Jacob L. Shapiro
It is almost difficult to remember that the top story at the start of 2016 had nothing to do with Brexit, instability in Turkey or Europe’s banking troubles. This year began with a series of crashes in the Chinese stock market that sent global markets into a small panic. That caused many to question the capabilities of decision-makers at the top of the Chinese economy and led to large capital outflows, which totaled just below $100 billion in January alone.
After a few weeks, Beijing was able to get the situation under control by falling back on an old strategy: pumping money into the domestic economy. But this time it did so at an unprecedented rate. The total amount of social financing used during the first quarter of 2016 surpassed the stimulus China relied on to get through any quarter since the 2008 financial crisis. The stimulus did the job and stanched the bleeding. But it looks like the bandage is beginning to fall off and China is still staring down the barrel of the same structural economic challenges it had in January.
One of the most worrying signals comes straight from the People’s Bank of China (PBOC). The head analyst for the PBOC reportedly said that China was falling into a “liquidity trap.” China has been able to maintain its targeted GDP growth rates so far this year, but beneath the veneer of positive news in the first half of the year is the distressing observation that many private enterprises are hoarding capital rather than investing it back into the economy.
One worrying sign is that though private investment has been slowing in China since 2012, it has fallen off a cliff in 2016, reaching record lows of 2.8 percent year-over-year growth. Total investment is growing at more than 10 percent, but that is driven largely by state investment. As a portion of overall investment in China, private investment in May was at its lowest in four years.
At the same time, capital outflows are beginning to pick up again. Goldman Sachs estimated at the end of last week that foreign exchange outflows from China doubled in June from the previous month, approaching almost $50 billion. Non-performing loans are creeping upward, reaching 1.75 percent of total bank lending at the end of the second quarter, according to the China Banking Regulatory Commission. Even more worrying, unofficial statistics suggest the true percent of total loans that are non-performing in China could be anywhere from 3 percent to 20 percent.
Amid these warning signs, fresh rumors abound about discord between President Xi Jinping and Premier Li Keqiang. An article in the Wall Street Journal on July 22 stated that the discord between Xi and Li was spilling into the open and highlighted contradictory statements the two made at a meeting of China’s State Council on July 4. According to the Wall Street Journal, Xi seemed to be calling for “stronger, better, bigger” state-owned enterprises (SOEs), while Li emphasizes that SOEs should “slim down” and “follow market rules.”
We first began tracking rumors of discord on May 9 after a piece was published in the People’s Daily newspaper – citing an unnamed “authoritative insider” – that has been interpreted by many as a not-so-subtle critique of Li’s economic policies.
The critique levied by the “authoritative insider” plays a relatively minor role in the development of this potential split, and its importance has been exaggerated. It is far more consequential that since Xi came to office, he has systematically taken control of economic policy-making in China, which historically came under the purview of the premier. He has sidelined Li by confining Li’s responsibilities to various smaller committees that either Xi runs or are directly answerable to him.
Xi has been consolidating power since he came to office in 2012, and now cracks in his authority seem to be few and far between. The anti-corruption campaign is continuing apace, dismantling and reorganizing any group that could meaningfully challenge Xi’s rule. The People’s Liberation Army is also being reorganized and as far as we can tell has not resisted Xi’s consolidation attempts in any meaningful way. Xi seems to be very much in control in China and the most serious challenge that anyone has proffered at this stage amounts to just whispers and rumors ahead of next year’s 19th Party Congress.
It is hard to make very much of these whispers at this point. For one thing, anyone who claims that they know precisely what is going on between Xi and Li either has a direct connection to both men or is simply guessing. For another, personalities matter relatively little at this level of geopolitics. Xi and Li are political leaders in China and both are looking at the same set of problems and trying to figure out the best way for Beijing to address them. Unless something dramatically changes, Li doesn’t have the power necessary to unseat Xi or to challenge him for the presidency, and a “leadership struggle” between the two will most likely end with Li losing the premiership five years earlier than is customary.
What we can say is that, without having a complete transcript of the State Council meeting on July 4, it is impossible to know whether Xi and Li really were contradicting each other. But wanting bigger and stronger SOEs and wanting bloated inefficient ones to trim down are not necessarily mutually exclusive paths. If Li is smarting from loss of authority in his role or from lingering embarrassment from the critiques of the previously mentioned “authoritative insider,” he isn’t letting it show. On July 21, while speaking directly to provincial governors, he backed Xi’s supply-side reforms by exhorting the governors to eliminate inefficiencies and encourage private investment.
The more important point is that Li even has to do that in the first place. The problems that are showing up at political and economic levels throughout China stem from a divide between what is good for individual regions and what the central government believes is good for China. Just two months ago, Xi spoke at a meeting of the Central Leading Group for Financial and Economic Affairs, which Li also attended, and pointed out that some regions had “not yet taken effective actions” in responding to the directives of the central government. Whether or not there is a crisis of leadership emerging, the most important point in the Wall Street Journal article was that some Chinese officials claim to be confused about which policies they should follow and therefore are sitting on the sidelines instead of pursuing Beijing’s priorities for the country.
Much is made of the fact that the Chinese Communist Party derives its legitimacy from presenting a unified front, making sure unemployment stays low, or containing social unrest. This is of course true, but it is in many ways an oversimplification. There is a push and pull between the center and the periphery in China, and Beijing cannot simply tell the provinces what to do and expect it to be done with no questions asked. When we say that the Communist Party’s legitimacy is at stake, we are really talking about the party’s ability to govern. Xi may very well be a dictator, but the ability to make China function as one country is rooted in Beijing’s ability to convince the various local areas that they should pursue reforms because these reforms are in their interest, and not just because Xi tells them to do so. The party’s legitimacy is one of the most important currencies Xi has to accomplish this, and a fight between Xi and Li would severely weaken that currency.
And that is the real crux of the problem. Whether there is serious discord at the top is less important than the fact that even the appearance of disagreement can have serious ramifications for China’s ability to pull off the massive economic restructuring it is attempting. As for Xi and Li, if they are on the path to a struggle for the party’s leadership, it wouldn’t be the first time that two similarly minded political leaders chose to fight each other rather than face their shared problems. But even if they are, China’s problems are bigger than either of them.