Beijing’s economic fragility and its implications for the Indo-Pacific

Since Nixon opened or rather reopened China in the 1970s, the ancient power has rapidly emerged as one of the world’s truly great economic and industrial powers despite the failure of Mao’s Cultural Revolution and poverty sweeping across the People’s Republic of China.

Characterised as the period of “Boluan Fanzheng” or “Eliminating Chaos and Returning to Normal” by Mao’s pragmatic and reform-minded successor, Deng Xiaoping, in an attempt to “correct the mistakes of Cultural Revolution” through an opening and liberalisation of the Chinese economy, paving the way for the true beginning of the globalised economy.

As Deng’s China rapidly began to industrialise and modernise beginning in the late 1970s, many nations began to peg their economic prosperity and stability to the rising power, Australia, least of all, doubled down, leveraging its vast mineral and resource wealth to transform China into one of the world’s major economic powers.

Seemingly unassailable in its economic and industrial ascendency, China’s economic miracle avoided the Asian Financial Crisis and steadily positioned the nation to become the “factory of the world”, resulting in the hollowing out of many national industrial bases in favour of cheaper, “just in time” supply chains.

For Australia, it is the economic relationship that has ensured our record and history-beating recession-free run of economic growth, but now, Beijing’s near four-decade economic miracle appears to have run aground with major implications for the security, prosperity, and stability of the post-Second World War order.

Compounded by the lingering effects of the COVID-19 pandemic and the waves of ceaseless lockdowns, border restrictions, and impact on supply chains at home and abroad, coupled with Beijing’s attempts to coerce trading partners like Australia during the pandemic, served to shatter the once-alluring illusion that as China became wealthier and its leaders and people became more prosperous, they would become more liberal, democratic, and less autocratic.

As if caught in a fever dream, we now know that this is far from the reality of the economic, political, and strategic reality we now confront, presenting major challenges for both Australia and the Indo-Pacific.

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Highlighting the potential impact of this, a number of economists and strategic policy analysts have begun to sound the alarm regarding the major implications of China’s declining economic stability, domestic demographic challenges, and the future of the Indo-Pacific.

Leading the charge is ASPI senior fellow David Uren, who asks, Is China’s economy about to go bust? Uren sets the scene, stating, “Australia is more exposed to a downturn in the Chinese economy than any other advanced country … The spate of gloomy commentary about the Chinese economy in the Western media reflects real concerns, but markets are not behaving as if the world’s second largest economy is on the cusp of its ‘Lehmann Brothers moment’.”

This mixed reality is expanded upon by The New York Times columnist Bret Stephens writing for The Australian Financial Review. In his piece, Seven ways the West can manage China’s alarming fall, he explains, “the main challenge we will face from the People’s Republic in the coming decade stems not from its rise but from its decline – something that has been obvious for years and has become undeniable in the past year with the country’s real estate market crash”.

Managing stagnation and decline

As previously stated by Uren and now a well-established fact, Australia is perhaps the nation most dependent upon the continued economic prosperity and stability of China and will require sustained focus and commitment to overcome the inherent vulnerabilities we now face.

This reality, coupled with the structure of China’s “political economy” under Xi Jinping, presents significant challenges, as explained by Uren, who, in quoting the president of the Peterson Institute for International Economics, Adam Posen, states, “China’s political economy under Xi has finally succumbed to a familiar pattern among autocratic regimes. They tend to start out on a ‘no politics, no problem’ compact that promises business as usual for those who keep their heads down. But by their second or, more commonly, third term in office, rulers increasingly disregard commercial concerns and pursue interventionist policies whenever it suits their short-term goals.”

The vulnerability of this command-driven approach as embraced by Xi Jinping, particularly in recent years, also serves to reinforce two central points of Stephens’ thesis, namely, don’t think of China’s misfortunes as our good fortune and don’t assume the crisis will be short-lived.

In particular, Stephens explains, “A China that can buy less from the world, whether in the form of handbags from Italy, copper from Zambia or grain from the United States, will inevitably constrain global growth. For US chipmaker Qualcomm, 64 per cent of its sales last year came from China; for German car maker Mercedes-Benz, 37 per cent of its retail car sales were made there. In 2021, Boeing forecast that China would account for about one in five of its wide-body plane deliveries over the next two decades. A truism that bears repeating is that there is only one economy: the global economy.

