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Forbes magazine China After 30 Years of Reform Do Hu and Wen have Deng Xiaoping's wisdom? Gordon G. Chang I Every society changes, but China's changes faster. The startling transformation that began 30 years ago this month with the accession of Deng Xiaoping has been one of the world's great stories. Deng's great legacy was undoing Mao Zedong's. Mao captured China and then proceeded to regiment, repress and ultimately deny it of vitality. When he died in September 1976, Chinese leaders knew there would have to be reform. The debate in Beijing was how much should be allowed and how fast it should occur. The now-accepted narrative is that Deng argued for a startling transformation of Chinese society. We buy the story that he first debated with his fellow revolutionaries, then experimented and finally decreed change. Yet, in reality, reform progressed more by disobedience than design. Initial failure to meet state-planning goals forced Deng to back away from command-economy tactics and permit individual initiative. Peasants on large collective farms, for example, were permitted to form "work groups" to tend designated plots. Central government policies specifically prohibited these groupings from including just one family. But families started to look after their own plots--and local officials pretended not to notice. Urban subterfuge followed rural subterfuge. Deng's Beijing strictly prohibited private industry, but entrepreneurs proceeded by operating their businesses as "red hat" collectives and enterprises--private companies operating under the flag of state ownership. Deng's reforms succeeded because the Chinese people disobeyed Deng's rules. Such defiance would have been unthinkable in the Maoist years. Deng's great contribution, therefore, is not so much that he planned China's "economic miracle" but that he let it happen. The economy during the last three decades has grown at an average annual rate of 9.8% largely because peasants, workers and frustrated bureaucrats made themselves into entrepreneurs and pushed their country forward. By ignoring central government decrees, they built private businesses now accounting for as much as half of the Chinese economy. For many years, China has marched to the banner of gaige kaifang (改革开放: cải cách khai phóng), "reform and opening to the outside world." Progress, of course, has not occurred in a straight line. In the last three decades, there have been periods of fast change followed by retreat. The years of consolidation have, in turn, been followed by more structural change. Today, China is once again turning inward. Since 2006 the central government has been blocking foreign takeovers and, for the most part, frustrating important reforms. Beijing tinkers these days, but the initiative of the early years, which resulted in positive change, has been largely lost. That's a problem because China needs to continue transforming itself. The Communist Party has created growth by grafting free-market mechanisms onto its Marxist structure. It has tried to reform its system, but what has really happened is that the new has grown alongside the old. The state still retains ownership or control over important enterprises and still makes economic decisions best left to the market. Bill Gates may say that China has "capitalism at full speed," but that's not correct. The country's technocrats, unfortunately, are still holed up in offices in Beijing preparing detailed five-year plans and directing the workings of the economy, allocating resources, pricing goods and awarding contracts. "Socialism with Chinese characteristics"--Deng's famous phrase--may mean many things, but it is, above all, socialism. Although analysts think China's leaders can mix two inherently different economic systems, their arguments, however persuasive, are implicitly premised on Chinese leaders continuing their decades-long program of reform. The growth we see today is largely the payoff from earlier reforms. Growth tomorrow requires reform today. China's current political system, however, cannot sustain the pace of necessary economic restructuring. The Party apparently thinks--probably correctly--that further economic reform would threaten the country's authoritarian system, so the Party will not sponsor much more change. So it should come as no surprise that this slow-or-no-reform period coincides with a time of political retrenchment. The conservative government of President Hu Jintao and Premier Wen Jiabao has enjoyed a period of especially fast economic expansion--2007 was the fifth year of double-digit growth--and continual economic success has naturally blunted arguments about the need for further restructuring. Yet the Chinese economy has begun to sputter this year, in part because of its internal imbalances and in part due to the global economic crisis. Soon, Hu and Wen will be confronted with the reality that China needs a sustainable economic model, just as Deng and his colleagues 30 years ago faced the inescapable evidence of the failure of Maoist economics. Strong-willed Deng ultimately succeeded in presiding over the transformation of the Chinese economy. The issue is, in a very different time with very different challenges, whether Hu and Wen also possess Deng's wisdom to let the Chinese people push their country forward. China at this time needs a Deng Xiaoping, but, more important, the Communist Party needs to let the Chinese people transform their economy and their society II Everyone wants the Chinese to rescue the global economy with their $1.9 trillion in foreign exchange reserves, the product of 30 years of economic reform. Unfortunately, for two principal reasons, Beijing will not do so. First, using the reserves would expose the Chinese government to substantial risk. Second, Chinese leaders are reluctant to