Will China’s Rise Continue?

One of the most relevant trends in our times has been the rise of China to the status of major political, military, and economic power. Many analysts predict that China will surpass the US and will become the world’s leading superpower in a not so distant future. This column will argue that while the recent past growth of China has been impressive, it is far from certain that China will continue to grow at the same pace. The reasons for that assessment are demographic, economic, but mostly political.

Let us start with the demographics. China is the most populous country in the world with 1.42 billion people in 2019. However, China´s population growth is decelerating rapidly. The population will start to decline by 2028. This is a consequence of an extremely low fertility rate, partly explained by the radical one-child policy enforced from 1979 to 2016. The transition from high fertility to low fertility generated the so-called demographic dividend, an interval of time with few children, few old people, and an abnormally large fraction of the population of working age. Between 1978 and 2010, China’s working age population share increased from 58% to a remarkable 74%. The demographic dividend is now gone. The UN estimates that the working-age population share will decline to 62% by 2040. In this process, the Chinese population is aging rapidly. In 1990, only 5.7% of the population was 65 or older. That fraction doubled to 10.6% by 2017 and will double again by 2040, reaching 22%. This accelerated aging occurs in a country with relatively few people covered by pension schemes, and with fragile and underwhelming healthcare systems. There will be an enormous and costly increase in the demand for social protection. Exactly at the same time, labor force declines, savings decrease and the workforce becomes less dynamic!

Another problem that China faces is the middle-income development trap. In the past, many countries were able to grow from extreme poverty to middle incomes. However, very few were able to keep growing and join the richest countries. Brazil is an example of those countries that did not succeed.

China’s growth in recent years is nothing short of amazing. From 1990 up to 2017 China experienced an annual average real GDP per capita growth rate of 8.9%. The corresponding figures for the US, Japan and Portugal are 1.4%, 0.9% and 1.2%, respectively. In 1990, the per capita GDP of China was 8% of Portugal´s and that ratio increased to 55% in 2017. Currently, China is a middle-income country, precariously standing at the threshold where most countries fail to transition to full development. Will China succeed in breeching that threshold? Much of the growth of the Chinese economy followed a pattern seen in other countries. This includes a massive migration of workers from low productivity rural areas to urban and industrial areas. High savings rates and foreign investment provided the capital needed. China became a factory to the world. In part, this also occurred with the industrialization of the Soviet Union. However, China had the great advantage of integrating itself with world trade. Benefiting from its huge size, China was able to attract foreign investment and to force, by reasonable and unreasonable means, large transfers of technology and know-how. Nowadays, there are large and very profitable firms in China such as Alibaba and Tencent. However, they thrive in a protected market. Mostly, these firms are not innovating, just catching up to the technological frontier. Some firms, like Huawei, seem to have what it takes to be successful in the world market, but it is not clear if they are not rare exceptions. Will Chinese firms be able to take the next step and start innovating and operating at the technological frontier?

Chinese optimists point to the fact that the country’s scientific output, in areas such as IT, artificial intelligence, etc., seems to be very large. Coincidently, these are the types of technologies a totalitarian state finds useful to monitor its subjects. However, interpreting them as signs of future economic success is premature. China’s internationally relevant scientific output occurs in narrow areas. For example, China's contribution is still irrelevant in the Social Sciences. Furthermore, it seems to follow the soviet model of science. That model was successful for military purposes or space exploration (a trendy area at the time, much as AI is today). It did not work well for the economic and social development of the Soviet Union.

Despite recent successes, other problems of a political nature arise for the future. China tried an experiment never before carried out successfully in a large country: to have market capitalism and, at the same time, have it ruled by a one-party totalitarian state. This contradicts western historical experience. The Chinese elite (its "aristocracy") thought of a model where a group of very clever and very well trained people would run a country with good intentions and none of the messy problems of democracy (like occasionally electing demagogues and choosing policies that hinder growth). That aristocracy would be enlightened and large enough that the policies it chose would always be for the good of the whole country and not for the benefit of cliques. For a while, this model seemed to work: The presidents of China came and went, respecting their term limits, and the political processes seemed to run smoothly. This did not last long. As Aristotle said 24 centuries ago, there is a natural tendency for aristocracy to degenerate into oligarchy. Current president Xi Jinping eliminated his own term-limits, and started a discretionary use of corruption charges against enemies and perceived rivals. Other bad policies are under way, such as propping up inefficient state firms by wasting investment capital from the politically run bank system.

Ultimately, whether China can make the transition to become one of the richest countries depends on a very simple fact: Is liberty necessary for full economic development? The answer arches back to Schumpeter and his concept of creative destruction. For a truly advanced economy to work, new firms and technologies that render incumbents obsolete must be allowed to prosper, putting the incumbents in danger, and occasionally relegating them to the dustbins of history. It is very unlikely this will happen in a country governed by a self-interested clique with weak limits on its own power. It will always be easier and cheaper for that clique to rid itself of rivals by using the power of the state they control. It will be easier - but that will prevent full economic development. Right now, this seems to be the way China is heading.

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