What sank Soviet economy now threatens to scuttle China's

One of the CPC’s most famous slogans was, “The Soviet Union’s today is our tomorrow.” Photo: Reuters
One of the CPC’s most famous slogans was, “The Soviet Union’s today is our tomorrow.” Photo: Reuters

Summary

The greatest new challenge to the Chinese economy is the change in the CPC’s objectives for it.

The 20th National Congress of the Communist Party of China (CPC), held this past October, confirmed President Xi Jinping and China’s top political leadership for the next five years. But what that means for the Chinese economy going forward will depend on three factors: the state of the country’s institutions, past and current economic conditions, and the leadership’s political intentions.

China’s most fundamental institutions are totalitarian, reflecting and reproducing the CPC’s monopoly control over every facet of society, including the economy. The party-state institutions of totalitarian control were transplanted, in full, from the Soviet Union in 1949. While Soviet-style totalitarianism collapsed three decades ago under the dead weight of its economic failures, China appeared to be an exception. The question now is whether China’s own totalitarian experiment can last.

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To answer that, one must understand the structure of “totalitarianism with Chinese characteristics." A key pillar is regionally decentralized totalitarianism (RDT), which combines highly centralized totalitarian control over politics, ideology, and personnel with decentralization in administrative and economic affairs.

This is the arrangement that facilitated the post-Mao reforms. Centralized totalitarian control of the economy was relaxed, and RDT evolved into regionally decentralized authoritarianism (RDA). But since Xi came to power in 2012, China has shifted back towards totalitarianism, with the CPC leadership reasserting control, particularly over the burgeoning private sector. That reversal is a central reason for China’s sharp economic slowdown in 2022.

Much of China’s rapid economic growth in the early post-Mao reform era was recovery following the devastation inflicted from the late 1950s until the late 1970s by the Great Leap Forward and the Cultural Revolution. But the remaining share represented something beyond mere recovery, and is something of a puzzle.

China’s reforms succeeded where all of the reform efforts by its communist counterparts in the Soviet Union and Central and Eastern Europe had failed, because China had managed to solve a fundamental incentive problem that characterizes party-state bureaucracies. This earlier success offers clues about whether its economy remains sustainable today.

Following Mao’s death, the CPC leadership came to believe that economic growth was the key to its survival, and it settled on RDT as the institutional foundation for new reform policies. Under the new model, regional economic performance would determine the promotion of local party-state bureaucrats, which led to competition between subnational bureaucrats. To gain an advantage, some covered up or even supported illegitimate private enterprises, and thus inadvertently unleashed rapid growth in China’s private sector – a development that was incompatible with totalitarianism and certainly never tolerated in the Soviet Union.

With private enterprise becoming increasingly embedded in the Chinese economy, the CPC took the additional step of amending the constitution to recognize private-property rights, making China the first communist state to do so. At this point, there was a relative relaxation of control, and RDT began giving way to RDA.

Under the RDA model, the private sector, a rudimentary civil society, and non-state-owned mass media outlets were allowed to grow – and did so rapidly – provided that they did not challenge the CPC’s political monopoly. Then came China’s 2001 accession to the World Trade Organization, which brought an enormous inflow of foreign investment and a dramatic increase in exports. That development and the rapid expansion of the private sector became the decisive drivers of China’s rapid growth this century.

But though RDA enabled this early growth, it is also the root of a longer-run problem. The sustainability of China’s economic dynamism is persistently threatened by the exclusive state ownership of land, a state monopoly in the banking sector, the absence of judicial independence, discrimination against the private sector, and a dearth of domestic demand. While the CPC’s desire to rebuild its legitimacy drove the relaxation of totalitarian control in the early reform years, the 2008 global financial crisis gave the party an excuse to renew its push for total control.

The regime relied on a massive accumulation of debt to boost infrastructure development across the board, which generated a high economic growth rate, at least for a while. But most of these investments were inefficient, and China entered a vicious cycle of overleveraging and overcapacity. Worse, the massive debt-backed public spending sidelined the non-state sector. As the public sector advanced, the private sector retreated.

Another problem is China’s lack of an independent judicial system to uphold the private-property rights the constitution recognizes. Instead, the judiciary tends to protect state-owned enterprises and party-controlled assets; sometimes, it even serves as a channel through which the party-state expropriates private owners. This lack of judicial independence is bad for business for another reason, because it means that contracts are not enforceable in any predictable way.

