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a China scholar David
Shambaugh has turned
very bearish, writing
“the endgame of Chinese
communist rule has now
begun.” This is a good
opportunity to review
our own thinking about
China, but our conclusion
is that the American
scholar’s arguments are
flawed.
a The Chinese economy
was recently described
as “stuck in a series of
systemic traps,” but it’s
important to note that
real income growth
rose about 8% last year
(compared to about 2%
in the U.S.), driving an
11% rise in real retail
sales (vs. 2% in the U.S.).
a Shambaugh accurately
cites corruption as a
major problem, but is this
likely to trigger a regime
collapse when 59% of
Chinese surveyed by the
Pew Research Center
revealed they are highly
satisfied with their lives
(compared to 65% in the
U.S. and 43% in Japan)?
Sinology
by Andy Rothman
April 1, 2015
THE COMING CHINESE CRACKUP?
Prominent China scholar David Shambaugh has turned very bearish,
writing in The Wall Street Journal (WSJ) in March that “the endgame of
Chinese communist rule has now begun.” This provides a good opportunity
to review our thinking about China’s prospects. But in my view, Shambaugh
does not make a compelling case to support his about face in perspective.
As head of the China Policy Program at The George Washington University,
Shambaugh is a respected analyst of Chinese Communist Party (CCP)
affairs, so his WSJ op-ed, “The Coming Chinese Crackup,” has received
much attention. This op-ed is also a big departure from Shambaugh’s earlier
view of China’s prospects.
In his 2008 book, “China’s Communist Party: Atrophy and Adaptation,”
Shambaugh was fairly sanguine about the country’s prospects:
“The central conclusion of this study, however, is that the CCP is
adapting fairly (but not entirely) effectively to meet many of these
challenges, has learned the negative lessons of other failed communist
party-states, and is proactively attempting to reform and rebuild itself
institutionally—thereby sustaining its political legitimacy and power.
Whether the CCP can continue to make the necessary reforms is, of
course, an open question. So far, so good—but this is no guarantee of
continued success.”
In the WSJ commentary, Shambaugh wrote “times change in China, and
so must our analyses. . . We cannot predict when Chinese communism
will collapse, but it is hard not to conclude that we are witnessing its final
phase.”
Continued Strong Economic Growth
ANDY ROTHMAN lived and
worked in China for more
than 20 years, analyzing
the country’s economic and
political environment, before
joining Matthews Asia in 2014.
As Investment Strategist, he
has a leading role in shaping
and presenting the firm’s
thoughts on how China should
be viewed at the country,
regional and global level.
But Shambaugh’s argument is flawed, especially when he looks at the
health of the Chinese economy, which he describes as “stuck in a series
of systemic traps from which there is no easy exit.” He doesn’t elaborate,
but it’s important to note that real (inflation-adjusted) income rose about
8% last year (compared to about 2% in the U.S.), while wages for migrant
workers, who move from China’s countryside to staff the nation’s urban
factories and construction sites, rose by almost 10%. As a result, consumer
spending remained very healthy, with real retail sales up almost 11%
(vs. 2% in the U.S.).
Figure 1. REAL GROWTH RATE OF PER CAPITA DISPOSABLE INCOME, U.S. VS. CHINA
Year-on-Year
12%
10%
8%
6%
4%
2%
0%
-2%
2005
U.S.
2006
2007
2008
2009
2010
2011
China
2012
2013
2014 Average
from 2005
to 2014
Sources: U.S. Bureau of Economic Analysis, China National Bureau of Statistics
China’s GDP growth has been slowing. But because the base on which last
year’s 7.4% calculation was made was more than 300% bigger than the base
from a decade ago (when growth was 10.1%), the incremental increase in the
size of China’s GDP last year was 100% bigger than the increase at the faster
speed 10 years ago.
Shambaugh notes that economic reforms proposed by Party Chief Xi Jinping
“are sputtering on the launchpad.” And he adds, “Yes, consumer spending
has been rising, red tape has been reduced, and some fiscal reforms have been
introduced, but overall, Mr. Xi’s ambitious goals have been stillborn.” By my
reckoning, however, there appears to be more of the steady, gradual structural
change that impressed Shambaugh in the past.
China continued to rebalance and restructure its economy last year.
Consumption contributed more to GDP growth than did investment, as was
the case in 2011 and 2012. The tertiary sector (services, retail and wholesale
trade in addition to finance and real estate) was larger than the secondary
sector (manufacturing and construction), as was the case in 2013.
