Beyond the Games

The shining spectacle of the Beijing Olympics has opened the eyes of the world to a new China. However, the Chinese authorities still face many challenges to keep this resurgence on track, writes Jonathan Fenby

AFTER THE Olympics, China will have a second big reason to celebrate, dwarfing the Games in significance for the world's most populous country and for the rest of the planet. In December, led by the Communist Party chief and president, Hu Jintao, the People's Republic of China (PRC) will mark the 30th anniversary of the adoption of market-led economics under the patriarch Deng Xiaoping.

That decision, taken at a party Plenum at the end of 1978, began the enormous transformation of the country. The effects of this decision rippled out across the rest of the globe, affecting everything from the price of copper and coal, to inflation in developed countries and the ability of the US government to fund its federal deficit.

The Olympics have crystallised China's pride in its achievements, demonstrating a patriotism bordering on nationalism. Nevertheless, a generation on from Deng's economic shift, China faces enormous challenges. These include a serious imbalance between the booming coastal regions and a poor interior, a pollution crisis, bounding inflation, industrial re-structuring, corruption and wealth disparities wider than those in Europe or the US.

China may be depicted as a dragon which threatens to take over the world economy, but its government and ruling political party face a management job like no other on earth, and there are signs that the leadership is not ready to take the tough decisions needed.

Even though the PRC is a one party state with a big repressive apparatus supporting the regime, its leaders are well aware of the need to maintain social stability. This is particularly necessary in the face of tens of thousands of popular protests each year against land grabs by officials, corruption, pollution and malfeasance by local bureaucrats.

In many ways, the market has taken over to drive economic developments in ways that escape the leadership, especially when foreign factors come into play. There is still a big public sector, particularly in key industries, infrastructure and transport, but the big state firms operate largely on capitalist lines.

Major industries have shown themselves capable of circumventing or blocking government decisions in their own interests. For instance, provincial steel plants have stalled a consolidation of their industry that was first decreed more than a decade ago, while the energy lobby has prevented the establishment of a ministry to control power and coal, despite backing for the measure from top politicians. For a regime which puts such great store in control, these are deeply worrying signs.

The Communist Party may not face an organised political challenge, but with the economy in the driving seat, the lack of authority from the top is cause for concern, with the country's rulers caught between myriad conflicting pressures.

China today presents a series of paradoxes; a red-in-tooth-and-claw communist-ruled state that is still an autocracy treading a wary path between conflicting interest groups; a great power with 10 per cent growth and the potential to be richer than the US by 2030 that still has hundreds of millions of poor citizens; a thrusting new presence on the world stage with a looming demographic crisis at home which means there will not be enough workers to provide for the elderly in a couple of decades.

The first 30 years of the new Chinese economy were not plain sailing either. To begin with, Deng had to fight for power with Mao's anointed successor, Hua Guofeng, who was progressively sidelined - but who made an unusual appearance at last year's Communist Party congress, obese and asleep in his seat.

Deng won the debate to liberate the economy, first in the countryside and then in the towns, beating back conservatives who argued that the economy should be, like a bird in a cage, always subject to restraint.

However by the late 1980s, the economy was overheating seriously, with high inflation and major corruption scandals. Protests in 1989, centred on Tiananmen Square in Beijing, challenged the leadership before being put down in the army massacre of June 4th. Deng and his colleagues showed then that they put the primacy of their communist rule above all else and would not allow political liberalisation to accompany economic reform. However, in 1992 the patriarch had to launch a new drive for reforms after economic conservatives had used the political challenge to slow down the market.

His success led to renewed inflation which was quenched by a tough-minded prime minister, Zhu Rongji. At the time Rongji remarked that he was having a hundred coffins made - 99 for speculators and crooks and one for himself, since he might well be assassinated for his efforts.

After Zhu restored order and pegged the yuan to the dollar at an advantageously low rate, the party leaders, Jiang Zemin and now Hu Jintao, presided over the extraordinary burst of growth that saw GDP expand by 11.9 per cent last year and a trade surplus that generated $1.8 trillion (€1.23 trillion) in foreign exchange reserves.

That success was celebrated last month with the opening of the Olympic Games. Old Confucian symbols and tableaux depicting Chinese achievements down through the ages rammed home the point that this is a country with a civilisation stretching back some 4,000 years.

