China – a brief economic and institutional history

Temple of Heaven at Beijing, China/Image: SCMP

Over the last two decades, China has been a major source of fascination for many of us because of its booming economy and speedy modernization. It has seen unimaginable levels of consistent economic growth since 1990, and has become a model for wealth creation. It was a poor and isolated country during Mao’s time, and the apparent sleeping giant seems to have woken up. For China, this is the time when they arrive at the centre-stage of the world, after their century of humiliation.

Starting from the 1990s, China has seen explosive economic growth and a corresponding increase in power. There is a group of observers who extrapolate these events to predict that China will be the next economic and military super-power. With this apparent success of China, there is also talk of the Chinese autocratic system being a better system than democracy. While all this does inspire awe and applause, let us take a step back and look at China with a critical eye.

That brings us to central proposal of the article: China may have seen the greatest economic boom of all time, but it is often seen across the world that great booms are followed by great busts. This means that the boom phase of China will not last forever, and will come to an end. In fact, the boom ended by 2010.  For China, it may not be an instantaneous bust, but more of a steady deceleration of the economy. This deceleration will be accompanied by a major question on the power of the Communist Party, and the emergence of strong competing interests that intend to fracture China. The Party will respond to this question by being extremely heavy handed and reduce the power of the fracturing forces by economically isolating itself from the rest of the world. This is eerily similar to the process Mao Zedong had used to keep China together, and it is no surprise that Xi is being compared to Mao. We, in India, should help China in this isolation process by eliminating most of our trade with China. 

Broadly, this piece will be dedicated to covering a brief economic and institutional history of China in the 20th and 21st centuries, aimed at the Indian readership. But, before we dive into the modern history of China, let us look at a set of axioms about China, based on which the behaviour of China will be explained, and predictions will be made:

China is an empire, not a modern nation:

The most crucial aspect of a modern nation is a focus on the individual The rights and choices of the individual are held supreme. This often appears as a set of fundamental rights guaranteed by an independent judiciary, and the ability of representative democracy to make laws for that. None of it exists in China. Courts are not independent according to their own admission. The Chinese Communist Party is above the law, and makes and breaks the law as per it’s interests.

On the other hand, empires focus on the interests of the ruling class. They look at people as the ones who need to be controlled according to their wishes. They impose a language and a belief system on everybody to make them feel part of the same community owing loyalty to the empire. China displays more empire-like behaviour: imposing Mandarin on everybody to create a loyal population and holding the interests of the Communist Party supreme. On that note, it goes without saying that the Communist Party looks at itself as a successor empire of the line of dynasties of China.

Image: Published on Medium

The Communist Party is communist only when necessary for the Party:

The Communist Party of China is not an ideology-based party. It is a group of power holders who follow whatever idea or set of policies that helps them maintain and grow power. It is named as the “communist” party only because that is the ideology which worked for them during their rise in popularity in the inner China of 1920s.

When Mao started popularizing ideas of communism in Changsha in Hunan province, it was a poor and oppressed region. A high level of oppression is usually the necessary condition for a large group of peasants to take up guns, dreaming about a world where everybody is equal. Two well known examples are: the serfs of Russia in the early 1900s and the peasants of Naxalbari in the 1960s.

Subsequently, the Communist Party has changed its ideas and policies as and when the environment has required them to. For this reason, let’s refer to them as the “Party” in the article.

Historically, there have been three types of systems, depending on whose interests are looked at: a) A king/queen and their cronies, b) a large group of people who often form a parliament or a council of nobles and c) the common people. Typically, a modern nation intends to focus on (c) but ends up focusing on a mix of (b) and (c). China, since 1949, has oscillated between (a) and (b). It took a perceived entry into (c) in the 1980s, but has since corrected to (b), and it appears that it moved to (a) when Xi Jinping was coronated as President for life.

Top priorities of the Party:

The Party has the following priorities: a) Maintain power in China, b) Grab power in foreign lands if they are comfortable with (a). Actions to achieve the super-power dream usually appear when the Party is focusing on (b).

They often camouflage this as China gaining dominance in the world, but in reality, it is just the Party gaining more power. This is quite evident from the way Chinese institutions are structured. The Chinese military is not loyal to the people of China, but to the Party. It is just the armed wing of the Party, with the assigned task of maintaining and growing the Party’s power using force.