Unpacking this reality further, Stephens’ adds, “Optimists think the crisis won’t affect Western countries too badly because their exports to China account for a small share of their output. But the potential scale of the crisis is staggering. Real estate and its related sectors account for almost 30 per cent of China’s gross domestic product, according to a 2020 paper by economists Ken Rogoff and Yuanchen Yang. It is heavily financed by the country’s notoriously opaque US$2.9 trillion ($4.5 trillion) trust industry, which also appears to be tottering. And even if China averts a full-scale crisis, long-term growth will be sharply constrained by a working-age population that will fall by almost a quarter by 2050.”

This combination of factors, coupled with the declining levels of domestic consumption and stability within China’s domestic economy spells major trouble for Australia, which leverages its vast mineral and resource wealth to propel the modernisation and urbanisation of China’s vast population.

However, for Uren, this isn’t all doom and gloom, as he states, “China’s vast economy, with its competitiveness in global manufacturing, its leadership of most elements of the energy transition and the world’s biggest population of middle-class consumers, has a resilience overlooked by some who risk schadenfreude in their forecasts of inevitable doom.”

Uren adds, “Some of the global commentary has suggested that a downturn in China wouldn’t matter much for the West because China is a relatively small source of demand for most nations, with notable exceptions like Australia. New York Times columnist and economic Nobel Prize–winner Paul Krugman says Chinese demand is only 1 per cent of GDP in the United States, adding that its economic woes may help bring down US inflation. For Australia, by contrast, exports to China represent almost 8 per cent of GDP. Only a handful of countries like Zambia, Chile and the United Arab Emirates have greater exposure. Australia’s exposure to China has brought it two decades of rising living standards, despite weak domestic productivity.”

A declining economy makes them dangerous

This combination of factors only serves to make China increasingly unpredictable and dangerous on the geopolitical stage as domestic factors push Xi Jinping and his cadre of high-party functionaries struggle to look externally to respond to the challenges facing the rising superpower.

Highlighting this is Paul Krugman of The Sydney Morning Herald, who states, “The basic point is that China, in various ways, suppresses private consumption, leaving the country with huge savings that need to be invested somehow. This wasn’t too hard 15 or 20 years ago, when Chinese GDP could grow as much as 10 per cent a year largely by catching up with Western technology: A rapidly growing economy can make good use of huge amounts of capital. But as China has grown richer, the scope for rapid productivity gains has narrowed, while the working-age population has stopped increasing and has begun to decline.”

For Australia, a nation that is incredibly dependent on China’s continued economic growth for everything, ranging from higher education and real estate, through to energy, raw resources, and agricultural produce, this spells major trouble for our own long-term economic prosperity and stability.

This is reinforced by Krugman who states, “The International Monetary Fund believes that over the medium term, China can expect a growth rate of less than 4 per cent. That’s not bad – it’s something like twice the growth most observers expect for the United States. But China is still trying to invest more than 40 per cent of GDP, which just isn’t possible given falling growth.”

Equally confronting for Beijing’s leaders is the fundamental structural and systemic design flaws inherent within the Chinese system and it’s hybrid command/market style economy, or as Deng Xiaoping used to say, “Socialism with Chinese characteristics” which has only retreated under Xi Jinping’s government.

Highlighting this is Peter Zeihan in his book, The End of the World is Just the Beginning: Mapping the Collapse of Globalization, where he states, “Chinese fascism has worked to this point, but between a collapse of domestic consumption due to demographic aging, a loss of export markets due to deglobalisation, and an inability to protect the imports of energy and raw materials required to make it all work, China’s embracing of narcissistic nationalism risks spawning internal unrest that will consume the Communist Party.”

Ultimately this brings us back to the actions that Beijing may take in order to quell domestic political and economic challenges, with major concerns about China’s ambitions for Taiwan and the broader Indo-Pacific as a whole as the nation seeks to prop up its economic growth, while ensuring that its demographic cliff doesn’t trigger a domestic societal collapse.

Again, something highlighted by Krugman, who states, “Trying to reduce that superpower’s ability to do harm makes sense, even if it makes many people nervous. And the possibility that China may not be as much of a superpower as many expected doesn’t change that calculation.

“If anything, China’s problems may reinforce the case for precautionary action. China’s rulers have long relied on economic achievement to give them legitimacy. Now they’re facing trouble on the home front, most immediately in the form of rapidly rising youth unemployment. How will they respond?” Krugman posits.

Final thoughts

Whether for ill or good, China’s ambitions and actions will shape the prospects of peace, prosperity, and stability in the Indo-Pacific more completely than any other nation, however, we in the developed world can’t be held to ransom by authoritarian and ethnic supremacist nations as Xi’s China has increasingly become.

Helping China is mutually beneficial for nations like Australia, but it can’t come at the expense of our values and principles. Nations like Australia and the United States by virtue of their position within the post-Second World War international order can go a long way to helping where possible and guiding where necessary.