The most important “rebalancing” is the shift toward an economy that
is driven by private sector entrepreneurs, and away from the model of an
economy led by state-owned enterprises. Last year, state firms accounted
for 32% of total fixed asset investment, down from a 58% share in 2004.
Investment by private companies has grown faster than that by state firms
in 59 of the past 60 months, which should lead to far better investment
decisions.
I expect this reform process to continue, in part because China’s leaders have
no choice. They must continue to improve the operating environment for
private firms, which account for about 80% of all urban employment and
almost all new job creation. I have modest expectations, however, for further
progress on the reform of state firms, as the government remains concerned
about job losses.
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Elite Fleeing, or Trying to Get Their Children into UC Berkeley?
Additional evidence cited by Shambaugh in support of his view is that “China’s
economic elites have one foot out the door, and they are ready to flee en masse
if the system really begins to crumble.” He references a Hurun Report survey
that found that 64% of 393 “millionaires” polled said they were either leaving
China or planned to do so. But is this evidence of an impending crisis in China?
According to the Hurun Report, those rich Chinese said, “education is their
main reason for considering migrating. Fees are one factor: in many countries,
tuition fees for foreign and domestic students are different; thus over a number
of years, the cost of emigration evens itself out. Another factor is the rapid fall
in the average age at which children go abroad to study: many parents have
realized that if children leave home too early, this can have a negative impact
on their development. Therefore they want the whole family, or at least the
mother, to accompany their children when they go abroad.”
While this reflects significant problems with China’s education system, it does
not signal that the political system is crumbling. Moreover, while I don’t have
hard data, my anecdotal experience is that rich Chinese who establish a second
home in the U.S. to facilitate their kids’ education have not abandoned China;
they have continued to run their businesses in China while pursuing their
dream of their children graduating from a prestigious American university.
And, according to the data, many of those Chinese students will eventually
return home, in large part because of the job opportunities in China. In 2013,
414,000 Chinese students went abroad to study, while 354,000 returned to
China. The Ministry of Education estimates that since 1978, about threequarters of Chinese students and scholars who went abroad returned to China.
Figure 2. STUDY ABROAD FIGURES FOR CHINESE STUDENTS (ANNUAL)
500,000
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
1980
1985
1990
Number of Chinese students studying abroad
1995
2000
2005
2010
2014
Chinese study-abroad students who have returned
Source: CEIC
Political Repression and Corruption are Real Problems …
Greater political repression by President Xi Jinping is another reason Shambaugh
cites for his new pessimism, noting that “a more secure and confident government
would not institute such a severe crackdown.” I agree that during his first two
years as Party chief, Xi has further reduced the already very limited space for even
modest political dissent, and it probably does reflect “deep anxiety and insecurity,”
as Shambaugh notes. This is very troubling and, over time, must be improved, but
is this a sign that China is closer to a “breaking point?”
3
… But Chinese are Fairly Content with Their Lives
Shambaugh accurately cites corruption as a major problem, which he says not
only “riddles the party-state and the military” but “also pervades Chinese society
as a whole.” Data from interviews of more than 3,000 Chinese in 2014 by the U.S.based Pew Research Center, however, found people pretty content, despite strong
concerns about corruption. Fifty-nine percent of respondents described themselves
as highly satisfied with their lives, compared to an emerging markets median
of 50%, and 65% in the U.S., 47% in South Korea and 43% in Japan. Sixty-four
percent of high-income Chinese said they are happy (72% in the U.S.), while 50%
of low-income Chinese agreed (56% in the U.S.).
Figure 3. 59% OF CHINESE ARE SATISFIED WITH LIFE
On a ladder of life from 0 to 10, on which step do you stand at the present time?
Percent who responded with rankings of 7 through 10.
Turkey
Russia
59%
China
33%
U.K.
65%
66%
U.S.
South Korea
Japan
Germany
0%
2014
10%
20%
30%
40%
50%
60%
70%
2007
Source: Spring 2014 Global Attitudes Survey Q2, Pew Research Center
More interesting, especially in the context of Shambaugh’s recent pessimism,
the share of Chinese reporting that they are highly satisfied with their lives has
risen from 23% in a 2002 Pew survey to 33% in 2007, and 59% last year. And
68% of Chinese told Pew that they are optimistic that their standards of living
will improve in the coming five years.
Rule of Law is a Significant Long-term Challenge
Shambaugh accurately calls out the absence of the rule of law as a serious
shortcoming. Again, the questions we should ask are, how likely is this to trigger regime collapse, and what are the prospects for change?
