A dragon out of puff

IF THE ebb and flow of China's recent history is any guide, the country is due for a period of momentous change. Every decade or so since the communists came to power in 1949 has seen a juddering shift of gear—the famine-inducing Great Leap Forward, the violent factional strife of the Cultural Revolution, the start of economic reforms and the nationwide anti-government demonstrations of 1989. And already two signposts to the next milestone have come into view.

The first was the country's accession to the World Trade Organisation (WTO) last December, after a 15-year quest. In theory this should not only provide the world with unprecedented access to China's markets, it should also bind China's economic reforms with the norms of international business. Optimists say it could eventually make China's secretive, undemocratic and corrupt government more open and accountable. Pessimists fear it could exacerbate unemployment and financial instability and hasten the collapse of the Communist Party.

The second is a quinquennial party congress due late in 2002 (with no date set yet) which will launch a series of leadership changes. These could be the most wide-ranging of the past two decades and open the way to a transfer of power to a younger, perhaps politically more open-minded, generation. It is equally possible, though, that the new leadership might try to shore up its legitimacy by beating the drum of nationalism and thereby push China into confrontation with Taiwan, the United States and Japan. Rarely in recent years have there been such divergent views on where the country is heading.

That China has entered a critical phase of its economic reforms is not in doubt. But the hopes (or fears) raised by WTO accession and the prospect of a new generation of leaders are probably misplaced. The way China is run is unlikely to change as a consequence, at least not for several years. What will change China in the nearer term is the handling of the final and most arduous phase of its reform. The chances of failure are likely to rise as Chinese leaders become absorbed in the fractious politics of succession. And the consequence of failure could be the very upheaval that Chinese leaders have struggled so hard to avoid since the convulsion of 1989.

The terms of China's accession to the WTO are more far-reaching than those set for any other new member of the trading organisation or its predecessor, the General Agreement on Tariffs and Trade. They require China to open hitherto jealously guarded markets, such as banking, insurance, telecommunications and agriculture. In some sectors, the lowering of trade barriers will cause unemployment to rise. In others it will create new job opportunities. But tariff barriers are the least of China's problems: its own are already among the lowest of any developing country. Much more important, the country still needs to introduce many changes before it can call itself a market economy. With or without the WTO, China needs to make those changes to keep its half-reformed economy from collapsing. To do this successfully, China must maintain brisk economic growth. Even at the official rate of 7.3% (which was probably an exaggeration), growth last year was insufficient to absorb the fast-swelling ranks of the unemployed. In the coming decade, China needs to create 8m-9m new jobs a year, up from 5.5m-6.5m in the second half of the 1990s, according to conservative World Bank estimates. It could be more. Yet average annual growth is expected to stick at around 7%, about 1.5 percentage points less than the average for the late 1990s.

Where once China was able to able to boost the economy by releasing the pent-up power of sectors restrained by Maoist folly (first agriculture, then small private and mixed-ownership enterprises), it has now run out of easy sources of new growth potential. It must get the marketplace to deploy labour and capital much more efficiently. Both are still being stifled by government interference. China's state-owned banks, which dominate the banking system, are technically insolvent thanks to indiscriminate, politically inspired lending to loss-making state enterprises. Moribund though most of it is, the state sector is still vital to China's economic and social stability because it employs (or at any rate keeps on its books) 45% of the urban workforce and receives most of the state banks' loans.

The various mechanisms that keep a market economy running, from public listings to bankruptcies, are still fettered by politics. In a recent book on China's business environment, “The China Dream”, Joe Studwell put China's bankruptcy rate in the 1990s at no more than 0.05% a year, one-twentieth the level in America. China's two stockmarkets, now a decade old, remain the almost exclusive preserve of inefficient state-owned enterprises. Most of the shares are held by the state or its employees, so ordinary shareholders have no influence over the way the companies are run (usually badly). One of China's richest private businessmen who knows the markets well calls them “congenitally deformed children born after the rape of capitalism by socialism”.

