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Conversation: Gauging China's Response to its Slowing Economy

6 MINS READMar 16, 2015 | 13:02 GMT

Jay Ogilvy: Hello, I'm Jay Ogilvy and I'm here with Rodger Baker to talk about China. Big subject, big uncertainties. Now, Stratfor has, is in the business of making forecasts and I'm intrigued with the degree to which the big wide world out there is finally catching up with Stratfor's forecasts, yours of about ten years ago. I was very struck by an article in The Wall Street Journal on Saturday [March] 6th by China scholar, very respected scholar, Dr. Shambaugh, who lays out five different points for, his idea is the endgame is near. I'm curious to know what your reaction to that article is?

Rodger Baker: Well in some ways, seeing that article come out wasn't necessarily a validation of what we've been pointing out for a while. But it is interesting to see these concepts start to move into what would be more accepted territory. So when we were first looking at the factors that we predicted would lead to sort of the end of the system that we see in China as it is. First and foremost the end of the economic growth pattern that they had. And second that leading into a social and political situation that in many ways they would probably be unable to hold together that may lead to a fracturing of China and then some reformation of China coming out of that on the other end. We may have been a tad premature. And we were seen as very negative on China during some of the highest times of Chinese growth. But as we look and see some of these aspects come into play in China, the problem of the Chinese for example in adjusting their economy to the fact that they lost most of the European market, it's interesting to watch as this plays out. What were some of the points that you saw in the article that really raised your interest?

Jay: Well part of what piqued my interest in Shambaugh's account was the beautiful combination of sort of generalities with specifics. He said now there's an exodus of some of the big money. They interviewed something like 393 high net worth individuals and discovered that 64 percent of them either were now emigrating or planning to emigrate. That was one point. That's a red flag when the money leaves town. He gave us a beautiful example, the birth tourism, the number of Chinese women who were traveling to the United States to have a baby who then gets a U.S. passport and then go home again. That was a lovely specific that impressed me. He describes the woodenness of a lot of top Chinese officials who seem to be just going through the motions and not really believing the holy writ anymore. He describes how the anti-corruption campaign is turning into a kind of political purge of people who were loyal to either Hu or earlier leaders. So this combination of specifics, I thought, was very impressive from a man who is a major China scholar. Now on the other side, what I cannot help remembering is how I, you, many others through the 1990s kept kind of saying they can't keep maintaining this 10 percent GDP growth year after year after year. It seems clear to me that the significance of the third party plenum in the fall of 2013 was to acknowledge that the traditional growth model that has worked for 30 years is now obsolete. And they really do seem to be turning. Can they turn the ship in time and far enough? That's the question, and what I see in favor of the new leadership is that the traditional Chinese fear of chaos. Right? Hunluan, I'm probably not pronouncing that correctly, you can get the pronunciation right. But the fear of chaos is so strong in China that I think that people are going to be very reluctant to get rid of the current system and the control by the Chinese Communist Party. They would rather continue with an even repressive control rather than dip into chaos.

Rodger: Well one of things that I would argue though, is that very fear has taken them to this point that they're at right now. In other words, for at least a decade, in discussions with Chinese Research Institute and their interactions with higher level Chinese officials, the Chinese government has recognized the need to change the economic model, the need to stop relying on that sort of export driven model, the need to reshape how domestic consumption works, how the economy works inside China. But there was always a fear that the transition between those two economic models was going to be chaotic. And so there was a continuation of holding onto the old model, even when it was completely inefficient. So companies were anecdotally — even before the European decline — many Chinese companies were running at zero or negative profit margins. But they were continuing to run and continuing to operate because of the fear of what change would mean.

Jay: And they could continue to run as employment agencies.

Rodger: Exactly. And I think that has been one of the problems of the government. One of the things — if I were to look for something and I don’t know whether it is positive — but look at it as the anti-corruption campaign is also about massive recentralization of power. So while the Chinese profess market forces, what they are talking about actually is a very strong consolidation of central leadership. And they have looked back at history and history shows China that China has a strong central leadership. It then creates a massive bureaucracy to be able handle the size of China. Over time the bureaucracy become the power, the center weakens, there is some form of external shock or external crisis, the system collapses, a new power comes in, centralizes. And I think what they're trying to do is preempt a different power from coming in. This is the Communist Party trying to gut the Communist Party to save the Communist Party to save China. And my concern is that I had an opportunity to speak at the Chinese Defense University and they invited me there to speak with a Chinese economist and we both discussed the problems of the Chinese economy. And we both discussed the difficulties of reform. And my outcome was I don't see how they make it through the system. And his outcome was because we recognize the problem of course we're going to make it through the system. And I think that false confidence, whether it's real or not, that false confidence is going to ultimately come back and cause them more problems than I think they want to have.

Jay: Well thank you for your views. I'm very ready to acknowledge that you know that great vast country far better than I do. So I'll come back and ask you again and again for your views. Thank you, Rodger. 

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