Power bubbles are Hu's big challenge
By Francesco Sisci

BEIJING - It's one of those questions too scary to ask publicly: very politically incorrect yet very true as it throbs in the back of many minds. Will Washington allow China to overtake America economically - and should it? And what can America do in a restrained way, short of the usual doomsday scenarios, which can be dismissed because of their incalculable consequences for everybody?

Recent International Monetary Fund (IMF) calculations set a date for a first step in the overtaking: 2013, when China's GDP (Gross Domestic Product) should become larger than America's in PPP (Purchasing Power Parity) terms. China's overtake of Japan last year in terms of GDP makes it likely it will exceed the US in

2013, and this reinforces the possibility of a real overtake at current exchange rates sometime in the next decade or so.

The consequences of this shift could be huge. China would de facto take center stage in the world, and although militarily China would still play second fiddle to America, China would then have the theoretical ability to engage America in an arms race. That scenario could potentially bankrupt the US, as in the 1980s when the economically larger US took on the Soviet Union in an arms race that eventually busted the communist state. Simply put, dollar per dollar military expenditure costs more in the economically smaller country and eventually bankrupts it.

Incidentally, this logic was quite clear to Deng Xiaoping in the early 1980s when he refused to deplete China's weak coffers engaging in an arms race and instead focused all resources on an economic build-up.

Even without considering the strategic consequences of China's GDP accruement, one can just remember America's reaction in the 1980s to the possibility that a friendly nation and strong military ally, Japan, could overtake America: it was a scare and a call to action against a state that at its peak had a GDP about two-thirds that of America's.

Europe united by the euro in the early 1990s fared only slightly better, as the overall euro economy was - and is - larger than the American economy. But politically and militarily the European Union (EU) is a non-entity. America supported the EU extension that has de facto undermined the possibility of a political union that would be potentially menacing to the US.

In a decade, America overcame three major challenges at once: it beat the Japanese rise, it busted the Soviet Union and forestalled a possible European political union. Meanwhile, it started the new phase of globalization that is changing the economy and politics of the world.

Then why should America, which was displeased at the possibility of being economically overtaken by one of its two bosom friends, and which managed to take on so many issues at once, accept the economic ascendancy of China, a state that is not an ally and has a very different political system?

Certainly, circumstances now are different from 20 years ago. The whole world is moving up thanks to the America-driven process of globalization, and it is hard to imagine one force that could stop or would be willing to stop the growth of giants like India, Brazil, Indonesia, South Africa ... and China, which is creating more wealth and welfare for everybody. Certainly the US didn't try to stop the momentum earlier because it saw China's potential economic contribution, and it envisaged a possible peaceful political change. But now China is almost overtaking the US, and political change is not happening.

Prima facie China doesn't seem to need political change. Its system withstood the 2008 financial crisis better than the West, providing practical proof of its value. Yet this could be just a temporary answer if one considers that crises are a cyclical feature of the capitalist economy that dominates the world, including China. Then China's ability to weather a storm doesn't ensure that its system will be able to withstand an economic crisis, especially as new domestic threats are building up.

China came out of the financial crisis with too much power given to SOEs (state-owned enterprises), which gulped down the lion's share of the public credit surge to move out of the doldrums. This increased their already huge firepower. They have now billions of dollars in profits that they can channel any way they please - and God knows where. As these SOEs are systematically within the state, they can use their money to advance their agenda and protect their turfs within the state system - entirely legally.

Meanwhile private enterprises, which in the 30 years of reforms have been the main drive of economic development, are finding it more difficult and expensive to do business:
While Beijing's inflation-fighting policies have so far left state-owned companies unscathed, private sector borrowers say they are being forced to choose between bankruptcy and taking on underground loans at up to 10 times the official rates. ''Monetary policy is tighter now than before the global financial crisis,' said Zhou Dewen, head of the Small & Medium Enterprise (SME) Development and Promotion Association at Wenzhou, the heartland of China's private sector. 'For SMEs it is a crisis of survival [and] several commercial and industrial companies have been forced into bankruptcy,'' he said.''[1]
This is breaking the social pact that bolstered reforms. Private entrepreneurs could develop their own business as long as they didn't meddle in politics. Now the private sector is being squeezed out while not messing with politics because of the ability of SOEs to advance their own agendas thanks to their political underpinnings. Social and political cohesion is at stake, as SOEs are antagonizing a group of entrepreneurs; but fast-paced development could be in danger too. SME are the most efficient producing most growth, without them China development could grow slower and inefficient moving into a former Soviet model.

