WORLD MARCH 22, 2012
In China, a perennial T.V. favorite is the “rear palace” costume drama, depicting the conspiratorial high politics of bygone dynasties. An analogous kind of half-concealed theatre seems to be taking place today, not behind the sequestered walls of the imperial palace, but in the Chinese Communist Party’s headquarters at Zhongnanhai. The fall-out from Chinese Premier Wen Jiabao’s urgent calls this month for political reform—which was quickly followed by the ousting of a top regional official, Bo Xilai, from the party leadership—have fanned whispers of a secret succession war within the party’s top ranks.
But as the turmoil continues, it’s not just committed China watchers who should be paying close attention. The wrangling now taking place not only affects China's political trajectory, but also has the potential to bring disaster for the country’s economy.
LAST WEEK’S EVENTS were not a herald of new political tensions, but an expression of the existing, deep-seated divisions among China’s political elite. “Power is increasingly decentralized to different factions,” says Victor Shih, a political scientist at Northwestern University. Among the “vested interests” represented in the halls of power, there are the princelings, who hold a great deal of sway as the sons of the old revolutionary vanguard; the top executives of state enterprise, shaping policy-making from their ministerial seats in government; and powerful, well-connected regional leaders demanding resources from the capital. These and numerous other factional alliances are defined by networks of personal relationships, running through all levels of government, from China’s top policymaking body, the Politburo Standing Committee, to the Party magistrates in China’s cities and provinces. Whereas the top party ﬁgure once had supreme authority, attention now “must ﬁrst and foremost” be paid “to the interests of the factional groups,” Shih told me, for it is the core elite from these groups “that ultimately decides policies, promotions, and even the political survival of the President of China.”
But whatever their disparate objectives, each faction has gained from China’s furious economic growth, with wealth and political power increasing as a result of money flowing freely through their respective spheres of control. How convenient, then, that they also hold the purse-strings of finance through China’s state-controlled banks—banks whose reserves can be quickly mobilized for extending loans to projects championed by influencers in the party. It stands to reason why these vested interests haven’t been eager for the easy money to stop, and in fact have been cheerfully flexing their political muscles to direct investments into their own jurisdictions. “As long as you have politically powerful enterprises, as long as you have a banking sector which is dominated by the state and the Chinese Communist Party, there will be very high incentives to over-invest,” Shih says.
This over-investment has brought about what some have termed “the mother of all bubbles.” Redundant infrastructure, empty luxury apartments, and half-completed commercial projects sit everywhere in China, with more popping up for the benefit of the developers and politicians involved. “Pegging its currency to the dollar and keeping interest rates low created perfect conditions for a bubble around 2005 to 2007,” Edward Chancellor, an authority on financial bubbles and author of Devil Take the Hindmost, told me. “Then, massive stimulus in response to the global financial crisis in 2009—the extension of easy credit—really made it possible for the bubble in real estate and infrastructure, especially, to grow.”
Warning signs of overheating have been steadily emerging. Chancellor cites data from Goldman Sachs suggesting that China’s total amount of credit has ballooned to 190 percent of its GDP. According to Shih, many of the investments this credit is financing have “very low, and even negative proﬁtability, even in the medium to long run.” That reality now seems to be registering: Housing prices in major cities have fallen this year, and so has the rate of deposits into state-owned banks, which means the money that has served as the basis for investment loans is drying up. In recent months, there has also been a decline in the foreign reserves at the People’s Bank of China, an indication that capital might be leaving the country. But “the trouble with bubbles is once they are inflated, you must carry on with inflating them,” Chancellor says, because “if investment stops growing, you get a contraction of credit and falling asset prices.” To keep things going, it seems that banks are now making loans to each other and effectively expanding the money supply; but this, in turn, drives up the threat of inflation. “I suspect that the endgame is the breakdown of the Chinese credit system,” Chancellor adds.
Fevered investment has brought the Chinese economy to a precarious state, and the country’s current political climate only magnifies its fragility. Absent centralized party discipline, the various political factions are unlikely to temper their own investment habits. But, Shih says, “the entities that would like loans from the banks are so politically powerful. Increasingly, the central government won’t issue orders that might harm these other interests.” And statements from policymakers in Beijing indicate a total paralysis of any far-sighted economic reform efforts. “If you read things like statements by the premier [Wen Jiabao], he is giving lower forecasts for growth—7.5 percent this year, which is lower than the 8 or 9 percent of previous years. But at the same time, the People’s Bank of China is putting in measures to loosen controls and increase credit,” says Yasheng Huang of MIT’s Sloan School of Management. “There is a big difference between what is being said and the actual policies being instituted.”
The leadership transition to take place makes 2012 an especially important year for deciding China’s political—and, by extension, economic—fortunes. Seven of the nine members of the Politburo Standing Committee will be replaced by new appointees. Their future policies are the subject of much speculation, but there is good reason to suspect that they will lead with parochial interests in mind: Belief that all political factions need to have their own representative in power certainly seems to have guided the choices for this new leadership. The two men who will take the top positions—Xi Jinping and Li Keqiang, the future President and Premier, respectively—will no doubt each be obliged to pacify their respective allies and opponents. If history is any guide, it may be that such an imperative will be fulfilled by encouraging ever more accelerated economic growth, despite all the signs that the dangerously imbalanced economy is already in distress. “When you change power, from one generation of leaders to another, you want to do it in a way that puts the country on the high GDP growth pathway; so it doesn’t look good if GDP is slowing down,” Huang says.
Given all the political in-fighting spilling out to the public—and the many incentives to stoke economic growth—it remains an open question whether China’s leadership can be counted on to right the course of the country’s economic development. Accomplishing that “will take a very strong leader in central government,” says Shih. “Perhaps Xi is such a person. But you have to wonder: If he had the potential to be a very strong leader, would the vested interests have chosen him to be the next leader of China in the ﬁrst place?” Even if Xi had the makings of a political genius, it would be hard for him not to continue a policy of “more of the same” in his first few years in office. “New leaders in China want to do things that clearly put them on the map,” says Huang. “But in China, there is not much room to do anything except to grow the GDP. So, new leaders typically come in wanting more investments, with a stronger push for GDP growth.”
There remains among some—commentators, officials, casual spectators of this unfolding drama—a lingering hubristic belief that imbalances in China’s state-directed economy can always be controlled and corrected through political means. Yet it is clear that the present model of Chinese state-direction is not only what inﬂated this investment bubble to begin with—it’s also now making it impossible to take the right course of action to ﬁx it. “There is no bubble in history in which the government has not been intimately involved,” Chancellor says. “Those who say that China’s state-directed economy is a different case have forgotten that.” Alas, too many such people seem to have found their way into positions of influence in China’s government.
Boer Deng is a literary intern at The New Republic.