Meanwhile, the exclusive state ownership of land and the state monopoly of banking have led to severe problems in the real-estate sector, which contributes directly and indirectly to about one-third of GDP. China’s real-estate marketization, which began in 1998, was designed to convert state-owned land into local party-state fiscal revenue. The key reform was to make each local government the sole landowner within its jurisdiction.

But to maximize their financial gains from land, governments at all levels try their best to raise prices by reducing supply. Consequently, Chinese real estate, measured by the ratio of local real-estate prices to average per capita household income, is among the world’s most expensive. In the Xi era, China’s real-estate value exceeds that of the United States and the European Union combined. But this intentionally created bubble is now on the verge of bursting.

In addition to creating trouble in the real-estate sector, exclusive state ownership of land and the state’s banking monopoly have destabilized the Chinese financial and fiscal systems. Using land as collateral, governments across China have borrowed massively from state-owned banks, pushing the country’s total debt-to-GDP ratio to 300% in the first quarter of 2019 and making its leverage rate among the highest in the world.

Worse yet, most debts in China are mortgage loans that use land and financial securities as collateral. Now that the Chinese economy has been slowing, the devalued mortgages behind these pro-cyclical debts are starting to weigh on the entire economic system, possibly triggering financial and fiscal crises.

Low domestic demand is compounding all these problems.

In the past, China could substitute the revenue from exports for low domestic demand. But now that China’s ties with the world’s high-consumption advanced economies are deteriorating, exports can no longer be relied upon to drive growth. China’s own ratio of private consumption to GDP remains one of the lowest in the world – just 38.5% in 2021, compared to nearly 70% in the US and 56% in Japan.

The fundamental reason for chronically low domestic demand is that household income growth has been lower than GDP growth for decades, because the state has taken too much through state agencies and monopolies. But another reason is severe income inequality. A massive number of people – especially the officially defined rural population – live in absolute poverty regardless of their livelihoods, owing to various institutional constraints. In a 2020 speech, then-Premier Li Keqiang reported that about 600 million Chinese had a monthly income of around CN¥1,000 ($140); in fact, 500 million earn less or even much less.

The greatest new challenge to the Chinese economy is the change in the CPC’s objectives for it. Economic development for the sake of the party’s survival has been supplanted by the goals of peaceful political evolution and the prevention of “color revolutions." Since 2012, the CPC leadership has been systematically tugging China’s political economy back toward totalitarianism.

Even though China’s social pluralism (private businesses, civil-society organizations, independent media) remains limited, CPC leaders still worry that this narrow space provides a basis for rebellion.

Prominent private-sector entrepreneurs have been purged, and leading non-state companies in the digital economy have been ruthlessly suppressed – developments that have both undermined the private sector and reduced China’s access to the world’s advanced economies.

Following the CPC’s recent Congress, it now seems clear that totalitarian control over every corner of society will be strengthened. The number of moderate technocrats and their weight in party-state agencies will be reduced. Economic policy will be politically determined. State-owned enterprises and party-state bureaucracies will steadily crowd out private enterprises and markets. The devastating “zero-covid" policy has already showcased how far the CPC’s power can and will extend.

By the 1980s, the Soviet Union’s per capita GDP (measured by purchasing power) was about one-third that of the US, whereas China’s per capita GDP today is only slightly above one-quarter that of the US. Even worse, as a consequence of the CPC’s decades-long “one-child policy," China’s population growth rate has started to decline and the demographic structure implies that both labour supply and domestic demand will run into deeper trouble. All of this means that China still has a long way to go just to catch up with the relative development level of the Soviet Union. Whether it will do so is an open question now that it is moving back to the failed Soviet system of central control.

In the 1950s, one of the CPC’s most famous slogans was, “The Soviet Union’s today is our tomorrow." That tomorrow may well have arrived, with the CPC on its way to transforming today’s China into yesterday’s Soviet Union.

The party’s leaders apparently do not realize that the same problems that sank the Soviet economy are now threatening to sink China’s. With each passing day, that outcome appears more certain.  ©Project Syndicate, 2022. www.project-syndicate.org

Di Guo is a senior lecturer of strategy at Brunel University’s School of Business. Chenggang Xu is Senior Research Fellow of the Stanford Center on China’s Economy and Institutions at Stanford University.

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