Trade war and China's reform

This year is the 40th anniversary of the start of China's reform. Forty years on China’ reform has basically followed Deng Xiaoping's doctrine which is to integrate the power of the one-party state with market efficiency.

Economic decentralization is the key to China's strategy. Basically through the grant of high level economic autonomy Chinese local governments (province, municipality, and county) have been effectively turned into economic entities” while their political and administrative functions are kept intact.

By taking advantage of their political power and state ownership, Chinese local governments of all levels can stimulate the local economy by deploying economic resources at less than market value in a massive scale.

For instance, local governments can acquire land from rural and urban residents with limited compensation and sell such land to developers at significantly inflated prices and again collect huge tax revenue through real estate projects and property transactions. This so called "land finance" that has created about half of the revenue for Chinese local governments over decades has played a pivotal role in the building of modern infrastructures, the attraction of foreign investment, and the setting-up of basic social security networks in China.

However this Chinese model has deep flaws: The market function is deeply distorted and the economy is effectively divided between provincial borders. The Chinese manufacturing industries being developed tend to have problems ranging from overcapacity, a dependance on foreign technology, concentration on low value added processing and high levels of pollution.

Politically China's reform is actually a process of reshuffling the control over the assets once state owned such as land, mines, and factories. As governments play a key role in this process, those privileged (insiders who have or are close to power) inevitably gain unfair advantages in the redistribution.

China's reforms achieved an unprecedented economic expansion in the first 30 years but has slowed down in the last 10 years as hidden problems have increasingly surfaced.

Polarization has become one of the most acute problems due to  unfairness and corruption in the reshuffle of the control over state assets and redistribution of wealth. As an indication China's Gini coefficient has reached  0.47, one of the highest among major nations in the world.

Pushing ahead with economic expansion at whatever cost, in anticipation that it would generate opportunities for the poor, has been the main response of the government to the situation. But increasingly this position becomes ineffective and unsustainable.

China's labour supply peaked in 2012. In addition, the government has to lift minimum wage to appease the poor and increase business payment on social security and environment protection. These steps inevitably raise production costs. Chinese manufactured products are also suffering from weakening demand and a rise of protectionism worldwide.

The downturn of the manufacturing and export drive sees capital seeking a safe heaven in the Chinese housing sector. But skyrocketing house prices as a result further intensify polarisation of the society, weakens the middle class and makes the debt level of Chinese local governments, private businesses and households a major threat to the Chinese financial sector.

It was against such a background President Xi Jinping took office in later 2012. Among Xi's policies formulated to meet the challenges following three are the most influential.

First, Xi has initiated an unprecedented anti-corruption campaign aiming at keeping the government effective and clean, which is essential for the government to be up to the task as an initiator, coordinator and mediator of the reform.

Second, Xi's government has formulated an ambitious plan "China Manufacturing 2025", which aims to build a variety of strategic industries to an internationally advanced level by 2025.

Third, endorsement of Belt & Road Initiative. By focusing on building infrastructure covering countries in Eurasia this initiative is expected to open more markets for Chinese industries.

Without the trade war imposed by the US president Donald Trump, Xi's policies would lift China out of the mud and set China free in its course of replacing the US as the largest economy in the world.

The trade war has abruptly disrupted China's rhythm. The real danger for China is that if employment is affected, the Chinese government will have to stimulate the economy. This will further stretch the highly leveraged Chinese financial institutions.  Given sluggish export and manufacturing, the capital is likely to end up in the housing sector where bubbles are already large. If such bubbles burst possibly causing a massive devaluation of the yuan, outflow of capital to overseas, high inflation and social unrest, it would bring the economy into a standstill.

However it is the political sector where the impact of the trade war is more dramatic and complex.

China is never short of supporters of western values. If their view was suppressed in the past, the trade war has emboldened them to speak out. Never in the history of the PRC have those opinions, opposed to government positions, circulated so extensively in public, through the Chinese social media such as Weibo and WeChat.

To the people in this camp, China has no chance of winning a trade war with the US. Furthermore they see the pressure imposed by the US could trigger major political changes in China. Some influential articles reaching readers in millions explicitly call for establishment of western democratic systems in China.

The government faces challenge not only from the right but also the left. Maoists openly blame Deng Xiaoping for his reform leading to renaissance of capitalism in China  and resulted in disastrous outcomes such as polarization of the society, severe environmental damage, widespread corruption and deterioration of social moral standard.

The criticism on the government and tense situation promote some dissidents inside and outside China claiming that China's collapse is imminent.

This is an irresponsible exaggeration.

The majority of Chinese are supportive to the government position to the trade war. They believe obeying the command of the Americans is fundamentally inconsistent with the interests of the nation. In addition, the vast majority of Chinese want stability. Political turmoil can only bring chaos and destruction.

There is no doubt that the trade war has suddenly exposed China to various dangers which predominantly originated from mishandling of various domestic issues. In fact China's capability in standing up against the US pressure is primarily dependent on if China can correct these mishandling in a timely fashion.

Ignorance of the inequality in association with the introduction of market economy and over confidence in dealing with the side effects of interaction between political power and capital are the two fundamental embryos breeding so many problems in China.

Transparency and democratic tools will be urgently needed in order to control the abuse of government power and deal with market failure. However this should not be interpreted as establishment of multiparty parliament system in China, which is unfit for China at this stage.

If China could find a way to control the downside in association with the integration of the one party state with the market, China's model would be more attractive. If not, China's future will be very dim.