Chinese President Xi Jinping at the opening of the 19th National Congress of the Communist Party/ Al Jazeera

Top fears of the Party:

In light of the first priority above, it is imperative for them that they keep a watch on internal forces which challenge the Party’s power within China. They have researched the history of China’s dynasties to keep a watch for the top threats each one has faced. These threats usually appear when the ruling power becomes weak and oppressive. Because of their weakness, they clamp down on their populations, leading to rebellions. There are 3 major patterns in which Chinese dynasties have fallen or weakened:

a) Peasant rebellions: China’s history has seen numerous peasant rebellions against different dynasties. For example, the An Shi rebellion (756 – 763 AD) severely weakened the Tang dynasty and pushed the empire into a state of chaos. The modern peasant is the industrial factory worker, who can rebel and severely weaken the Party’s power. This factor appears in the Party’s economic policies after 2008, which we will cover in a later section.

b) Rise of alternate ideologies: Any ruling system rules based on the belief of the subjects in the system. During times of weakness, the ruling powers of China become insecure about the belief people have in them, and start fearing alternate belief systems. These alternate belief systems, depending on the followership, can become a serious challenge to the ruling elite’s power. This may include any cultural or religious group. The most famous example for this is the Taiping rebellion (1850 – 1864), which severely weakened the Qing dynasty and gave the British the opportunity to attacked and take control of Hong Kong in the second Opium War.

To address that fear, the Party clamps down on any cultural or religious group it sees as a potential threat to it’s power. This may include Muslims in Xinjiang or Christians all across China. Similarly, Falun Gong practitioners have been persecuted in China since the late 1990s. Needless to say, free speech is banned in China.

c) Military revolts: This is often the final nail in the coffin of a Chinese empire. When the ruling power becomes extremely weak and loses any gentle ways of maintaining power, they resort to using force. This makes military generals more powerful. If the empire weakens further and simply relies on the military generals for power, the generals have an incentive to rebel and proclaim power for themselves. One famous example is the defection of General Yuan Shikai from the Qing empire in 1912.

China’s geography problem:

China has a major geographic problem, which has far reaching consequences on it’s economics and power structures. It is the difference in economic opportunities between the coast and the interior. The “coast” can be defined as the part of China which is less than 300 km from the sea coast, and rest of it as the “interior”.

Whenever the coast trades with the rest of the world, it creates a class of people or  merchants whose interest is not necessarily aligned with the central command of China, whoever is running it. This was especially visible during the Ming dynasty’s rule when the merchants openly rebelled against the emperor  It gets further complicated when we see that the interior does not get to trade in the same way because of high logistics costs over land. This causes a difference in interests of the interior and the coast, creating a challenge to the central power structure. For example, during the Warlord Era after the fall of the Qing dynasty, the Manchurian warlord was closely allied with Japan, while the others did not have the same interest.

Because of this threat to power, different dynasties have periodically banned trading from China’s ports, to keep their rule intact and the empire united. The most recent one was Mao’s ban on foreign trade, up until Deng Xiaoping’s reversal after 1978. We can look at an older example to get a better perspective. The Canton system was established by the Qing dynasty in 1760 to limit trading from Chinese ports. All ports were closed off, except those in Guangzhou in the south. Only state approved merchants from the “Thirteen Factories” were allowed to trade. This came to an end only after the British forced them to open the ports for trading in the 1840s after the first Opium War.

It is because of this factor, that foreign traders are looked at with skepticism, as it is their trade with China’s coast causes disunity in the country, leading to a challenge to the central power. The term “hostile foreign forces” was extensively used during Mao’s time, as Chinese ports were still open. In the decade of 2010, this term has re-appeared into common usage, as China is trading through it’s coast.

It is worth noting that even during times of isolation, state-approved or state-owned trading has been encouraged as that keeps cash flowing into the state coffers and does not pose a challenge. One example of that is salt in the Ming dynasty. In the later stages of that very dynasty, the ports were opened up and taxes were drastically reduced on trade, causing the merchants to gain significant amount of wealth and power. Their extent of power can be judged by the event when the Wanli emperor tried to raise taxes, the local officials representing the merchants beheaded the emperor’s representatives. 

The Story

China’s Terracotta Warriors in Xi’an/Image: published in
Smithsonian Magazine

With the axioms in place, let us go into details of China’s history in the 20th and 21st centuries. When the Party was rising to power in the 1920s, China was a divided country with different sections having different foreign influences. So, just like the Qing emperor in 1760, the Party banned private trading with the rest of the world in the 1940s. The Party largely reported to Mao Zedong, who had become the “core leader” thanks to his leadership in the Long March.