Sustained high growth will require strong demand, yet the incomes of most rural residents (who account for 65% of the population) have been stagnating for the past four years. The only long-term solution will be to move the huge amount of surplus labour in the countryside—at least 150m people—into other sectors. Yet rural credit co-operatives, the obvious source of funding for rural industries, are bankrupt, and cities cannot provide enough jobs even for their own people, let alone an influx of peasants. China will benefit from continuing large inflows of foreign investment and a better export performance as the global economy recovers. But given the country's size, the economy still relies primarily on domestic engines of growth, which are sputtering. Growth over the past five years has relied heavily on massive government spending. As a result, the government's debt is rising fast. Coupled with the banks' bad loans and the state's huge pension liabilities, this is a financial crisis in the making.

Western governments and business leaders once placed great hope in China's prime minister, Zhu Rongji, who took office in 1997 and successfully navigated the country through the financial crisis that erupted in the rest of Asia that year. But Mr Zhu is likely to step down when his current term of office ends in March 2003, with at best mixed results in reforming state enterprises and the banking system. Like the rest of China's leaders in recent times, he has been hamstrung by his unwillingness to do anything that might bring a repeat of the unrest of 1989. Will China's next crop of leaders be any more resolute?

New faces, old ideas

The forthcoming change in the party leadership is the first in communist China's history to be signalled in advance. Until now, changes at the top of the party have followed death or secretive party struggles. Even this time, there has been no public announcement that the current party chief, Jiang Zemin, will step down at the party's 16th congress later this year. Yet there have been many strong hints, some from Mr Jiang himself in meetings with foreign dignitaries, that after the congress he will be succeeded by the vice-president, Hu Jintao. The party's second-highest-ranking official, Li Peng—who played a prominent part in suppressing the 1989 protests—is also widely expected to leave the ruling Politburo, as is Mr Zhu, who ranks as number three. If all this comes to pass, it will be the first time since Mao's death that so many of the top jobs have changed hands at once.

Yet how much difference will these changes make to the way the country is run? Hopeful China-watchers point out that in Taiwan the Communist Party's erstwhile enemy, the Nationalist Party (Kuomintang), eventually embraced democracy after four decades of dictatorial rule during a period of rapid economic growth. But the Nationalist Party was not as weighed down by ideological baggage as the Communist Party. President Jiang's effort last year to open the party to the owners of private businesses (once decried as capitalist exploiters) was an attempt to lighten the load. Yet even that mild concession aroused furious debate within the party. Since then, party officials around the country have been told to exercise great caution when recruiting private businesspeople, and not to give them prominent positions in the party.

One thing the Communist Party does share with the Nationalist Party is a record of pervasive corruption. Economic growth helped the Nationalists survive, despite their poor image, until President Chen Shui-bian of the opposition Democratic Progressive Party defeated them in 2000. But to emulate that trick, China would need sustained double-digit growth to keep unemployment at bay. It has little chance of achieving that, nor would it want to, remembering the inflationary side-effects of its double-digit growth spurt in the early 1990s.

So the party's best bet for avoiding destabilising unrest would be to increase public participation in politics. However, many in the party fear that surrendering any power to the public might lead to a collapse reminiscent of the Soviet Union's. The younger generation of leaders show no signs of being any more courageous in this respect than their predecessors. Mr Hu, at any rate, does not look like the bold, imaginative and determined leader that China needs to steer it through the next few critical years.

In the coming decade, therefore, China seems set to become more unstable. It will face growing unrest as unemployment mounts. And if growth were to slow significantly, public confidence could collapse, triggering a run on banks that would undermine China's financial stability.

As long as the leadership can avoid the kind of vicious internal struggles that prompted the 1989 unrest, the party will probably remain in power. But it will be a weakened, inward-looking organisation, vulnerable to crises. If this forecast proves correct, that is bad news for China and could be bad news for countries dealing with it. A weakly led and politically insecure China, roiled by unfulfilled nationalist aspirations, might prove an unpredictable actor on the world stage.