Fifth-generation problems

China's orderly transition hides troubling facts

At the 18th Congress of the Communist Party of China (CPC) this week, one of the world’s most outwardly smooth transitions of power will occur. The administration of President Hu Jintao and Prime Minister Wen Jiabao, the “fourth generation” of leadership of the People’s Republic, will step aside and be replaced by younger partymen. Unlike the transition from the first generation – of Mao Zedong and Zhou Enlai – to the second generation of Deng Xiaoping, this transfer of power is planned and stable, as was the case when Jiang Zemin and Zhu Rongji of the third generation gave way to Messrs Hu and Wen in 2003. But, unlike in 2003, the economic fundamentals are likely to make the new administration’s task difficult.

Mr Hu’s tenure as general secretary of the CPC and president of China has seen extraordinary growth rates, averaging close to double digits. China’s citizens have seen their standard of living soar, fuelled by a raging appetite in the rest of the world for their products following the country’s entry into the World Trade Organisation system in December 2001. The space for political and civil freedom remained small, certainly, but expanded significantly — especially at the local level. This did not trouble the CPC particularly, as support for the system remained strong as long as incomes rose steeply every year. But export- and investment-driven growth cannot last forever. The global slowdown following the financial crisis of 2008 was met at first with sharply increased government investment – financed through household savings expropriated by a repressive financial system – that only exacerbated the unbalanced nature of China’s growth. As acceptance spread through the government and the party that export growth would not return and that misallocated investment was becoming a severe problem, growth has fallen to 7.4 per cent per annum in the last recorded quarter. Nor is the arithmetic encouraging. To bring Chinese consumption rates to levels on a par with those in equivalent countries, household consumption will have to grow at least three percentage points faster than GDP over the course of the fifth generation’s tenure. But this will require an equivalent dip in investment and hence overall growth.

The temptation will be for the new leadership to let the problem slide. Indeed, both the incoming president, Xi Jinping, and the likely next premier, Li Keqiang, have developed a reputation for “successful inaction”. However, it is clear that misallocated investment is hurting not just the return to capital, abysmally low in China, but also the quality of governance. The invest-at-all-costs mindset is leading to impropriety and corruption across the system in a manner not unfamiliar to Indians. This, in turn, stokes popular anger — worrying the party. In 2010, for the first time, spending on internal security topped China’s defence budget, and has grown faster since. Meanwhile, the engineers who run the party are struggling to transform the earlier philosophy of “social control” into “social management”. But the economic necessities of rebalancing – reducing coal subsidies to energy-intensive industries is one such – will be opposed by those who have benefited from the current regime and been enriched by it. For example, China transformed from being a net importer of steel to a net exporter and the world’s largest consumer in the three years when the amount spent on coal subsidies tripled to $16 billion a year. The triple threat of economic slowdown, popular discontent and powerful dissenters will demand action of the new leadership, not successful inaction.