Mao was an iron-fisted leader with the tendency to crush anybody who spoke against him, and had a preference for an extremely heavy handed approach towards ruling China. After consolidating control, he visualized a plan to make China a great country on the world stage, with an improvement in industrial and agricultural output. His plan, called the Great Leap Forward, consisted of two main aspects: increasing rice production and increasing steel output. He had a strange fascination for overtaking Britain’s steel output. While the intent may have been right, the methodology he forced people to adopt was unscientific and illogical. His method of increasing rice output was to plant seeds very close to each other. This caused a reduction in the harvest, leading to a famine which killed more than 30 million people across China. The plan was illogical from the outset, but because of the way the Party was structured, nobody questioned him. On the contrary, junior members of the Party spent all possible efforts to force people to adopt Mao’s plan. To produce steel, the junior members had to either force people to produce it without any requirement or make up statistics to appease Mao. The pressure by junior Party members on the people to produce “steel” was so high that they even started putting their domestic pots and pans into the furnace to produce a ferrous output believed to be steel. In reality, the only output was useless pig iron. There was no free media to report on any of the above stories, and was hardly known outside China. In fact, Chinese students in the US used to distribute pamphlets about a “bumper harvest” of rice. The lack of dissent in the Chinese system is a crucial factor behind major problems China faces, which appeared again in the future.

After Mao’s death, Deng Xiaoping became the Core Leader in 1978, and he disagreed with Mao’s ways of increasing the Party’s power. He wanted a more inclusive system and famously said “it does not matter if the colour of the cat is black or white, as long as it catches mice”. At the same time, the US had an interest in getting China to “open up”. The belief in the US was that if they engage with China economically, China will gradually become a more inclusive country, and ultimately a democracy. The US was in active competition with the Soviet Union during those days to promote democracy, as opposed to communism. The US and China made a deal in 1979, followed by the de-recognition of Taiwan in 1980.

With that, the Party started experimenting with inclusive open-market behaviour, like allowing farmers to sell their surplus produce, allowing private “use rights” of land etc. Deng also started promoting more freedoms, at least within the Party. The cost of disagreement with the Core Leader during Mao’s time was often torture and death, as Liu Shaoqi faced. Deng changed this, and the new punishment was a mere expulsion from the Party. This was, in a way, the Magna Carta of China. This also led the common people to believe that they have more power in their hands. The Tiananmen Square demonstrations of 1989 were an outlet of that feeling. However, the brutal repression of that demonstration was a clear indication by the Party that the apparent freedoms were only for Party members and not for the entire population. In fact, Deng was so impressed by the Party’s handling of the Tiananmen Square event that he picked the person in-charge of the brutality as a subsequent President – Jiang Zemin. The US expectation of China gradually turning into a democracy can best be called a delusion. Nowhere in the world has democracy ever been achieved without drastic events. This fact was covered in a paper in 2008 by Acemoglu and Robinson that democracy leads to high income, and not the other way round.

Deng had another realization that for faster economic growth, decentralization of the decision-making system is necessary. This was evident from his South Tour of 1992. After this decentralization, a look at the specifics of the events at the provincial level will give us a better perspective about China’s progress, up until the 2008 recession. In fact, Deng pushed 80% of the government’s budget to investing in coastal provinces. So, let us look at how the coastal provinces progressed from 1992 to 2008.

As with the usual system of the Party, individual provinces were given GDP growth targets and the officials were promoted based on their ability to achieve those growth figures. A number of opinion leaders view this part of China as being similar to any democratic capitalist country, with free markets and a laissez-faire attitude of the state. However, this couldn’t be further from the truth. The central planning merely shifted from Beijing to the province level. Let us look at a coastal province in China in 1992. They have been given a GDP growth target, and need to figure out ways to do it. The closest thing they see, is exporting to other countries: something Deng appears to have laid out early on. Starting from that time, China became the world leader in low value manufacturing. The provincial Party chiefs helped this by guaranteeing state loans, irrespective of whether the exporters can pay back the loan or not, as long as they can build up the numbers. Notice that this is very different from our conventional understanding of an export business. There is no profit motive and questionable property rights. If you want to export, the Party provides you a loan, no questions asked. It is okay if you cannot pay back the loan. This was the time when the US was lenient on China, and was happy to lap up Chinese exports. And, given the fact that the exporters were not really asked many questions by their debtors about interest payments, the exporters did not care about their perception in the market, and ultimately did not care about product quality. This probably explains why Chinese products are infamous for bad quality. This also got global companies interested in manufacturing in China, leading to Chinese exports sky-rocketing. The new creation of wealth led the Party to craft a new message to justify their legitimacy – “continual delivery of prosperity”.