Now that the Olympics are over, the leadership is back to making sure that the great engine launched in 1978 stays on the road and speeding ahead. This involves at least a dozen major issues. Not only are there multiple challenges, but the sheer size of China means that they all take on enormous proportions.

Growth and stability

The issue here is whether the PRC can combine strong growth with stability. Will rising incomes produce a more harmonious society, as Hu Jintao would wish? Will the policy of pumping more money into rural areas lessen the coastal-inland divide?

Or, as some recent statistics have indicated, will the coastal cities move even further ahead?

The 11.9 per cent growth figure recorded for 2007 was too high for comfort, and will fall to 10 per cent for this year. But what if it starts to drop towards the 7-8 per cent minimum needed to keep the show on the road?

Trade

Though China is famous for its exports, trade contributes only 10 per cent to GDP. However, this remains a vital force in maintaining growth in the economy. As costs of inputs, wages and shipping have risen, China's exports to the US have moved from being deflationary to being inflationary. The PRC faces competition on price grounds from Vietnam and South Asia so it needs to move up the value-added chain. This is starting to happen - the fastest growing export sectors are now machinery, IT goods and cars.

It also needs to diversify geographically. Again, this is happening with the European Union becoming its biggest market and sales to southeast Asia and other big developing countries, including India, growing fast with dependence on the US declining. This is in a large part a result of the currency factor.

After slowing down earlier this year, exports in July were 27 per cent above their level in the same month of 2007 while the trade surplus for the month rose by 4 per cent to $25 billion (€17 billion).

Inflation

Growing demand, particularly from the new middle class of 100 million people, has fuelled food inflation. Following this have been rising energy and input prices, plus a flood of liquidity from hot money attracted by the strengthening currency. This may account for part of a 45 per cent rise in foreign investment this year.

The government has imposed price controls - on main foodstuffs, for example. Now, it is also being forced to subsidise domestic producers to keep up their margins. The annual rate of increase of consumer prices began to decline this summer, but that was from a high base established in 2007. Even if the fall continues, the rate for this year will be more than double that enjoyed in the first years of this century. The fall is due largely to dropping pork prices as pigs bred last year are slaughtered. This could lead to a fresh meat shortage next year. While still limited, non-food prices are growing at four times the rate of 2005-2006, and factory gate prices in July were 10 per cent above their 2007 level, pointing to higher consumer prices or squeezed margins for companies.

Pollution

China is the world's biggest emitter of CO2 gas. Some cities have terrible air pollution - as witnessed in the strenuous efforts to clean up Beijing's air for the Olympics. The health effects are serious, with half-a-million people estimated to die prematurely of lung diseases each year. Heavy metal deposits poison land and rivers are heavily polluted. Desertification is eating away at arable land in the north. Fines for environmental degradation are low, and local officials meant to implement regulations may protect polluting factories to help local industry and collect tax revenue, apart from more personal connections. Environmentally-friendly technology are expensive.

Land and food

China pursues a policy of meeting 95 per cent of its own grain requirements from its own fields. However, urbanisation and land pollution has brought the amount of arable land close to the minimum required to meet that target. Growing demand for meat from the emerging middle class means a greater need for land devoted to feedstock. In a sign of government concern, measures have been taken this year to clamp down on food exports. The next decision may be whether or not to use genetically modified strains of wheat.

Water

There is a chronic shortage of water in northern China, a situation aggravated by growing industrial use. Urban water supply systems are antiquated, with more than 200 cities taking their drinking water straight out of rivers into which untreated sewage pour. With water prices kept at artificially low levels, there is little incentive for companies to invest in treatment and supply systems.

Inefficiency

Despite its success, many sectors of China's economy are quite inefficient. Energy and water use is quite wasteful by international standards. The railway system is in need of considerable modernisation - much of it is single-track and trains stop too often, slowing down traffic.

As a result, it is quicker to import coal - which provides 70 per cent of China's power - by sea from Australia than to take it by rail from the coal fields in the north to the power plants in the south.

The electricity grid is badly organised and its poor condition was shown up by its failure during snow and ice storms in central and southern China in January and February of this year.