Therefore, they de facto become states within the state, interest groups of potential oligarchs dominating the whole economy according to their own particular interests. All fights or compromises are hidden, bought and sold without much public knowledge or possibly also without the knowledge of the state's top echelons. They also control large swaths of land, which at will can be translated into cash for them and income for different municipalities, fueling the existing housing and credit bubble.

In other words, China avoided the 2008 crisis by sowing the seeds of a future political-economic crisis of its own. This might have been unavoidable, but what should be avoided is the belief that the present solution is the best of all worlds. It is not: this situation created the present credit and housing bubble and the ''power bubble'' of the SOEs. Both have to be curbed because otherwise the market, and China's economy along with it, will die. SOEs have to be carved up and privatized, and provisions have to be taken from SOEs for retirement and health care pensions and put into separate entities and insurances. Otherwise, with the present graying trend of the population, in 10 years, many elderly people could starve.

All urban land, including public and industrial plots, should be brought into the market and should have a value on the books. It makes no sense economically or politically to sell land at one price to a real estate developer, at another for a factory, and to give it away for free to a ministry. Also because in China's present system it is easy for industrial players or ministries to sell land in the market, pocketing huge off-book profits that go God knows where.

The suspicion that this money, at least partly, goes to fuel special interests, turf wars, and political jockeying doesn't seem unfounded. To avoid such activities, China needs to re-concentrate power (see Too many cooks spoil foreign-policy stew, Asia Times Online, Jan 7, 2011). But how can China do this?

This economic turmoil occurs on the backdrop of a very murky political transition. In one year, China will present to the world its new leadership. We know that some kind of political campaign is going on (see Bo Xilai focuses multiparty vision, Asia Times Online, Apr 20, 2011). But the really scary thing about China is that nobody will know how this group of people, possibly the most powerful in the world, was chosen. Xi Jinping might become soon the single most powerful leader, and nobody knows how that was decided. Then it is impossible to have rational forecasts of the political and economic directions China will take in the future.

In short, to solve those problems, China needs to set a very quick agenda for privatization (to break up the excessive power of the SOEs) and democratization, which is the way to regulate and bring to the open the murky political jockeying and also to re-concentrate power to the top. It is not easy to think about it because SOEs and some rich localities with much to lose and will fight. But privatization and democratization would be minimal premises to help convince America that China overtaking the US economically in the future could be acceptable and not threatening.

A part of the official Chinese rhetoric argues that democracy can hold back China's necessary economic progress. But this is not the point. Democracy is not about progress yes or no, it is about peacefully mediating power struggles (which exist in any political system) in an open, regulated manner that provides long-term stability. Hidden power struggles are dangerous and highly destabilizing.

Without privatization and democratization, China's leadership would be taken on two fronts. Domestically, murky SOEs power and political jockeying will hijack policies and fracture political consensus that in turn could flare up in the open, with or without the intervention of external forces. Externally, a growing number of countries, prodded by or prodding America, could coalesce against China, stifling China's economic growth and fanning its internal contradictions. There could be different phases of this process: a slow external ''demonization'' of China that would start nervous reactions, arrests, and crackdowns and that in turn would further prove the demonization and fuel it while spreading dissent inside; a second phase of domestic and external investment could be slowed, something that can bring dwindling domestic investments, capital flights, and exacerbating social tensions.

It doesn't need to happen this way and possibly won't. Chinese leaders have proved very resilient and brave, facing very tough tests for their country. President Hu Jintao has to rise to a challenge unprecedented possibly since the times of the fall of the Qing Empire.

This time it is not a leadership grown soft after hundreds of years of rule: these are people who endured and survived the largest famine in history, the Great Leap Forward; the largest and cruelest political movement in China, the Cultural Revolution; and the greatest transformation ever experienced, the Reform and Opening Up. This should steel them to face the new and most difficult test - the present one.

1. Alarm at China's private credit crunch, Sydney Morning Herald, May 4, 2011.

Francesco Sisci is a columnist for the Italian daily Il Sole 24 Ore and can be reached at fsisci@gmail.com

Many friends were important in discussing this topic over the past few months, but Edward Luttwak and Joerg Wuttke were particularly helpful in focusing the issue.