become an integral part of an international rescue effort. Their main contribution to global recovery, they continue to say, will be to stimulate their own economy. Can they do so? Beijing, lamentably, has maintained an economic model particularly ill-suited to deal with faltering global growth. Much of its success in recent years has been due to exports, and Beijing's initial response to shrinking consumer demand around the world has been to boost this critical sector, which now accounts for about 38% of the Chinese economy, by direct and indirect measures. The most important of these export-boosting measures involves the currency. Until July 2005, the renminbi was tightly pegged to the dollar. From that month until July 2008, Beijing permitted a managed float against an undisclosed basket of currencies. As a result, the renminbi appreciated 9.4% against the dollar in this three-year period. Last July, however, the ruling Politburo switched gears, dropping the fight against inflation and starting a campaign to stimulate growth. As a part of its growth campaign, it adopted measures to stimulate exports, including keeping the value of the renminbi at artificially low levels to give the country's exporters important price advantages. This month, the People's bank of China, the country's central bank, engineered a one-day fall of almost 1% of the value of the renminbi, apparently a warning that Beijing would resume its efforts to cheapen its currency. Such steps can only aggravate tensions between China and its trading partners, but, more importantly, they show that Chinese leaders are not seriously trying to get their economy to more stable ground. Long term, China will prosper only if it develops a large internal market. Why? The world will not--actually, cannot--indefinitely continue to absorb Chinese goods in ever-increasing amounts. So Beijing has no practical alternatives other than to create internal demand. But driving down the value of its currency--one of Chinese officialdom's principal responses to the global economic crisis--inevitably depresses consumption, which accounts for just 35% of the Chinese economy. In no nation does consumption play a smaller role. Falling consumption dashes hopes around the world that Chinese consumers will be buying foreign products and thereby stimulating growth in other countries. Yet foreign expectations were never realistic to begin with. As an initial matter, it would take years for Beijing to reorient its economy from exporting to consumption. Moreover, Chinese officials have always been reluctant to allow their internal market to power growth overseas. China's record trade surplus in November was largely the result of a precipitous fall in imports. Understandably, central government technocrats are too worried about their own economy, which is decelerating at an alarming pace, to help others. In 2007, China's gross domestic product grew by an impressive 11.9%; this quarter, analysts say they expect 5.8% growth, which really means it will grow by 5.2 or 5.3%. If this trend continues, next year's growth will come in well below the World Bank's most recent forecast of 7.5%. It is true that most other nations would welcome 5.8% growth, yet that level is dangerous for an economy that was expanding twice as fast just a few months ago. The slowdown has been so sudden that Chinese economists are now worried about deflation. The slowdown creates another risk for the economy: the prospect that both domestic and foreign parties will convert their renminbi to other currencies and take their money out of China. In the first week of December, there were signs they might be beginning to do so. If "hot money" flows reverse and funds illicitly leave China, the consequences could be severe. Among the first victims would be the Chinese banks, which are likely counting large amounts of questionable loans as good assets on their books. In the last few years, they have gone on a lending spree, blowing up their balance sheets in the process. Continual growth has papered over these loan-quality issues. As money leaves the country and the economy slows, however, many bank customers--especially hard-pressed local governments--could have trouble paying back their loans. No one knows the extent of the problems in these financial institutions, but the central government's statistics showing single-digit nonperforming-loan ratios have a too-good-to-be-true quality to them. To reverse the downturn in growth, Chinese leaders have decided to step up their investment in the economy, especially infrastructure. Early last month, the State Council, the central government's cabinet, unveiled a $586 billion spending program over nine calendar quarters. The downturn is so sharp, however, that Beijing announced it is working on a second stimulus package and now issues a continual stream of bulletins--almost all of them vague--on new initiatives. The problem is that, even after 30 years of reform, Chinese leaders have yet to develop an economy that can stand on its own. As we saw in the Great Depression, countries with large current account surpluses are especially vulnerable to deteriorating global conditions. This time, China, which has been accumulating these surpluses, now finds it cannot adjust its economy quickly enough to make up for the sharp decline in exports. The Chinese were once protected from external financial disruptions, such as last decade's Asian financial crisis. But at this moment, due to 30 years of integration of their economy into the global system, they are particularly vulnerable. III Starting in early November and continuing into this month, taxi and bus drivers went on strike in more than 10 major cities across China. In other recent disruptions, citizens in various locations broke into government offices, attacked police and burned official vehicles. Workers took