The China bulls and the bears both have it wrong, says Jonathan Fenby, author of a new book on the country. Here, he talks to Merryn Somerset Webb about what lies in store for China.
Most people with a view on China fall into one of two camps. They are either bulls, in which case they hold the mathematically illiterate view that the Chinese economy can expand at 8%-10% a year forever; or they are bears, in which case they look to history, note that this has never happened before, and expect to see slowdown turn to crisis (regular readers will find it relatively straightforward to figure out where we stand on this one). I'm interviewing Jonathan Fenby because he seems to think there is a middle way.
When I went to listen to him speak about his new book, Tiger Head, Snake Tails: China Today, How it Got There and Where it is Heading, at the Edinburgh Festival in August, he pointed out that most commentators have no idea "just how complex China is". The key to understanding China and hence seeing that the bulls and the bears are "both right and both wrong" is to see that the Communist Party is the "biggest political movement ever".
The party has 82.6 million members and every aspect of the economic "miracle" has to be understood in the context of the fact that the core aim of the party (and the nine-strong "corporate board" of top members that run it and hence the country) is "to keep China strong and the party in power".
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I meet Jonathan in the middle of the Bo Xilai scandal Bo is a party official facing criminal trial so we start by talking about that. It has exposed corruption and a lack of unity at the top of the party. How much of a problem is this?
The party treads a fine line on this one, says Fenby. There's a view that, while you have to be seen to be doing something about corruption in order for the party not to be brought down by public anger, you can't do too much about it or you won't have any party members left. The result is a balance in which bureaucrats are generally allowed to get rich at the expense of the people, as long as they stick to the party line (this is where Bo fell down).
The problem which central planners are aware of, says Fenby is that corruption leads to "major misallocations of capital". That's particularly the case in economies such as China's, which are very dependent on infrastructure projects. Any time a city launches a new project, they will hand it to a company in which they have an interest, which will in turn subcontract it to another in which other connected people have an interest. At each level of decision making (who gets to provide the labour or the materials, for example), there will be a new round of corruption all jobs are assigned via a "patron pupil relationship" or network, rather than by any kind of fair tender.
The good news, such as it is, is that as China slowly switches to more of a consumption-based economic model, this kind of easy theft will become less of an issue. I wonder if that economic shift might come with any kind of political shift might the new council (which takes over in November) democratise slightly? After all, they've got some pretty serious stuff to deal with the economy is slowing; there are rising numbers of corruption scandals; a casual glance at the internet tells you that there are more and more popular protests; there is no space for further economic stimulation in China; social media is connecting all sorts of dots the party would prefer remained unconnected; and it seems clear that the problem of inequality is going to have to be addressed properly at some point. Might the party need to give away a little power to soften some of the coming blows and to hang on to its power and influence?
Fenby accepts that the new lot aren't going to have an easy job. He isn't worried about the GDP numbers at the moment. You can argue endlessly about what the real growth rate is in China (it all depends on how much you believe the inflation numbers), but it is the trend that matters.
While there won't be a new big stimulus package (there just isn't the money note that the last "package" announced was just a load of existing projects "cobbled together"), there is plenty of local government spending on the go: "this is not the stuff that hits the headlines, this is buses, this is urban transport, this is sewage, this is schools".
This is the kind of thing that, alongside the ability of the Chinese government to simply sidestep any banking crisis (by setting up a bad bank and shovelling all the bad debt the bears worry about so much into it), gives one reason to assume China won't collapse any time soon.
So will it rule the world instead? Probably not, says Fenby. The real problem in China is the "unfinished revolution". The market has been introduced to the nation, but the structural economic problems underlying the economic miracle haven't been addressed at all. All the land is owned by the state, making all farmers effectively insecure tenants (akin perhaps to Scotland's pre-clearance crofters) and all farming very small scale.
At the same time, no real action has been taken to deal with the "desertification of the north" or the use of unsuitable pesticides and the river-borne pollution they cause. Urbanisation has also eaten into the farmland available and in particular into the vegetable fields you used to find inside most city limits. Guangzhou has "lost 25% of its vegetable growing land in the last five years".
All this means that "agricultural supply cannot keep up with demand for food... and when you've got the middle class getting used to eating more varied diets and... 15% pay rises for blue-collar workers, food demand is obviously going to go on increasing greatly". China has had a "whole string of good harvests over the last eight to nine years".
What if it has a bad one; does that make him worry about inflation? It does. There is hardly any manufactured goods inflation in China at the moment: "inflation is food inflation and the main driver of food inflation is pork" (China has 55% of the world's pigs). Right now, due to the rise in the price of pig feed, "a lot of pigs are being slaughtered ahead of time". So at some point next year there will be a shortage and price rises.
But agriculture isn't the only major structural problem in China. Next up is the labour market, in particular the system by which, regardless of where they go to work, people remain registered in their home towns. Those then become the only places they can buy property or access services (education for their children, for example).
The first generation of migrant workers accepted this. Almost anything was better than village life and they generally planned to go home anyway. But their children "don't want to go back to the countryside". They want to settle properly in the cities that is something that is causing social tension between their "large floating population" and the regular residents of the cities.
What's next in his list of worries? The banking system that "doesn't really operate as a banking system"; the legal system under which judges swear an oath of loyalty not to the legal system but to the party (hence the 98% conviction rate); and finally the extreme underpricing of water and energy, both of which China is very short of. None of these things are being addressed or look like they will be soon enough. Westerners like to think that communist leaders are able to take great long-term policy views, but look at China and you see that they aren't keen to take the short-term pain of proper structural reform either. "Look at the actual record. It's not there."
What's the biggest risk to Chinese stability today? Short term, it's food prices. "The nightmare scenario for China would be if you have bad harvests, the pig cycle was more acute than usual, and you then started to get food inflation going ahead of wage increases, at which point you get the danger of a wage food price spiral."
And longer term? "Society." The most important part of China's evolution over the last 30 years has been in its society. The middle class has become "used to a different sort of life" one that doesn't really fit with the political context. The real long-term danger (and here we come to the answer to the question I asked back at the beginning) is that political reform is put off and the party is showing no signs of being interested in loosening the reins of power. Structural reform is also being put off and if, as a result, growth falls, it then becomes hard to keep the middle classes "materially happy".
China is currently something of a safety-valve-free "pressure cooker", relying entirely on growth to keep it stable. "An end to the good times could bring an explosion."
Who is Jonathan Fenby?
The son of two journalists, Jonathan Fenby always knew what career path he wanted to follow. After graduating from Oxford University, he joined Reuters as a graduate trainee. Spells in France and Vietnam followed before he joined The Economist as bureau chief in France and Germany.
He returned to England in the mid-1980s to work for the newly launched Independent newspaper, then switched to The Guardian, where he became editor of The Observer. He worked at the Sunday paper from 1993 to 1995, then landed a post as editor of the South China Morning Post between 1995 and 1999.
While at the Hong Kong-based newspaper, he wrote several books on China, World War II and France. In 2006, he decided to use his emerging-market knowledge to form a research analysis firm and, with several partners, established Trusted Sources. Now aged 69 and based in London, he splits his time between managing Trusted Sources' China desk and working on his own TV and book projects.
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Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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