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January 9, 2009 - Editorial - It's time to watch how China responds to a recession

The rapid and fairly steady economic ascent of China since the early 1980s has finally hit the wall of an old-fashioned recession.  Many businesses have closed, and countless jobs have been lost.  This marks a turning point in modern Chinese political and economic history which may prove to be as significant as the collapse of the Berlin Wall and the Soviet Union.

In short, China stands at a crucial fork in the road to alternative future scenarios.  Nobody can reliably predict the outcome, any more than they could have predicted the future of the Soviet Union and Europe in the early 1980s.  There are many scenarios - and they aren't all good.

Does the future belong to more individual freedom, responsibility, and entrepreneurial competition in China, despite the messy social problems which accompany greed and rapid but very unequal economic outcomes?  The relative absence of a social "safety net" in China through domestic philanthropic and charitable or faith-based organizations reflects the continued expectation, as in natural disasters, that the government will quickly intervene.

Will China revert to old practices?  Will the social pressures of economic hardship shake the commitment to long-term economic reforms, or even bring a significant crackdown in order to maintain the unquestioned authority of the party and state leadership and bureaucracy?

Keep in mind that, at this time, China isn't even admitting that it is facing a recession.  It still expects 8.5% growth, but is already moving to try to stimulate the economy.

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During the many years of incredibly rapid growth in China, the social pressures from among those who were left out by the growing prosperity were more easily contained.  There is concern now that, if the economy gets much worse, social unrest may trigger repression.

As in America, many young people were living the dream that they could create their own futures, and that hard work and savings would soon be rewarded.  Savings and investments brought prosperity which seemed unimaginable only a generation or two ago.  It seemed to be a sure bet.  The growth potential for China seemed to be without limits.  What could go wrong?

To a large degree, this mindset also grew the foreign investment bubble in China.  The Chinese dream of a vast middle class of eager consumers with rising prosperity finally seemed to be a reality.  The growth potential was so huge that all the obvious problems and obstacles were rationalized as necessary burdens which would soon be overcome in some way.  Few were foolish enough to believe that it would be easy to succeed in China during this extraordinary transition period, but it was a matter of faith that it was certainly worth the investment to get in the door early because of the vast long-term potential.  It was a gold rush mentality.

Is this the end of the Chinese dream?  No, that is not necessarily the case any more than the latest recession in the USA means the end of the "American dream", or the need for sweeping changes and vastly more government intervention in the economy as the solution.

It will, however, depend very much on the Chinese people, and how they respond to the current economic problems.  Will the "reform" movement be stopped, or reversed, by a public backlash against the hardships of a major recession?  Or will the Chinese people continue to press their leaders to have faith in the power of individuals to find solutions, rather than in the power of government to impose social order and "fairness" at the expense of freedom?

Have the greater freedoms and prosperity of recent years been an illusion to intoxicate the masses in China with a false dream while the party leaders and bureaucracy achieved greater economic and political power, or will the people of China now look to themselves rather than to their government as the key to their future prosperity?  Are they free to choose their own future?

This doesn't question the remarkable progress of the last 30 years in China.  Whether one agrees with all of their policies or their motivation, the results stand in stark contrast to what was achieved in the prior 30 years.  No matter how difficult the situation may appear to be today, it pales by comparison to the disaster in China after the Cultural Revolution (1966-76).

Unlike their Russian contemporaries who remained in denial about their failure at that time, the Chinese leaders embarked on a very ambitious reform program to try to manage their way out of the obvious mess which they had created.  As with some of the "Asian Tigers" which achieved rapid economic progress through government intervention and industrial development policies until they hit a financial crisis, China's government was driving the economic changes while trying to keep a lid on political pressures.  The state was still firmly in control, and gradually implemented reforms instead of collapsing all at once like the Soviet Union.

Unfortunately, given the demographics of China, a huge percentage of the current population never lived through that era of the Cultural Revolution, or the prior hardships.   They are just told of it by elders or in history classes, but it may seem as irrelevant and distant to their own lives as the era of the Great Depression seems to most people in the United States.  We all know it happened, and have been told  many tales about why it happened, and how bad it was.  Experts still argue over whether federal policies helped to end it or to prolong and worsen it.  Few, however, have vivid personal memories of it.  Most of that generation is now gone.