to the streets in the country's export powerhouse, the Pearl River Delta of Guangdong province, as factories closed. The size of the demonstrations dramatically increased in October as the big toy manufacturers there started to go out of business. In the first half of this year, more than 67,000 factories shut down in China. Slightly more than half of the country's toy manufacturers failed from January through July. These closures occurred before the full impact of the global financial crisis hit consumer sentiment around the world, so failures for the second half of this year--and for 2009--could be worse. China's economy is faltering. As bad as it will be, the downturn this time will undoubtedly not be as severe as the economic failures following Mao Zedong's disastrous Great Leap Forward beginning in the late 1950s and the chaotic decade-long Cultural Revolution beginning in 1966. In both cases, the Communist Party was able to recover and maintain its Leninist political system. Will it be able to do so this time? At first glance, it appears that China's ruling organization looks secure. President Hu Jintao's six-year political crackdown has encountered virtually no organized opposition, and protestors are far from forming a nationwide coalition against the Communist Party. In the absence of a competitor, the Party has been able to adjust to conditions and make the transition from a revolutionary group to ruling organization. Columbia University's Andrew Nathan, who is no friend of the regime, argues that Deng Xiaoping and his successors have institutionalized themselves by smoothing out successions, promoting meritocratic politics, modernizing a large bureaucracy and establishing the means of political participation to strengthen legitimacy. "Regime theory holds that authoritarian regimes are inherently fragile because of weak legitimacy, over-reliance on coercion, over-centralization of decision-making and the predominance of personal power over institutional norms," Nathan writes. "This authoritarian regime, however, has proven resilient." Yet, after 30 years of reform, Chinese society today appears especially difficult to govern. Officials still prepare their five-year plans, but the Chinese people are making a "kinetic dash into the future" without so much as a roadmap or a compass. Once clothed in faded totalitarian garb, the Chinese today appear colorful. This mall-shopping, Internet-connected, and trend-crazy folk are remaking their country at breakneck speed as they outrace everyone else on the planet. Deprived for decades, they don't just want more. They demand everything. It's hard to describe the Chinese because they change so fast, faster than any other group in our times. "China's leaders may run what looks like a closed political system, and their decisions seem autocratic," notes Clinton-era official Robert Suettinger, "but they are struggling to keep up with a society that is changing in a direction and at a speed they cannot fully control." Not only is the Communist Party losing control, it is losing legitimacy. As a veteran journalist told me just before leaving the country a few years ago, "I don't know anyone who believes in the Party anymore." The ruling group's loss of support has meant that, as China has grown more prosperous in recent years, it has also become less stable, with protests rising dramatically this decade from what we can tell. The political system is obviously having increasing difficulty channeling discontent as citizens are starting to think they have rights--and as they are becoming less afraid of their government. There may be as many as 150,000 protests each year in the People's Republic. It's not hard to see why. Sustained modernization is the enemy of one-party systems. There can be nothing but trouble when political institutions do not keep up with the social forces unleashed by economic change. Nothing irritates rising social classes like inflexible leaders. Beijing's policies seem designed to widen this gap between the people and their government, thereby ensuring greater instability for the foreseeable future. Today, there's unimaginable societal change at unheard of speed thanks, in large part, to government-sponsored economic growth and social engineering. Yet, at the same time, the Communist Party stands in the way of meaningful political change. In good times, the Communist Party has been able to maintain its dominant role. But the real test of a political system is what happens when conditions worsen. "When times are bad economically, a small incident can rapidly become a big one," said Guo Cheming, a Communist Party cadre watching a protest at a failed toy factory in Dongguan, one of the principal manufacturing centers in Guangdong. The poetic Mao put it this way: "A single spark can start a prairie fire." After the abandonment of its ideology, the Communist Party made the continual delivery of prosperity its primary source of legitimacy. We are about to discover whether the regime can survive a downturn when decades of economic reform have weakened its mechanisms of control and made the Chinese self-aware and assertive, people who, for the first time in their history, are carrying on national conversations about their collective future. Deng Xiaoping's legacy is still not set, even after 30 years of economic reform. Now, his place in history is not in the hands of the government he led but in those of some 1.5 billion active citizens, perhaps the most dynamic people on the planet. IV Mao Zedong exported revolution. Thirty years ago, his successor, Deng Xiaoping, reversed course. Where is Beijing's foreign policy headed now? First, we need a little background. Deng, who presided over the initial stages of China's reform era, wanted his country to "bide time" and keep a low profile, at least until it could develop its economy and get