As my loyal readers know, I’ve been a bear on China for many years. Maybe I’m starting to believe my own books,(1) but poor China seems to be unraveling almost exactly according to plan.

As a reminder, my concern about China’s future centers on the irreconcilable conflict between the Communist Party’s need to remain in power and the Chinese economy’s need for human and economic freedom. My thinking goes like this.

If you want to shift from a backward, peasant economy to a powerful industrial economy, having an all-powerful top-down government isn’t all that bad an idea. The Soviet Union moved, in barely a generation, from an agrarian economy to the second most powerful economy in the world. And China accomplished the same thing.(2)

Unfortunately, industrial economies only take a society so far. Eventually, no matter how much capital is allocated to heavy industry, those industries don’t become more efficient or more competitive – in fact, they just get bloated.(3) Other, lower-cost economies begin to eat your lunch and suddenly you have millions of workers who aren’t doing productive things but will get very unruly if they lose their jobs. The only way out is to transition to a post-industrial economy driven by individual consumer demand and the provision of services needed by an advanced economy – i.e., not just manufacturing and mining.

But there’s the rub. A modern, post-industrial society(4) requires human and economic freedom. Consumers need to be allowed to decide what they want to buy without interference from a central government worried about controlling the population. Companies need to be allowed to decide what to produce without interference from a central government worried about controlling the means of production. Ideas and knowledge matter much more than brawn. In other words, if China is going to move forward from here, it has to transform itself into a vastly more complex post-industrial economy, where capital is allocated moment by moment to where it is needed most.

No centralized government, no matter how wise or powerful, can possibly succeed in allocating capital efficiently in a knowledge economy, as the USSR found out the hard way. You can have a powerful, top-down Communist government, or you can have a powerful, bottom-up economy competitive with that of the US. You can’t have both. With some parts of Soviet society demanding freedom and others demanding order, Russia got neither. It ended up with bloated, state-controlled production and the clinched fist of Vladimir Putin.

And China is now finding all this out the hard way as well. The Central Committee has studied the Soviet collapse to death, and what they learned was that, yes, you have to choose. And since no society in history has ever transitioned to a knowledge society when burdened by a despotic government, Beijing has chosen to ditch economic reform and growth in favor of remaining in control.

The symptoms of China’s unraveling are everywhere, but three examples are the most compelling:

(1) Growth has slowed dramatically. Even according to Beijing-speak, growth has plummeted from 13% per annum a few years ago to 7% today. The Western press tends to swallow the 7% number whole, even though the chance that a large economy could come in at exactly 7% every quarter is flat-out hilarious.(5) China’s real growth rate is probably closer to half what is claimed and its vaunted economy is probably not much bigger than Japan’s.

(2) As noted above, if China is going to have any chance of transitioning to a modern economy, Beijing needs to loosen up. People – and companies – need to be free to think and act for themselves. But, of course, thinking people would endanger the Party’s hold on power. So, instead, China is not becoming freer and more pluralistic, it’s actually consolidating all power in one man, à la Mao. This power grab is being disguised as an assault on corruption, and certainly corruption needs to be addressed – China is far and away the most corrupt country of any size in the world. But, despite what you read in the Western press, Xi isn’t really interested in corruption. Is it really possible for even the gullible Western press to believe that every corrupt official in China happens to be a foe of Xi, while every honest official happens to be an ally? Amazing!

(3) Xi has made a major point of his intention to put much more emphasis on private enterprise and economic reform. But so far, very little has happened. In fact, the one major effort to inject more free enterprise into China – the Shanghai Stock Exchange – has blown up in the Party’s face. As Chinese stock prices rose higher and higher, Beijing took full credit. But, apparently, the Party missed Adam Smith 101. Capitalism, in the form of stock markets or otherwise, isn’t just about winners. True, longer terms all boats get floated, but shorter term there will be winners and losers and rainouts. For a long time, the Chinese stock market was on a winning streak, but what goes up must come down. And when it came down, it came down with a bang, collapsing 30% in a few weeks. So much for Beijing’s commitment to free enterprise. According to the Wall Street Journal,(6) a freaked-out Beijing has committed no less than 10% of China’s entire GDP to artificially propping up the stock market.

China can’t evolve into a post-industrial, consumerist society capable of competing with the US because that would inevitably mean the liquidation of the Communist Party. Therefore, China is doomed to continue to unravel. As the populace recognizes that growth isn’t slowing cyclically but permanently, and that the economy is growing far slower and is far smaller than the government admits, chaos will ensue. Officials will take sides (more repression versus less Party), and so will the Red Army. Only for very brief periods of time in its long existence has China been united as a country, and the current period – the Communist Dynasty began only in 1950 – looks like it’s about run its course.

Almost fifteen years ago Goldman Sachs announced that China would surpass the US in GDP terms by 2028. That prediction was less ludicrous then than it is now, but even then it was a case of assuming that the future would look exactly like the past and that, therefore, a straight-line projection made sense. Here’s a better prediction about when China will surpass the US: never.

[Note: After this post was written, but before it was published, China unexpectedly devalued the yuan, throwing global markets into turmoil. Probably, my post was leaked to the Chinese leadership, who suddenly realized that steady economic growth was a figment of their imaginations. Now, according to the New York Times, “the country’s already slowing economy is even worse off than reported and … the government is panicking.”]

(1) See The Stewardship of Wealth, Chapter 1, “On China.”

(2) But note that many democratic countries also industrialized at staggeringly fast rates: Japan, South Korea, Taiwan, the USA.

(3) Many economists have pointed out that when a rapidly industrializing society achieves a certain level of development—call it $5,000 in capital per capita in round numbers —growth inevitably slows down. While the exact mechanisms of this deceleration are a matter of dispute, the phenomenon has been observed in societies as different as the United States, the Soviet Union, post-war Germany and Japan, Taiwan, Singapore, Hong Kong, etc.

(4) The sociologist, Daniel Bell, is mainly associated with the concept of a post-industrial civilization. According to Bell, such a society is characterized by a transition from the production mainly of goods to the production mainly of services; the elevation in importance of professional workers over laborers; and the rise of knowledge and ideas as important sources of economic and social capital.

(5) “All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most.” Paul Krugman.

(6) “What’s Chinese for TARP?” 8/7/15.

Next up: The Financial Crisis and Moral Relativism

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