Is China heading for a fall?

With China's economy slowing and foreign businesses questioning their future in the Middle Kingdom, some commentators are suggesting the country may be heading for financial and even political collapse.

Slowing growth

This week Reuters reported that China's factory-sector growth had eased in April as new export orders fell for the first time in 2013. The report drawn from a private survey suggested that the recession in the euro zone recession as well as sluggish US demand for Chinese manufactured products might pose risks to China's economic recovery.

"The slower growth of manufacturing activity in April confirmed a fragile growth recovery of the Chinese economy as external demand deteriorated and renewed destocking pressures built up," said Qu Hongbin, chief China economist at HSBC.

This week even China's state owned news agency, Xinhua, acknowledged the downward shift. "China's non-manufacturing sector shrank in April with its purchasing managers index (PMI) at 54.5%, down 1.1 percentage points month on month,"  Xinhua said in a tweet.

Chinese growth is slowing after an almost unprecedented three decades of strong growth. But the question is by how much. The other major question is whether any slowdown or even fall into recession might affect western economies which are still attempting to pull themselves out of an economic downturn that has lasted nearly five years [BBC].

There are some that are relatively optimistic and believe that China will weather the storm. However, not everyone is so hopeful. Gordon Chang, author of the book The Coming Collapse of China,  speaking on the BBC World Service programme Business Matters this week, suggested that China was heading towards a financial implosion that would be far more significant than the recessions seen in the US and Europe.

"Failing economy"

"Essentially we've got an economy that is failing," says Chang. "It's not growing at the 7.7% that the national bureau of statistics claimed for the first quarter of this year. It's growing more like two or three percent when you look at like electricity statistics, corporate results, price indices, manufacturing surveys; and this is a problem for a government that has primarily based its legitimacy on the continual delivery of prosperity."

With economic failure looming, the government needs to create distractions. In the last year it has done so successfully, rallying support in nationalistic causes such as China's territorial disputes within the South China Sea, particularly with Japan.

"Essentially what we've seen over the last year or so is the government fall back on nationalism, the only basis of legitimacy left," Chang observes. "And that is creating problems as China is creating friction with its neighbours from India in the south to South Korea in the north, you see a political system in disarray, with a leadership transition that has not yet been consolidated, and we know that because Bo Xilai, that charismatic politician from Chongqing hasn't been tried yet, which means the political factions inside the communist party have yet to figure out what to do."

"But the real problem for the Chinese Communist Party is essentially that most people in China do not believe that a one party system is appropriate for a modernising society,, which means that the Communist Party can coerce, but I don't think that it can lead. And I see problems very soon... In 2001 I said it was going to be in a decade, I'm a year and a half out of time, but I think we're going to see this within one or two years"

Debt and overspending

The argument amongst the optimists is that China is still nonetheless seeing growth. However Chang maintains that the statistics don't necessarily paint a full picture or are being misread.

"The problem is that in 2009, 2010, you had an economy that was legitimately growing at double digit rates. Now you have growth that may be as low as 3%, and the real issue is you have a lot of economically useless production which is technically creating Gross Domestic Product but nonetheless it is economically harmful and you have the buildup of debt."

"The buildup of debt is something the leaders in Beijing cannot avoid, and with this time-bomb eventually it's going to go off. We know that because it goes off in any society where you've got too much debt. And China probably has a debt to Gross Domestic Product ratio of maybe 150 or 160 percent, well above the US's 103%, and this is a problem for Beijing."

In fact local debt by itself may exceed more than $3.2 trillion dollars according to one former finance minister, Xiang Huaicheng, raising further worries about government spending at a provincial level [Bloomberg]. Such concerns have even prompted credit ratings agency Fitch to downgrade China's sovereign credit rating from A+ to AA- [BBC].

Roads to nowhere

Everywhere in China the signs of rot are apparent. In an insatiable quest to dominate green energy, China's banks have pumped billions into solar-panel manufacturing, creating hundreds of factories and vaulting China into the world's largest producer. But the sector has become a victim of its own excess. Companies are failing, symbolized by the recent bankruptcy of market leader Suntech Power [BBC]. Steel companies continue to invest in new capacity even though debt is rising and losses mounting. Each mill is backed by local officials eager to create jobs but dismissive of the larger costs. The investments top up GDP, but not the health of the overall economy [Time].

