Stop telling me China is Socialist!

Communism: A revolutionary socialist movement to create a classless, moneyless, and stateless social order structured upon common ownership of the means of production, as well as a social, political and economic ideology that aims at the establishment of this order.

Given the existence and growth of private enterprise, of class distinctions, inequality, urban consumerism, and a pro-capitalist political discourse over the last three decades, China cannot reasonably be said to be a Communist country. Arguments in favour of such a definition tend to conflate the differences between Authoritarianism and Communism on the one hand, and Capitalism and Democracy on the other. Communism is not the only form of dictatorship, and democracy is not the only political system compatible capitalism. Anyone suggesting such a correlation would do well to look back to Nazi Germany or Fascist Japan.

Economically, socially, and politically therefore, China is no longer a Communist country. Moreover it does not claim to be.
So is China Socialist?

Socialism: An economic system characterised by social ownership and/or control of the means of production and cooperative management of the economy, and a political philosophy advocating such a system.

Note here the absence of a political definition to Socialism – it is an economic structure, not a particular political system (which is why Socialism can exist, ideologically, within a parliamentary democracy).

China used to be Socialist, for sure. China between 1955 – 1978 ticks all of these boxes. But since Mao’s death the ‘People’s Republic’ has been transitioning out of the Socialist economic structure.

Indeed since Deng’s set China on a course of market reform, in which it literally ‘grew’ out of a socialist planned economy. Reforms starting in 1978 capped plan quotas in absolute terms, increased procurement prices, and allowed the sale of surplus to be sold on the open market (at higher real market prices). Output was stimulated by this re-introduction of incentive, and the ‘planned economy’ gave way in relative terms to the market economy.

In 1982 the Party Congress officially endorsed an (oxymoronic) ‘Socialist market economy’.

By 1993 planning was abolished altogether. Already largely obsolete, its disappearance went by almost unnoticed.

The transition has been gradual and is not yet complete – 30% of GDP is still produced by State Owned Enterprises, and SOE’s still account for 21% of urban employment (much less in terms of total employment). However, this number is declining as more of these SOEs are privatised, merged, or liquidated by provincial-level government (which they have been empowered to do since the 1994 Fiscal Reforms).

China’s aim since 1978 has been economic development, plain and simple. The CCP have been ideologically agnostic about how this is achieved. Deng’s Southern Tour in 1992 was the final confirmation needed that Maoist Socialism had been relegated to an unfortunate past. Results, not ideology have driven China’s transition since then.

“Development is the only hard truth. It doesn’t matter if policies are labelled Socialist or Capitalist as long as they foster development.”
– Deng 1992

The CCP’s legitimacy is tightly bound to economic prosperity, and its leaders know it. On the one hand, China needs to continue to liberalise if it wishes to continue to increase its productivity (and therefore growth), for this it will need stronger institutions – most pressingly its banks need to be bailed out, restructured, regulated and privatised. On the other hand the CCP are conscious that their legitimacy depends on the population seeing them as directing the economy, this allows them to claim responsibility for rising living standards. As the economy liberalises, they will be decreasingly capable of doing so. This combined with a generational gap in expectations will pose the CCP with a different set of problems revolving around political legitimacy, freedom and fundamental rights. Nevertheless, there is little chance of the country reversing its policy direction since the alternatives are simply too inefficient to provide the growth China needs to sustain its delicate economy.

As to whether China can still properly be called ‘Socialist’ however, China is a transition economy. It is in the middle of a transition between Socialism and Capitalism. It has elements that can be labelled as either of the two, but cannot be fully categorised as one or the other. China may not be Capitalist, but it is certainly not Socialist. At this point it is more accurate to say that China is transitioning into Capitalism, rather than out of Socialism.
Some problems on the way…

China’s transition economy is in a very fragile state, the frictions of transition are evident in China’s whipsawing price index, unemployment, capital misallocation and inequality growth.

Specifically however, China has a few very very big problems that will result in some very nasty consequences:

1) 2008 Financial crisis

China’s tax structure is extremely decentralised: provincial level government remit a lump sum to central government every year. Provinces are then responsible for generating their own revenue and balancing their budget (since the 1994 Fiscal Reforms). They raise revenue through the SOEs, and through the levy of various taxes on private enterprise, VAT, income and corporation tax etc.

China is predominantly an export-orientated economy – much of its GDP depends on global demand, this makes it extremely vulnerable to external demand shocks, such as the one caused by the 2007-2009 financial crisis. Provincial level government faced plummeting tax revenues and SOE losses, leading to huge budget deficits or around 10 trillion yuan.

