China’s S-Shaped Threat

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China’s S-Shaped Threat

China is assumed by many destined to overtake the US as the world’s leading power. But history shows the dangers of extrapolating from today’s growth numbers.

According to the US National Intelligence Council (NIC), ‘China is poised to have more impact on the world over the next 20 years than any other country.’ China is already the world’s second largest economy, second largest energy importer, largest natural resource importer by volume, and largest emitter of greenhouse gasses. Indeed, following the S&P downgrading of the US credit rating to AA+, Beijing feels empowered to declare that it ‘has every right now to demand the United States to address its structural debt problems.’

However, despite its astute policy navigation, efforts to guide national development, and claims of exceptionalism, China isn’t immune to larger patterns of economics and history. And those patterns tell us that China faces costly internal and external challenges that will hinder its ability to avoid the S-Curve-shaped growth slowdown that so many previous great powers have experienced, and that so many observers believe the United States is undergoing today.

Where China is headed domestically and internationally has major implications across the board for virtually everyone on this planet. The country has risen at a rate beyond even its leaders’ expectations over the past three decades, and a power shift is afoot in the international system. The fully unipolar system that persisted from 1989 to roughly 2008 is no more. To many, this signals a clear power transition in which China is poised to overtake the United States as the world’s foremost power. Estimates emerge constantly as to when China’s economy will become larger than that of the United States, and it’s assumed that China’s diplomatic, information, and military aspects of national power will grow in proportion.

But many policymakers and economists question whether China’s current growth trajectory can be maintained in the face of clear structural challenges that include pollution, corruption, chronic diseases, water shortages, growing internal security spending, and an aging population—all factors that feed off of one another and exact increasingly large costs for the Chinese state and economy.

One prominent Beijing-based economist, for example, believes that the country’s growth will need to slow to 3 percent to 4 percent per year—less than half the current rate—if it is to sort out structural imbalances in its economy. That’s a rate that the United States, Japan, and many European countries would envy, but the global implications are very different from a 7 percent to 8 percent annual growth regime.

The S-Curve concept is a useful tool for describing how great powers rise and decline. Because of an historical tendency for national efficiency to decrease as society ages, states tend to decline and thereby cause a downward spiral of increasing consumption and decreasing investment that undermines the economic, military, and political underpinnings of a state’s international position.

A society or country experiences slow growth in the early years, then enjoys more rapid growth as more resources flow into the state treasury, infrastructure develops, and the birth rate falls. The process continues until the state reaches its maximum growth rate, at which point various countervailing forces begin to constrain expansion and set the economy onto a slower growth path or even a state of equilibrium. Domestically, social spending and partisan behaviour may threaten productive investment and economic growth. Internationally, a hegemon tends to ‘overpay’ for influence in the international system because of the tendency for allies to ‘free ride,’ and technological diffusion can undermine a hegemon’s economic and technological leadership. But differences in national system and circumstances may have profound implications for the creation and maintenance of national power.

Many argue that it is precisely S-Curve-like factors such as explosive growth in healthcare and pension costs and military/overseas commitments that threaten American prosperity and pre-eminence. But few have considered the possibility that similar factors could constrain China—and perhaps much sooner than commonly anticipated. In its early years of modernization, China exploited a ‘demographic dividend,’ namely low labour costs and initial infrastructure investment, to grow rapidly. But the country is now beginning to assume social welfare and international burdens that will likely slow growth progressively, and may even check China’s rise in the international system as its leaders are forced to make much more difficult sets of ‘guns vs. butter’ decisions.

Managing China’s challenges will require major shifts in the country’s economic, and perhaps, political structure. This may substantially constrain its potential economic growth and, proportionately, its ability to invest in education, innovation, the military and other factors that help determine a country’s comprehensive national power.

We can divide China’s challenges into the following categories: political, demographic, structural, economic, and security. However, a key point is that these problems don’t occur in isolation. Rather, they interact and have real potential to be mutually reinforcing – for example, if high local government debts eventually require central government intervention that would effectively remove funds that could otherwise have been used to address chronic diseases or be invested in education, research and development, or the Chinese military.