stronger. His general policy was to "seek cooperation and avoid confrontation." Jiang Zemin, Deng's handpicked successor, adhered to this constructive approach even though he desired recognition for China's growing status. Jiang saw his nation working cooperatively with the U.S. and its partners in a Congress-of-Vienna-like atmosphere. However, Hu Jintao, the current supremo, has shifted China in a new direction. Like Jiang, Hu believes the country should assert itself. Unlike his predecessor, he thinks China should take advantage of newfound strength and actively work to restructure the international system so that it will be more to Beijing's liking. This change of thinking has had consequences, occasionally taking China in adversarial directions. This decade, for example, the Chinese have fired lasers to blind American satellites, actions that can be considered direct attacks on the U.S. In October 2006, a Chinese submarine for the first time surfaced in the middle of an American carrier group. This episode, which occurred in the Philippine Sea southeast of Okinawa, was an obvious warning to the U.S. Navy to stay away from Asian waters. Then, in January 2007, the People's Liberation Army, in what was an unmistakable display of military power, destroyed one of China's old weather satellites with a ground-launched missile. During Hu's tenure there has been a noticeable increase in cyber-intrusions and attacks on defense and civilian networks in the U.S., Europe and Japan. Why is Hu Jintao pushing his country down a path of high-profile force projection? There are two main reasons. First, there is the inevitable change in outlook when a nation goes from poor and weak to rich and strong. So it is natural that this rising power is thinking about how to exercise newfound strength. Although not everyone in Beijing believes the bloated claims aired in the West about China's future, most Chinese officials nonetheless feel they will profoundly change geopolitics in the coming years. In any event, more and more of them see this moment as the time for China to reassert itself. The second reason for China's new assertiveness is political. Hu Jintao, an insecure leader, relies on the more hawkish elements in the Communist Party and in the People's Liberation Army to consolidate his political position in his ongoing struggles with the leaders of other factions inside the ruling group. Moreover, the PLA has appeared to gain political ground because the civilian leadership is increasingly dependent on its armed might to control a society transformed by 30 years of economic reform. Hu Jintao's courting of senior generals has been especially evident since the middle of 2004. The price for Hu has been even larger: increases in military spending and promotions for favored flag officers, such as Gen. Chen Bingde, now chief of general staff. All of this has created a dynamic in which nationalistic officers and civilians have gained influence on certain issues, such as Taiwan and Japan. Each year the Chinese pour about $85 billion to $125 billion into their armed forces, maybe more because the buildup is secret. Yet we do know, from what China's military officials write and say, that they are configuring their military to fight the U.S. There will soon be two navies with opposing missions, with the same force structure, with ships occupying the same seas. And the skies in the same corridors will be filled with both Chinese and American planes. Of course, it is only natural for a large continental nation like China to want to possess a military with global reach. Therefore, one of the greatest challenges for Washington is to steer Chinese ambitions in cooperative directions. So far, America has attempted to do this with a set of so-called "engagement" policies. "Engagement" assumes that an authoritarian China can be integrated into a liberal international system, which it had no hand in creating, as what the U.S. State Department calls a "responsible stakeholder." In one sense, the U.S. and the West have no alternative but to engage Beijing, yet Washington's policies are often tolerant of behavior that it would not accept from any nation other than China. For example, American administrations, both Republican and Democratic, have failed to speak out about Beijing's proliferation of nuclear weapons technologies to Pakistan, Iran, North Korea and undoubtedly other states, and Washington has adopted an amazingly indulgent approach to China's commercial and diplomatic support of the world's nuclear rogues. By continuing to assist China while ignoring deeply irresponsible behavior, the U.S. has unwittingly created perverse incentives for conduct that impedes, not advances, American goals and global stability. Washington's generous but misguided policies could cause problems in the future. Beijing, knowing that it has gotten away with unacceptable conduct in the past, will naturally think it will be able to do so in the future. Chinese leaders, during a time of intense domestic turmoil--three decades of reform has made China unstable, after all--may be tempted to raise the flag of nationalism even higher as a means of keeping themselves in power, and that could mean acting belligerently toward neighbors such as Taiwan or Japan. The relationship between Washington and Beijing can be described as "interdependent," but that does not mean they are equal. Americans assume they need the Chinese more than they need us--a common theme of op-eds and sound bites these days--but the truth is the other way around. Even if China can sustain its spectacular rise--and there is considerable debate on this point--it is rising inside an American-led international system, and Washington needs to do a better job of persuading Beijing to accept its obligations as a member of that system.
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