Central government was unwilling to bear this deficit on its own balance sheet because, quite simply, it is already stretched to the limit servicing its own debt (which stands at around 25% of GDP). Unlike most other countries, it can’t increase its debt to GDP ratio because:

i) It cannot raise revenue through a broadening of the tax base: China is too corrupt and the institutions are just not there. Central government tax revenue stands at just 11% of GDP.

ii) It cannot raise money from the private sector to fund its deficit. Liberalising capital markets would run the risk of collapsing the banks. China’s banking system is dominated by 4 state banks, all of which are insolvent due to a legacy of non-performing loans and capital misallocation. They are kept liquid by the artificial imposition of a controlled (and profitable) interest rate spread between deposit-interest payable and loan-interest received, plus the channeling of Chinese deposits into the banks (by limiting retail depositors to allocating their savings to low-yielding cash deposit, a volatile stock market or expensive real estate). Liberalising capital markets would drain funds from the state banks and probably drive them to illiquidity (as would a run on any of the banks).

iii) The central bank cannot buy up the debt without unpegging from the dollar, which might cause the Yuan to appreciate materially, resulting in a negative demand shock. Indeed, the PBC is forced to issue debt to soak up the excess liquidity caused by the buying of foreign denominated assets to keep the yuan down, not to do so would lead directly to money supply growth and inflation.

iv) It cannot really raise money from international creditor agencies, the amount of money required surpasses what the IMF could provide.

Between 2008 – 2010 state banks have issued 10 trillion yuan of credit to provincial level government, 20-30% of which is estimated to be non-performing, indeed government ordered the banks in 2010 to rollover the debt. These non-performing loans are equivalent to around 12x earnings of China’s two largest banks combined. Clearly therefore there is no way they can take such a hit. Central government will have to step in at some point and bail them out, not to do so would result in financial collapse – bear in mind that the Lehman Brothers collapse equalled the equivalent of 22 billion yuan, here we are talking (conservatively) about 2 trillion yuan.

Thus this is essentially a central government deficit-in-waiting. But quite what the government will do when the debt lands on its books, increasing total debt by 40%, is uncertain. Most likely there will be a combination of inflation, capital market liberalisation and RMB appreciation (and PBC buying).

2) Environmental destruction

i) China has developed a competitive advantage in heavy polluting industry. Environmental damage is a structural problem in that regulatory institutions are ineffective at a provincial or rural level, and business continues to operate in a pro-growth political and social environment. Growth brings with it political prestige for local officials, and environmental concerns are pushed aside.

ii) China’s energy needs have been met by fossil fuel production – mainly coal and petroleum. Moreover they are set to increase at such a pace that it will be almost impossible to decrease the level of fossil fuel consumption in absolute terms. China is the largest investor in green energy in the world, and wants to rapidly diversify its energy production, but even if it manages to hugely increase its relative alternative energy production, fossil fuel consumption will not go down because energy needs will be growing so fast.

The results have been stark:

30% of freshwater in China is so polluted it is unfit for any purpose
70% of rivers are unfit for human contact
The majority of China has a level of airborne ultra-fine particles deemed unsafe by the Wold Health Organisation
China has the highest level of lung cancer in the world
9/10 of the world’s most polluted cities are in China
300 million rural inhabitants rely on unsafe drinking water
Acid rain is destroying crops and poisoning fisheries
Desertification is growing due to over-exploitation of grasslands and deforestation by the logging industry.
By 2030 China’s freshwater reserves will fall to per capita water scarcity, yet the unequal distribution of water through China means that the effects will be concentrated to the north and west of the country. The CCP is in the process of relocating million out of these regions in anticipation of this water crisis.

The total cost of environmental destruction is estimated at 10% of GDP over the last decade.
The cost of ‘fixing’ these problems is incredibly high – it is very difficult to clean up a river, and impossible to purge underground aquifers of the toxic chemicals leaking into them. Any transition to cleaner output or a structural shift towards less energy intensive production is likely to be gradual and counter-balanced by growth constraints.

3) Pensions

China is facing a huge demographic squeeze – the one child policy has combined with increasing life expectations since the 1950s to create a top-heavy population distribution:
Starting in 2015, the working age population of China will start to decrease, yet the total population will increase till 2030.
By 2040 there will be 1 dependent for every 2 economically active Chinese, and 25% of the population will be over 60.

This means:
The tax base will contract as less people earn income, this decrease in the labour force will also be a headwind to macro growth.
Welfare costs will increase, since the number of dependents increase, and the cost of healthcare is rising as it gets more complex. and people demand increasingly better treatment.

However, China has been raiding both the common pensions pot and individual ‘private retiree accounts’ which are supposed to be ring-fenced since 1995, effectively hollowing them out. There are people who have been paying into these, who assume that the money will be there when they retire…

In total, China is facing an implicit pensions debt (what it needs to fulfil its already meagre pensions and social security promises minus what it actually has) equivalent to 85% of its GDP. There is just no way it is going to find this money. It will have to renege on guaranteed pensions, significantly increase the retirement age, inflate its way out of some of its liability, and bear the rest on its balance sheet. This will come at significant economic costs and social tension.

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