Around this time, the Party also started looking at infrastructure spending (not necessarily investment) as a way to raise the GDP growth numbers. They started spending aggressively on infrastructure, including real estate. This infrastructure spending rose to great heights in the 2000s, which also expanded the supporting industries like steel, cement etc. For the Indian population, watching Chinese cities have amazing infrastructure became a matter of envy. However, it was only an extension of the local Party leaders trying to prop up the GDP growth numbers to impress their bosses.

This mix of export-led and infrastructure-spending led growth went great until 2008, when the Financial Crisis hit. The markets that were importing from China (US and EU) could not import much, and China’s exports as a percentage of GDP dropped from 40% to 20% in a matter of 2 years. To stop China from plunging into a recession, the central Party leadership crafted the largest stimulus plan in history. “Stimulus” is just a fancy word for the government deciding to spend aggressively. The government borrowed heavily from its banks, and used that to build infrastructure, to continue growing GDP. This is where the top fear of the Party comes in. They could not afford job losses due to the recession and large scale unemployment of factory workers would lead to a serious challenge to the Party’s legitimacy. So, they kept shoving money into real estate and other infrastructure items. To give you an idea about how crazy this was, consider this: China produced more cement from 2011 to 2013 than the US produced in the entire 20th century. This kind of infrastructure spending led to unoccupied houses at a scale never seen before. An offshoot of this process is the creation of the infamous “ghost cities”, which have been built to prop up GDP numbers, but nobody uses them. To hide the extent of wasteful spending, the Party stopped publishing residential occupancy data in 2011. These events made the Party weak, as the legitimacy was under question. The desire for legitimacy and power led them to start boosting nationalism in China and we saw a string of nationalism-oriented events in China, ranging from challenging Japan over the Senkaku islands to a rise in threats to Taiwan. Their occupation of the Spratly islands can also be partly attributed to this nationalism. They also started increasing their propaganda messaging, one of which famously claimed that the Chinese autocratic system is better because China was unharmed by the 2008 recession, unlike the Western democracies.

Around the same time, there was a major leadership crisis at the top level of the Party. Deng Xiaoping was strong enough within the Party to appoint two future Presidents – Jiang Zemin and Hu Jintao. But, by the late 2000s, the Party had multiple factions representing different interests. While the extent is hard to estimate, the geography problem appears to be playing a strong hand in this setup. Xi Jinping was elevated to the President position as the least unacceptable candidate for all the factions, and he assumed power as a very weak leader. He was heavily challenged by the Jiang Zemin faction, which led him to take down Bo Xilai and Zhou Yongkang. With competing factions attempting to go their own way, Xi launched a fear-instilling campaign disguised as the infamous anti-corruption campaign. Interestingly, the campaign doesn’t setup any new checks and balances in the system, but just takes down Party members who are “corrupt”. This is Xi’s way of keeping the competing interests together, through fear. It can be noted that his steps match Mao’s heavy handedness, and now the cost of disagreement with the Party boss could mean death.

Xi’s weakness can best be exemplified by the events during his visit to India in 2014. At the same time as he was in Gujarat, the PLA was conducting incursions into Ladakh, making him look weak. We might interpret this event as China betraying us, but another event might shine some light on the truth. When Xi returned to China, he called out the military for not obeying his orders, and asked for obedience, as reported by India Today.

By the time Xi took power, China’s economy had become extremely inefficient, with a lot of capital which was typically going for infrastructure spending to prop up GDP numbers. The fact that this spending was not getting any returns was an obvious conclusion. On the other hand, they couldn’t cut down on this spending, as that would lead to the realization of the Party’s top fear. With that, the Party thought of using the same steel and cement production capacity to build infrastructure in other countries, using Chinese capital as predatory loans. These predatory loans would get them some form of a return on the money, which they weren’t getting in China. This is known as the “Belt and Road Initiative”, which the Party projects as a “shared future” initiative, and is often perceived as China’s effort at extending power across the world. In reality, they are just serving the dual purpose of avoiding their top fear and trying to get some sort of a return on their accumulated capital. They probably realized on the way that they could also use the predatory lending practice to grab control over other countries, leading to the infamous debt-trap diplomacy.