Political Struggles

As China’s leaders struggle to balance growth and social stability, at the national level, many will quietly welcome a shift to a slower, but still robust growth path that emphasizes quality of development as opposed to sheer quantity of GDP. For a central government with a long-term development strategy, 20 years of steady and slower economic growth may represent a more attractive path than five years of above-target annual growth followed by 15 years of diminished growth as unchecked pollution, chronic health issues, and other sustainability challenges exact a toll. Stable, medium-paced growth potentially offers a brighter future for China.

While the Communist Party retains an absolute hold on political power, there’s a rising probability that the coming years could see a transition to a leadership that remains authoritarian in many respects, but which more explicitly bases its legitimacy on a mix of technical competence and nationalism and allows for more pluralistic expression and consideration of policy suggestions, at least within government channels. It therefore seems likely that a broader range of political movements and viewpoints will find their expression in Chinese politics over time. A more diverse political system will have arguably a greater chance of being stable, predictable, and ‘responsible’ in its policies.

Demographic Issues

Population trends are typically decades in the making and take equally long to reverse, particularly in a country like China that doesn’t have, and likely can’t accept, significant immigration to help rebuild the population. By 2030-35 in even the most optimistic estimates, China will start aging to such a degree as to hinder its economic growth and other national power trends. China’s population of young male manpower (ages 15 to 24) has already begun to decline and the proportion of older, sicker, and less educated workers is starting to rise.

While China’s technological capabilities have improved in many respects, it hasn’t yet succeeded in moving far up the added value chain. These trends threaten the core of China’s current labour-intensive growth model, which is built on manufacturing conducted by large numbers of extremely low-salaried workers.

China’s one child policy combined with the financial and social implications of rapid urbanization is creating an increasing population of ‘kinless families’ of single children of single children with little or no extended family. In Chinese cities, fertility is extraordinarily low and the countryside is greying even more rapidly. With sole responsibility for the care of four parents, couples in this position may increasingly look to the government for assistance for pension and health care programs. These will take significant effort to establish as China lacks them almost completely now, and will detract from future economic growth and defence spending.

Structural Issues

China faces growing internal challenges from regional income disparities and rising incidences of chronic health problems such as cancer and diabetes that will require very significant financial resources to address while still trying to maintain economic growth. These health challenges are exacerbated by the rapid aging of Chinese society. Water pollution, meanwhile, is also a serious problem.  In China, fresh water represents perhaps the most pressing resource shortage, since it directly impacts local and global food security. Local experts such as Zheng Chunmiao, director of Peking University’s Water Research Center, say that China needs to begin reducing water consumption or it will face dire consequences within 30 years.

All this means that pollution has likely kept China from producing at its full economic potential, yet policymakers will be loathe to make the short-term economic sacrifices necessary to avoid further environmental degradation.

Lax Standards

Chinese economic growth has relied heavily in recent years on fixed asset investment in roads, rails, bridges, and airports, among other things. To finance these projects, many local governments took out bank loans, creating an enormous local government debt burden that many projects will never be able to cover. If China’s growth slows, non-performing loans could quickly become a major problem. In turn, the diversion of state financial assets to resolve bad debt problems would exact opportunity costs by keeping the money from being used for more productive purposes.

There are also important questions about the sustainability and future challenges of rapid infrastructure build-out, relating to quality, long-term maintenance costs and future hidden costs of correcting infrastructure decisions made rapidly or for the wrong reasons. With proper supervision, Chinese construction firms can build world-class infrastructure at competitive prices. However, in practice, the potent cocktail of politically-induced time pressure, corruption, and a safety culture that remains lax for a country with China’s aspirations have combined to yield an infrastructure base that far too often literally kills. Examples in recent years include the increased death toll in the 2008 Sichuan earthquake due to shoddy buildings constructed by corrupt contractors who cut corners and the July 2011 Wenzhou train crash, which killed 40 people when lightning allegedly stopped a bullet train that was then rear ended by another.

