Looming stagnation.

• Author: Pei, Minxin
• Position: The Color of China - Economy

Forecasters of the fortunes of nations are no different from Wall Street analysts: hey all rely on the past to predict the future. So it is no surprise that Chinas rapid economic growth in the last thirty years has led many to believe that the country will be able to continue to grow at this astounding rate for another two to three decades. Optimism about China's future is justified by the state's apparently strong economic fundamentals--such as a high savings rate, a large and increasingly integrated domestic market, urbanization and deep integration into the global trading system. More important, China has achieved its stunning performance in spite of the many daunting economic, social and political difficulties that doomsayers have pointed to as insurmountable obstacles to sustainable growth in the past. With such a record of effective problem solving, it is hard to believe that China will not continue its economic rise.

Yet, while China may sustain its growth for another two to three decades and vindicate the optimists, there are equally strong odds that its growth will fizzle. Chinas economic performance could be undermined by the persistent flaws in its economic institutions and structure that are the result of half-finished and misguided government policies. A vicious circle exists in which the Communist Party's survival is predicated on the neglect of fundamental aspects of society's welfare in favor of short-term economic growth. And many of the same social, economic and political risk factors the government has thus far sidestepped--heavily subsidized industries, growing inequality, poor use of labor--remain. Some are becoming worse.

Because the party relies on growth for legitimacy, Beijing invests in tangible signs of progress--factories, industrial parks and the like. This emphasis on "visible" gains has in turn led to huge social deficits. By focusing on short-term growth instead of long-term sustainability, health care, education and environmental protection have all been neglected. Not a cause for optimism.

The end result is a state built on weak political, economic and societal foundations with a potentially unhappy and restless people. Reducing these economic and social deficits will require both additional financial resources and politically difficult institutional changes. Allowing such deficits to accumulate is simply not viable.

Worse, China's difficulties will be compounded by the future deterioration of some of what have thus far been structural and political strengths--a large, young population; underpriced natural and environmental resources; and a public consensus in support of economic growth. With fewer people entering the workforce, a rapidly aging population and ongoing environmental damage, China faces the choice between stagnation, even disaster, or fundamental change. The fact that all of these risk factors have not derailed China's growth in the past does not preclude the possibility that they could do so in the future, especially if the Chinese government fails to make major policy adjustments.

Of course, these challenges--rebalancing China's economic growth, addressing social deficits and rebuilding a political consensus that supports growth--are manageable if the Chinese government can implement effective economic and political reforms and remove the underlying causes. But will Beijing do so? Does the Chinese political system possess the flexibility and inner strength to overcome the opposition of entrenched interests? Is the ruling Communist Party willing to take the risks of adopting reforms and disrupting a carefully balanced coalition of political and economic interests?

As the world is engulfed in a global economic crisis and Chinas growth engine starts to lose steam, it is time to reexamine the risk factors that lie ahead and rethink our complacent assumptions about Chinas future.

High rates of economic growth tend to conceal serious structural, institutional and policy flaws because, as the Chinese saying goes, "one mark of beauty can hide a hundred spots of ugliness." All too often, high growth rates themselves are taken as prima facie evidence of superior institutions and wise policies. Our obsessive focus on the speed of economic development often blinds us to the underlying weaknesses of the country. Over time, such myopia leads to complacency and, worse, a dismissive attitude toward warning signs of trouble.

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