The same is becoming true in China.  This generation has not yet experienced the hardship and desperation of a period in which countless families are very fearful about being able to meet their most basic economic needs.  There has certainly been no shortage of hardship in China in recent decades, but it seemed to be a temporary condition which could be solved by individual initiative - by moving to the cities where jobs were plentiful, or by other work.  There was a way out.  There was a dream.  No matter how bad things might be, there seemed to be some way to deal with it.  There wasn't the sense of hopelessness that, despite all efforts and hard work and savings, the hardships might continue for a long time, with no clear end in sight.  After decades of hardship, the rapid progress now seemed assured to go on forever.

Selective recent article links about foreign investment and economic changes in China

"Unmade in China", The Financial Times, Dec. 27, 2008
"To lift economy, China urges citizens to spend more", The Christian Science Monitor, Jan. 8, 2009
"China favors jobs at home over freer trade", The Christian Science Monitor, Jan. 2, 2009
"A Westerner grows up in China", The Christian Science Monitor, Dec. 18, 2008
"An entrepreneur agrees: 'To get rich is glorious'", The Christian Science Monitor, Dec. 18, 2008
"The Great Crash of China", Far Eastern Economic Review, Oct 1, 2008
Search fDi for articles on China

for other useful article links.

As in many other cultures which value the extended family, and are very resourceful in the face of adversity, the Chinese are quite capable of working through this economic problem.  It need not be a calamity.  Things can be done, as in other countries, to mitigate the social problems.  The government certainly has the resources it needs to provide a basic "safety net" during this period as an emergency response rather than through permanent new social programs.

The question, however, is simple.  Are the Chinese free to choose?  Will their government believe in the people, or will it believe in itself as the solution?  Will hardships be used as an excuse to give even more power to the government, and to crack down on those who may express different views about the way forward?

Our concept in the United States of a government "of the people, by the people, and for the people" is not really shared by most governments of this world, and certainly not in China.  In many countries, patriotism is defined by loyalty to the political party or government in power, and to the infinitely wise programs administered by the responsible bureaucrats.  As in the era of feudal monarchies and colonial empires, civil servants believe that they are justifiably running the world while manipulating business and trade to their own nationalistic social goals.  When the economy stumbles, however, it is never their fault.  On the contrary, each problem is perceived to be a new justification for even more government intervention.  This cycle of rewarding failure with more power and resources is the opposite of a free market.

The concept of limited government power and the wisdom of ordinary individuals and business  to responsibly look after their own interests with few constraints is not even shared by some democratic countries.  It is fairly easy for populist demagogues to rise to power and stay there in some countries, and to concentrate greater power in government bureaucracies and their own hands than we would ever regard as reasonable.  We have very different views about the role of government, and whether it serves the people or whether the people serve it.  This is a fundamentally different view about the rights and freedom of individuals, and their relationship to society.  There are technocracies in which the powers of bureaucrats over individuals are so pervasive that it seems almost subversive and dangerous to believe in individual freedom.

The social environment in which business operates is not a small consideration for investors.  Political risk analysis is a very inexact process of weighing the potential consequences of many different potential scenarios, and how to minimize the adverse impact of unpredictable risks without missing the good opportunities.

Just as economists can argue as vigorously about what happened in the past as they do about what may happen in the future, or about what government policies should be at a particular time, political risk analysis isn't a simple intelligence task to confirm facts.  The intentions of leaders can change and may be very difficult to correctly discern at any time, and regardless of intentions, they may be overtaken by events.  Their power to control events is limited.

For those who may not yet be familiar with The Christian Science Monitor, it is an excellent objective source of independent global reporting.  It provides a thoughtful and positive long-term perspective, rather than superficially describing the most sensational bad news headlines of the day out of context.

It puts the news events and trends into a broader context.  It is not a religious publication despite the church ties of it.  It was created a century ago as an alternative to the sensational and biased newspapers with the simple mandate "To injure no man, but to bless all mankind".

It has received many awards for excellence in journalism.

From a pragmatic standpoint, the future of China is up to China.  The people of China and their leaders will figure out their way forward, now that assumptions of exponential growth without end have been shaken by the global recession, regardless of what caused this to happen.

They have made a lot of progress in the last 30 years relative to the prior 30, but the future is not necessarily a simple extension of the past today any more than it was in the 1970s.  The choices taken at this economic turning point can lead to much better or worse outcomes.