Certain types of infrastructure are inherently dangerous, and even countries with very strong safety cultures can experience major problems, as Japan has with its Fukushima nuclear power plants. However, China’s ‘get it done as fast as possible’ infrastructure build-out mentality raises particular concerns as the country looks to develop complex and potentially dangerous projects in coming years, including more than 26 nuclear reactors that are currently under construction.

In the business sector, China also faces significant challenges to moving away from a primarily sub-contractor model to progress up the value chain. Beijing wants to build its long-term economic development strategy around quality, innovation and branding, but to achieve this there must be better intellectual property protection, a greater degree of openness for ideas and innovation to arise and prioritization of reliability and originality. China’s domestic heavy equipment sector clearly shows how powerful branding is, with Caterpillar, John Deere and other foreign vendors able to charge much higher prices for comparable equipment than can most domestic manufacturers. Brand building within China is likely to depend heavily on how well the business law and intellectual property regimes can protect innovations from the rampant and rapid copying that currently makes it difficult for innovative Chinese firms to recoup their product development costs and fully enjoy the economic value of their product and re-invest in new developments.

Securing China’s Place

Internal security, such as dealing with the as many as 180,000 ‘mass incidents’ that took place in 2010, demands vast resources in manpower and surveillance technology. China’s military modernization likewise depends heavily on the state of the economy. Strong increases in spending will be essential for China to secure the role it desires as East Asia’s most powerful non-US military force. To truly displace the United States from the region and become a more globally-capable power, even larger spending increases would be needed. China’s rise as a key global economic and security player depends critically on its economy and the trajectory of its power moving forward is likely to hinge heavily on the country’s economic growth path.

In the longer term, a variety of factors may limit People’s Liberation Army budget growth, at least to some extent. Various structural factors including higher health care and pension costs and rapidly rising wages that will erode the Chinese defence industry’s labour cost advantages could greatly restrict China’s ability to sustain rapid military spending growth, regardless of its leaders’ intentions. Personnel, equipment, and operational costs are all rising for the PLA, and there will be a limit to what can be afforded in the future. In coming years, China’s leaders are likely to face wrenching tradeoffs as China’s population ages, develops increased lifestyle expectations, and remains strongly nationalistic.

Even at a lower level of defence spending, China could still increase its power and influence substantially in East Asia and perhaps challenge US and allied interests there substantially. But the nature of the challenge could be very different depending on how Beijing chooses to allocate its resources along a continuum of focus from domestic security to regional dominance.

All this means thatChina’s rise could be slowed, complicated, or even threatened in critical aspects by a failure to deal with the political, economic, demographic and security challenges it faces. Potential challenges include water and resources shortages, environmental devastation, ethnic and religious discord, income and urban-rural inequality, enduring corruption, social unrest and political transition.

Such setbacks could be particularly dangerous for the Communist Party given popular expectations of rising living standards and foreign treatment of China being based in part on its perceived future potential. Substantial economic and even political reforms—at least increased rule of law, political pluralism, and freedom of expression—may be needed to address the needs of Chinese society in the future.

On the strategic front, slower growth and rising costs from internal challenges could crimp China’s ability to spend on military modernization. This could substantially curtail the country’s ability to become a major naval and air power outside of its immediate neighbourhood.

As for the S-Curve dynamic and what can be done about it, Beijing’s leaders will surely state that they retain control. China enjoys the advantages of relatively high government policymaking coherence, and a large population with an enterprising spirit that values education and has a tremendous work ethic. But the challenges China faces aren’t easily overcome, and how it tries to do so will have implications for us all.

Andrew Erickson is an associate professor at the US Naval War College and fellow in the Princeton-Harvard China and the World Programme. Gabe Collins is a commodity and security specialist focused on China and Russia. This is an edited and abridged version of a longer analysis. The full version can be read here.