The "economically useless production" of which Chang talks can be seen in the form of dozens, if not hundreds of ghost cities that have sprung up across China in the past five years. There has also been a continual explosion in the construction of roads and railways, some of which go to places that have yet to be built.

Effects of a collapse

Any collapse, either of the regime or China's economy would, as Chang says, be "monumental". He insists that such a scenario will occur because "nothing is going right for the party right now."

"It's taking on everybody internally and many nations externally. I think most people are going to be shocked, but when the party does fail, and it will fail spectacularly, people are going to say 'Oh my God', and we are going to perhaps have financial crises, and you can also see that this could all end very badly with general conflict in Asia and we're moving in that direction unfortunately with China sending its troops deep into Indian territory this month (April) [Defense News], and also China sending its ships into Japanese territorial waters [NYT]. All of these things are very important, and I think they could spell the event that history will remember for centuries."

Attacks in cyberspace

China is not only being assertive in its territorial claims. It's aggressiveness can also be seen in cyberspace. Increasingly western governments in particular have complained of China's cyberattacks, all of which China denies [The Atlantic].

Such attacks are of course potentially destructive, but they are also undermining business and trust between China and the West. For western companies operating inside China there are many issues at stake.

The 2013 Business Climate Survey [PDF], released on 29th March, shed light on how US firms felt about China's Internet restrictions. Of some 325 respondents, 55% said that China's censorship negatively affected their capacity to do business. Some 62 percent said the disruption of search engines such as Google made it more difficult to obtain real-time market data, share time-sensitive information, or collaborate with colleagues based outside China. Furthermore, 72% of respondents said that slow and unstable Internet speeds, slow due to the fact that foreign sites especially had to pass by China's censorship filters, impeded their ability to efficiently conduct business in China.

While 38% of respondents said their companies were shifting resources to cloud-based computing, only 10% said they would consider using cloud services based in China, with the top concern cited being security risks. Moreover, 26% of respondents said they had already been victims of data theft with some 40% saying the risk of data theft in China seemed to be growing [Business Week].

Such controls, and continued cyberattacks - often an attempt to obtain intellectual property and so corner another manufacturing sector - could eventually prove disastrous for China. Companies and organisations outside China are already looking at ways of blocking Internet traffic coming from China by setting up their own internal firewalls blocking Chinese IP addresses. China could, in the future, find itself being locked out of the Internet rather than preventing access to the Internet.

Should productivity become an increasing problem for companies based in China, it is possible that many could shift operations elsewhere. Some low end manufacturing companies have already begun moving to other Asian countries, such as India, Bangladesh, Vietnam and Thailand.

Should more hi-tech companies find China is too restrictive or insecure, they too may up sticks. Such a scenario would doubtlessly send China's economy spiralling. After all, China relies just as much of foreign investment as the world might, at present, depend upon cheaply manufactured products from China.

Indeed, China may not be the world saviour that some economic commentators have suggested.

Not the saviour

"China is not the engine of global growth. To be the engine of global growth you've got to take the imports of other countries to create prosperity elsewhere. Well China through its predatory trade policies is actually taking growth from other countries. And so I don't think we can say that China powers the global economy," Chang says.

While there may be a massive psychological shock from any collapse of China, Chang insists the world will adjust. "Low end manufacturing is already leaving China," Chang observes. "And after a while we'll recognise that the world can get along without China and markets will eventually adjust."

"Markets are very deep and very resilient and they can absorb almost anything." But what of China, should such events as described above unfold?

Uncertain future

Will China close its doors to the world and become more insular? Will its Internet become even more restrictive? Could the country tear itself apart as different factions vie for a slice of the pie?  Already there are rising tensions between Muslims and Han Chinese in parts of Xinjiang. Could there be a repeat of the 19th century insurrections such as the Panthay Rebellion in Yunnan that left over a million dead?

China has been born out of a constant tide of revolutions, and while there has been relative calm and order since Mao united the country under one flag there is no reason to assume that the state of flux is at an end.

tvnewswatch, Yunnan, China