Financial system

After 1978, the state banks splashed out with a flood of bad loans which were often motivated by political connections or cronyism. Many of these banks have subsequently launched international IPOs and have cleaned up their balance sheets to a considerable extent, but their lending criteria are still subject to outside influences and the allocation of capital is generally inefficient.

The bond market is also quite weak. Last year, the government tried to talk down a raging stock market bubble without much success. This year the bubble has burst and the Shanghai index has more than halved, impeding the development of a proper capital market.

Savings and consumption

Chinese savings rates - by households, companies and by the government - are very high by international standards. This has provided cheap money to fund growth. However, it also keeps cash away from domestic consumption. This consumption needs to be increased to balance fixed assets investment and exports as a driver of the economy.

Although nominally a communist state, China lacks proper healthcare, welfare or pension systems; so people continue to save against a rainy day, to pay for their children's education and to look after their parents, or themselves, in old age.

Law, accountability, democracy and corruption

China has never enjoyed the rule of law. At best, it can hope for rule by law so long as the communists remain in power; otherwise the party would have to subject itself to the legal system and, on the contrary, the prevailing orthodoxy is that the law exists to serve the party.

Equally, accountability is, at best, applied only when the party so chooses. For instance the officials responsible for the shoddy school buildings that buried pupils alive in the earthquake in Sichuan this spring have not been held responsible, whereas a teacher who posted photographs of the collapsed buildings on the internet has been sent for a year's hard labour without trial.

Democracy, again, is only spoken off officially in terms of how more internal debate might sharpen the party's performance.

In that context, corruption continues to mar the regime and major campaigns are usually motivated by political concerns. For instance Hu's decision to unseat the Communist Party boss in Shanghai on corruption charges was the direct result of a belief that he was becoming too independent of Beijing.

Global affairs and nationalism

China needed a generally benign international context in which to grow over the last 30 years. Nevertheless, latent sources of disruption are not hard to find.

Its aggressive purchases of raw materials in Africa, the Middle East and Latin America have ruffled feathers internationally and could point towards an impending war for natural resources. Relations with Japan have improved recently, but are always prone to be upset by the memory of Japan's invasion of China from 1931-1945 and the barbarous conduct of its troops.

China's military build-up, particularly at sea, may test the strategic balance that has governed east Asia since 1945 under the US umbrella. Support for the regimes in Zimbabwe, Sudan, Burma and Iran puts the PRC at odds with the West and damages the credibility of the party when talking reform at home.

The strong patriotic pride in China's recent rise have been seen to spill over into strident nationalism, as in the attacks on the French store chain Carrefour after protests against the Olympic flame in Paris.

Some subsequent events, such as the blocking of a purchase bid by the Carlyle group for a big construction equipment manufacturer, and a more discriminating attitude to foreign investment suggest that nationalism may be starting to affect official attitudes to business too.

Tibet and Xinjiang

The Tibet "issue" flared up this spring during the Olympic torch relay and discontent there appears to remain high despite a security clampdown. The vast far-western territory of Xinjiang is largely Muslim, despite the influx of Han Chinese, and Beijing, with US approval, says fundamentalist terrorist groups are operating in the area.

China insists that both regions are an integral part of its territory. Others would argue that the PRC is the last major land empire on earth, and will have to cope with all the problems of challenged empires.

Hu Jintao, the prime minister Wen Jiabao, and their colleagues appear to lack the effective policy mechanisms they need to cope with the problems lapping round their heels. They seem devoid of ideas, short of applying an autocratic clampdown, while this method is looking increasingly incompatible with a society which has enjoyed a huge increase in personal liberty.

Hu lacks a dependable majority in the supreme decision-making body, the nine-man standing committee of the Politburo, and has to negotiate policy or accept defeat by powerful politically-connected lobbies. Provinces, which were granted wide autonomy by Deng so long as they delivered growth, prize their semi-autonomy from the central authorities. Having been accepted as a constituent part of the Communist Party, the entrepreneurial class is flexing its muscle and using its political connections to the full.

China is so big and so heavily populated, with such regional differences and ambitions that it has always been difficult to control. Add in the dynamic of 30 years of explosive growth and the expectations bred by that and you have a potent mixture for the years ahead.

Jonathan Fenby is the author of the newly-published Penguin History of Modern China, 1850-2008(Allen Lane). He is China Director at the research service, Trusted Sources, www.trustedsourecs.co.uk