One could certainly argue that some of the problems are self-inflicted ones, such as through manipulation of exchange rates and other aspects of the Chinese economy and trade.  There is obviously blame to go around in many other countries too, which certainly includes the financial market problems in the United States and Europe.  Economists and historians can argue over that in the future, as they still do about the root causes and policy responses to the Great Depression.  For business leaders, however, the question is simply what to do now.  
From a political and economic risk management perspective, it seems obvious that CEO's should be taking a very hard look again at their assumptions about investment in China at this time, as well as reviewing other past decisions about the global strategic configuration of their operations and where to expect the most reliably profitable growth opportunities in the future.  
In that context, this is as important a strategic inflection point as the collapse of the Soviet Union and the resulting changes across Eastern Europe and former Soviet states as well as in the European Union.  The point isn't to fear that China's dream will now collapse into despair, but rather that the Chinese must redefine their own way forward - and that choice will have large implications for foreign investors in the country.  There may be better or worse scenarios for the future of China and foreign investment there as this global recession plays out.  
The point is that this is a crucial transition period in China - far more than the political and economic transition in the United States, where the process is fairly transparent and predictable rather than shrouded in secrecy.  We have had many smooth leadership transitions and many economic recessions as bubbles burst.

US media attention is focused almost entirely on the Obama transition, and on the foreign conflicts or events of the day.  Relatively little media attention, however, has been given to the strategic impact of this global recession in China or other countries which had been enjoying very rapid economic progress, including India, Brazil, and others.

India and Brazil are very different and more democratic societies than China, with very different political and economic systems.  Although there is pervasive state intervention in the economy in these countries too, including costly waste, corruption, and ineffective bureaucracies, they have also been down this path before in past recessions.  Their people have developed fairly low expectations of their government's ability to solve their problems.  When times are tough, they look to their families rather than the government for support.

As in the Brazilian "jeitinho", poor people figure out a way to work around whatever misery the bureaucracy creates in their lives.  In China, by contrast, the current generations have grown up with largely unshaken confidence that their government was making all the right choices, and that they should trust it and not question those choices.  Whether or not they really trusted or liked their government, they knew the way forward was to not make any waves.


While Indians, Brazilians, and many other citizens enjoy grumbling and joking about their fairly ineffective governments, without diminishing in any way their own national pride, the Chinese have believed in their government as the source of this remarkable economic transformation.

Brazilians had a somewhat similar experience during the "economic miracle" years of rapid development under authoritarian rule, with brutal repression of dissent until democracy was restored with some difficulty after years of hyperinflation, corruption, and economic hardship.

That finally left the military and civilian leaders fairly discredited.  Brazilians endured their economic and political mess and scandals with remarkable tolerance and good humor, rather than social upheaval, as they found their way forward.  The common joke that Brazil was the country of the future, and always would be, reflected patience rather than resignation.  There was still confidence, at the individual level, that Brazilians could create their own futures no matter how ineffective their government policies might be.  No leaders were above criticism.

It is not so clear, however, whether the younger generation in China will be as tolerant if their dreams seem to be shattered.  The downside of the pervasive role of government in the Chinese economy is that it is very easy to blame the government for all of their problems now, and to blame the foreign businesses as well.  Since open dissent is largely stifled, it becomes rather difficult to vent any such frustration without triggering a newsworthy conflict.  The Chinese people don't get to openly criticize their leaders and vent any frustration through sarcastic samba lyrics, popular novelas on TV, or through the Internet.  Instead, they still have to be very careful about what they say, and to whom, because of the power of the state.

For China, this is far more of a test of the progress which has been made over the last 30 years.  Will this be just an economic bump in the road, or trigger a major reversal of direction and relations with other countries, as has taken place in Russia under Vladimir Putin?  

The recent moves by Russia to assert itself in Georgia and through the gas crisis in Ukraine, as well as other initiatives, will hopefully NOT be followed by China sliding backwards too.  It remains an open question whether the rapid growth of China as a global economic power will lead to better working relationships or greater rivalry and nationalistic threats.  China was a great economic power and a source of valuable innovation for much of recorded history.  It has vast potential, but there are also unpredictable political and economic risks at this time as it responds to the stress of the global recession.

It's certainly time for business leaders to take a fresh look at their commitments in China, and whether they need to hedge them through strategic investments elsewhere in the world.  This may yet prove to be a good opportunity to grow in China at a time when foreign investment may be more welcome than before, rather than taken for granted as inevitable.

It depends on the Chinese response to the recession, however, because this won't be the last such recession, and there are always competing locations for business.  It's a major test of the commitment of China's people and political leadership to closer and friendlier working relationships with the rest of the world, as opposed to a retreat into authoritarian nationalism.

Does the future belong to individual freedom, responsibility, and business collaboration for mutual benefit, or to state power?  The response by China to the current economic stress should give a much better indication of the intended direction of change.  The future is not necessarily a simple extension of past assumptions.  China is in a crucial transition phase.



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