cally, the mood has pal­pa­bly dark­ened in re­cent months. Growth has been slow­ing for seven straight quar­ters and, with expected an­nual growth of 7.5 per cent, the econ­omy is grow­ing at its slow­est pace since 1999. That is the of­fi­cial fig­ure. Some ob­servers on the ground, who talk to com­pa­nies or comb through prox­ies for gross do­mes­tic prod­uct, es­ti­mate the econ­omy is do­ing worse than that.

If he chooses, Xi can rev up the stim­u­lus engine once more. By most es­ti­mates, the com­bi­na­tion of state and lo­cal debt is no more than 70 per cent of GDP. Re­stric­tions on prop­erty and bank lend­ing de­signed to tame in­fla­tion and cool the econ­omy can be lifted. Since some of the slow­down has been de­lib­er­ately en­gi­neered, it fol­lows that, if nec­es­sary, it can be re­versed.

Yet, that would be to swal­low the poi­son Bei­jing has been try­ing to spit out for a decade. The cur­rent gov­ern­ment, headed by Hu Jin­tao, has long recog­nised the need to re­bal­ance the econ­omy away from in­vest­ment and to­wards con­sump­tion. Those plans had not been go­ing well even be­fore 2008. Af­ter the Lehman Broth­ers shock, they were junked all to­gether as Bei­jing mounted what Gold­man Sachs called the big­gest stim­u­lus pack­age in eco­nomic his­tory.

The in­evitable side ef­fects of that stim­u­lus non-per­form­ing loans and po­ten­tially de­fla­tion­ary over­ca­pac­ity have not yet taken hold. As the econ­omy slows, the bill from the last spend­ing binge will come due. To dou­ble down on stim­u­lus would be to take pre­cisely the wrong course. No econ­omy can pro­duc­tively in­vest more than half its GDP year af­ter year. One econ­o­mist cal­cu­lates that half of all China's phys­i­cal as­sets have been built in the past six years.

Mao Yushi, one of China's most ven­er­a­ble economists, says that, af­ter three decades of fast growth, the coun­try stands at a cross­roads. "Sooner or later, there must be a cri­sis," he says. Mao, who was this year awarded the Cato In­sti­tute's Mil­ton Fried­man Prize, says many of the in­vest­ments rushed out af­ter 2008, in­clud- ing the high-speed rail net­work, will never earn a profit. Based on elec­tric­ity-me­tre read­ings, he es­ti­mates that al­most 30 per cent of China's hous­ing stock is empty. Even if the pro­por­tion is half that, it is wor­ry­ing.

Too many houses is just the start. HSBC says that the steel in­dus­try has record debts, huge losses and ris­ing in­ven­to­ries. Even so, it is con­tin­u­ing to crank up pro­duc­tion. As growth slows, un­paid bills to Chi­nese com­pa­nies have in­creased and some lo­cal gov­ern­ments have run into fi­nan­cial dif­fi­cul­ties. In the fi­nan­cial sys­tem, an erup­tion of wealth man­age­ment prod­ucts, sold as a high-yield­ing al­ter­na­tive to reg­u­lar de­posits, has drawn com­par­isons with US subprime loans.

Stresses in the econ­omy are bring­ing more so­cial fric­tion. Cap­i­tal flight has picked up as peo­ple seek a bolt-hole. There is wide­spread anger at cor­rup­tion. Al­le­ga­tions in the New York Times about the wealth of Premier Wen Ji­abao's fam­ily is but the most spec­tac­u­lar ex­am­ple. Cy­berspace is seething with sto­ries of ar­ro­gant of­fi­cials caught wear­ing ex­pen­sive watches or lord­ing it over the or­di­nary Chi­nese. Mid­dle-class anger has risen too. Ex­pec­ta­tions are out­strip­ping the abil­ity of au­thor­i­ties to de­liver the safer en­vi­ron­ment or the kind of jus­tice peo­ple seek.

Re­cent demon­stra­tions in the city of Ningbo against the ex­pan­sion of a petro­chem­i­cal plant were the lat­est in a se­ries of not-in-my-back­yard protests. Lo­cal gov­ern­ments have been sur­pris­ingly quick to yield to pop­u­lar de­mands. Even that may not be enough. "You must politi­cise your re­quest," says an aca­demic at one of China's most pres­ti­gious uni­ver­si­ties. "You must de­mand power, not just fix a spe­cific griev­ance," he says, pre­dict­ing that anger could boil more force­fully on to the streets.

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