While China hides all possible indicators of the economy going bad, there is one indicator which is often easy to spot: capital flight. It is the fancy term for lots of local rich people moving their money out in droves. This is because they can see that their money is not generating any returns in their own country, and they have the best understanding of local economic and political conditions. Capital flight from China started accelerating in 2014, and continues to this day. To give you an idea about the scale: the capital flight volume for 2016 is estimated to be $1 Trillion (Yes, Trillion with a T), when China’s GDP was $10 Trillion. Things came to a head in 2015, with a massive stock market crash, which the Party desperately tried to control, out of fear of the country’s reputation falling. The same year, some of the capital reached India, in the form of VC investments by Alibaba and Tencent. (given the economic conditions of the 2 countries, this is likely to continue). To give you an estimate of how bad it was in China in 2015: an estimate by noted economist Ruchir Sharma states that at the peak of the US housing bubble of 2008, $3 of extra debt generated $1 of GDP growth; while in China in 2015, $6 of extra debt generated $1 of GDP growth. And, it has gone worse since then.

Taking a step back: China is not in a good shape, with a weak leadership resorting to heavy handed tactics and an inefficient local economy. There is only one source of efficient economic value creation left in China – exports. This is also under threat now, with the trade war launched by the US President Donald Trump. Exports are the figurative blood transfusion keeping the bleeding Chinese economy alive. In the broader geopolitical context, the US is threatened by the rise in Chinese military power, and it’s hostile attitude towards everybody else. The trade war is punishment for that attitude, and the end of US leniency toward Chinese exports.

Future of China and what it means for India

Indian Prime Minister Narendra Modi and Chinese President Xi Jinping/Image: The Asian Age

With the economy having lost steam and the US attempting to cut off it’s last source of efficient value creation, the Party is in a fix. They had based their legitimacy on the continual delivery of prosperity, and started racking up debt from 2008 to keep the economic growth going. Even this seems to have come to an end. (debt-to-GDP ratio skyrocketed from 30% to 250% in 8 years). On the other hand, they are dependent on exports for any form of value creation in the economy, which the US is attempting to cut off. Also, the varying interests across China are still competing and making the country unstable. Xi Jinping is clamping down on everybody to keep the country together.

To save the figurative blood transfusion, you can expect them to attempt at sustaining and increase their exports in other markets – EU, India, Pakistan etc. They signed a Free Trade Agreement with Pakistan in 2014, after which Pakistan has seen a rapid rise in imports from China, with only a minor increase in exports to China. They are also trying to sustain and increase exports to India and EU. As long as foreign trade happens, Xi Jinping will force the trading coastal states to keep sending money into the interior to keep everyone happy and maintain the Party’s power in China.

With that said, China appears to be going into a period of isolation as it historically has. With the trade war, the Party seems to have realized that isolation is the only viable option to sustain power in China. They have started programs to make it hard for any foreigner or foreign company to stay in China. They have made it very hard to transact money to anywhere outside China. This isolation is not new, and also happened during Mao’s time. I’d like to propose that we help China in this process, by cutting off our imports as much as possible. This will accelerate China’s isolation and will make it weaker, sustained only by the heavy handedness of the Party. We are looking to boost our manufacturing and shifting manufacturing by Indian companies to India will be a big positive for us. It can also solve some of our unemployment problems.

Also, given the fact that the Chinese economy isn’t performing well, and India’s economy appears to be the only bright spot in the global economy for the next 10 years, we can expect more Chinese capital moving into India. In my opinion, we should welcome this, but strictly on our terms and also make sure that China cannot use this as a political leverage, as it typically does.

In context of the military, we can expect a more aggressive China. They are trying to boost nationalism, and a repeat of the condition of the 1950s and 60s is likely over the next few decades. We should keep a watch on their flashpoints, especially Arunachal Pradesh for us. On the other hand, we can support Taiwan over the next decade, in case we intend to add a chip to our negotiation table.

Finally, we can expect China to fall behind us economically over the next 30 years, and we can potentially be the world’s largest economy by 2050.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Kootneeti Team.

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The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of The Kootneeti Team

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Amal Sinha

Amal Sinha is a Consulting Editor at The Kootneeti on China and Geo-economics. His areas of interest include China, Pakistan, South East Asia, and the Middle East || Twitter: @amaleshwar

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