In a November 2014 issue of Sinology titled “A Missed Opportunity,” I explained
that:
I am optimistic about China’s medium-term economic prospects, within
the context of expecting gradually slower year-on-year growth rates. This
optimism is based in large part on the continuing evolution of government policy designed to embrace private enterprise and markets. My
biggest concern, however, is that there has been little parallel evolution
in China’s governance and institutions.
China’s economy and society are increasingly based on property rights:
private companies employ 80% of the workforce, create almost all new
jobs and are responsible for most investment and industrial sales; entre4
preneurs and artists are creating new intellectual property daily; 85% of
urban families own their home; and farmers have land-use rights. Yet the
country lacks the rule of law, which is needed to effectively protect these
property rights and ensure a fair, rules-based commercial environment.
This is already the source of many of problems. Corruption, weakness in
industries dependent on intellectual property rights and the widespread
theft of land from farmers—the main cause of protests across the country—
are all consequences of the lack of rule of law.
My conclusion was that:
In the near term, China can continue to thrive, as people find ways to
navigate corruption and the opaque system, and as the Party works to
reduce interference in the legal system by local officials. But as the pace
of economic growth inevitably slows over the coming decades, China’s
unique form of authoritarian capitalism is unlikely to provide the necessary institutional support for a modern, market-based society.
There are, at this moment, no signs that the Party is preparing to establish the rule of law. The Party appears to want to continue to use the
legal system to exercise its political control over the population, rather
than to move toward a system that is designed primarily to protect the
rights of individuals by limiting the government’s power.
We do need to acknowledge, however, that back in the mid-1980s, when
I first worked in China, it was not apparent that the Party was prepared
to significantly relax its control over people’s daily lives. But, a decade
later, the Party stopped telling its citizens where to live and what to farm.
In the mid-1990s, we did not expect the Party to dramatically shrink the
state sector and pave the way for private firms to become the engine of
growth. Private home ownership was not on the horizon. Today, most
urban Chinese work for private companies and own their homes.
During the past two decades, the Party has surprised in many ways. It
has taken a path that is unique among authoritarian regimes: relaxing
day-to-day control over people’s lives and commercial activities while
strengthening the Party’s control over the political and legal systems.
This is a key reason why the Chinese Communist Party has outlived
other authoritarian regimes. Constant, pragmatic reform of economic
policy is also why GDP growth averaged 10% for two decades before
cooling to an average of 8% over the last four years.
Establishing the rule of law would require the Party to take another
unique and dramatic step: to cede to its citizens some of the Party’s
control over the political and legal systems. Failure to take this step is
not a short-term risk for investors, but I believe it will be key to China’s
economic prospects over the next 10 to 20 years.
In his 2008 book, Shambaugh wrote that as China becomes richer, one of the
principal lessons it should learn from the USSR and Eastern Europe is that “the
task of government increasingly is to provide a range of core public goods—
health care, safety, education, environmental protection, social welfare, and
so on—to the population.” Party leaders appear to understand this, and while
public services remain very weak relative to the developed world, Beijing has
directed serious money into those tasks. Over the last five years, for example,
government spending on health care and education rose by more than 100%.
An even faster pace of investment in hard infrastructure such as power, roads
and subways is well documented.
5
I’m Sticking with the 2008 Version
Back in 2008, Shambaugh wrote: “One-party states can indeed remain in
power for long periods of time, and they possess a variety of tools and tactics
to do so. The ‘end of history’ is not inevitable.” However, in his more recent
op-ed, he changed tack with: “We cannot predict when Chinese communism
will collapse, but it is hard not to conclude that we are witnessing its final
phase. The CCP is the world’s second-longest ruling regime (behind only North
Korea), and no party can rule forever.” For me, his original arguments remain
more aligned with the continued progress I see underway in China.
Andy Rothman
Investment Strategist
Matthews Asia
The views and information discussed
in this report are as of the date of
publication, are subject to change
and may not reflect the writer’s
current views. The views expressed
represent an assessment of market
conditions at a specific point in time,
are opinions only and should not be
relied upon as investment advice
regarding a particular investment or
markets in general.
The subject matter contained herein
has been derived from several
sources believed to be reliable and
accurate at the time of compilation.
Matthews International Capital
Management, LLC does not accept
any liability for losses either direct or
consequential caused by the use of
this information.
©2015 Matthews International Capital
Management, LLC
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