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Will China Ditch Mao To Save The Party?
Asia Confidential
By James Gruber
November 9, 2012


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Over the past three decades, China's Communist Party has had a pact with its people: you give us one-party rule and we'll give allow you to get on with you lives and make money. In other words, blending authoritarian rule with market-driven economics. The problem is that the regime's legitimacy is being undermined by endemic party corruption. And ongoing economic growth is being jeopardised by government dominance in key sectors such as banking. The challenges for the new leadership, to be finalised next week, are re-affirming the legitimacy of the party's rule by cracking down on corruption in its own ranks while further freeing up the economy to allow the private sector to flourish.

 

Maintaining the status quo isn't an option. It'd jeopardise the future of the Communist Party itself. But the party has a habit of reinventing itself and I am cautiously optimistic that it'll do so again. You're likely to see China move more and more towards a Singaporean-style economic and political model.

This is over-simplying things though. To get a better perspective of the issues facing the new President, I thought it'd be useful to take a look back at the achievements and failures of the past decade's leadership. And, in something a bit different, I'll tell the story primarily in charts and pictures. It'll make for a more lighter read but I hope you find it thought-provoking nonetheless. The charts and pictures below are sourced from Bloomberg unless otherwise stated.

The Hu Jintao legacy

President Hu Jintao will step down as the General Secretary of the Communist Party this month and as President in March. He'll have spent 10 years in the respective positions.

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Under his reign, China has achieved extraordinary economic success. The economy grew 4x in U.S. dollar terms. GDP growth averaged 10.8%, compared to the 9.9% average of the previous regime. 

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Many now predict China will overtake the United States as the world's largest economy in the early part of next decade. This looks optimistic to me as it projects current growth numbers well into the future: a highly unlikely scenario.

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The economic gains flowed through the people's wallets, with urban income increasing 10% per annum and rural income rising 8% per annum, in real terms, since 2002.

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Interestingly though, investors in China's stock markets didn't benefit to the same degree. The Shanghai Composite Index rose 92% during the period, well behind Hong Kong's return of 126% and Asia ex-Japan's 180% return. 

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Money supply grew at a blistering pace, up close to 5x during the 10 years.

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Deposit rates offered paltry returns to China's abundant savers.

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In fact, real deposit rates (deposit rates minus inflation) have been negative for the majority of the past decade.

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This has led many to search for yield outside of the banks. Alternative wealth products have skyrocketed in recent years. This "shadow" banking system has many concerned.

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This search for yield also partially accounts for people wanting to get their money out of the country. That, and suspicion of the Chinese government...

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Who were the big winners during Hu's reign? Well, government spending on healthcare increased 9x, while spending on education rose 5x. The efficacy of the healthcare spending can be questioned though, given the still shambolic state of the health system.

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Property owners and developers were clear winners. Average home prices increased around 3x during the period.

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China's infrastructure was a clear beneficiary. The world-class road system attests to that. But the breakneck speed of infrastructure build-out is being questioned given recent high-speed rail crashes. 

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China's currency peg to the U.S. dollar and the undervaluation of the Yuan has led to a booming export market. Chinese exports were up almost 6x over the past decade. The U.S. and Europe have been the prime destinations for cheap goods.

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The world's commodities have benefited from a massive ramp-up in Chinese demand. China's investment build-out, particularly infrastructure and property, led to a voracious appetite for commodities. China is now the leading demand source for most commodities.

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Economic growth, but at what cost? Well, Boston Consulting Group estimates 1% of Chinese now controls more than 70% of the nation's wealth. The so-called Gini coefficient below measures income inequality, with China being the world's third most inequitable country.

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Corruption is now perceived by many to be endemic, particularly at the local government level. Concerns have been heightened by reports of the extraordinary wealth accumulated by the family of Premier Wen Jiabao and ousted politician Bo Xilai. A recent survey by the Pew Research Center suggests 50% of Chinese surveyed believe corruption is the country's most pressing issue.

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Macau's casinos have been one of the biggest beneficiaries of this corruption. The casinos have served as a useful way for getting money out of China, in a legal fashion (mostly).

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Pollution has also become a major problem in China. According to the Environmental Performance Index, a bi-annual report from Yale and Columbia Universities, China ranked 125 out of 132 nations when it comes to air pollution.

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Chinese savers have been obvious losers. By limiting savings options to bank deposits with controlled interest rates, the government has given the banking system access to cheap deposit funds, which it's used to fund the extraordinary growth in investments. The over-reliance on investments led to the recent 2009-2011 asset bubble, which is rolling over. Restructuring the economy to increase consumption and reduce investment is now a priority.

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Another issue that the new leaders will have to face is a peaking in China's population over the next 15 years. This will limit economic growth prospects unless the country can increase productivity.

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Greater productivity will be more difficult given the ageing of China's workforce. By 2016, it's estimated the working age population will peak. The primary cause of this: China's one-child policy.

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The extraordinarily difficult job of managing the world's second largest economy falls to the incoming President, Xi Jinping. He's spent much of his life as a leader of large coastal provinces, gaining a reputation as one who can build a political consensus while encouraging private enterprise.

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Xi Jinping's father, Xi Zhongxun, was a hero of the revolution who helped Mao Zedong win control of China in 1949. He was a politician known for his more liberal views and reformist bent.

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But Xi is also a product of the Communist Party, an organisation not known for its liberal views. 

As Gao Wenqian, a senior Policy Advisor to Human Rights in China, recently toldBloomberg:

"There are two Xi Jinpings. One is the son of Xi Zhongzun. The second Xi Jinping is a son of the party, the red empire. There will be conflicts between the two Xis."

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Xi will need to build a consensus among party leaders to undertake substantial economic and political reform. China's rise to being the next potential superpower depends on it.

And that wraps it up for this week.

(c) Asia Confidential

http://asiaconf.com

 


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