The Dragon at the Precipice

Transcription

1 Strategic Issue Assessment The Dragon at the Precipice China s Challenging Path to a Balanced Economy November

2 Key Findings China s success or failure in navigating its transition from investment- to consumption-led growth may be the single most important uncertainty facing the global economy and business landscape through China must employ a multipronged approach to reshape several aspects of its economy in the context of a rapidly transforming global environment. The policy imperatives facing Beijing include liberalization of its interest rates, greater regulation of its shadow banking industry, reduction of the rampant proliferation of credit, deflation of asset bubbles, and perhaps most importantly development of a robust service sector. In spite of the tremendous scale of the challenges that China faces in making this transition, our analysis suggests that China is more likely than not to succeed in this undertaking for three primary reasons: The current leadership s long-term political commitment to address these challenges and the unique extent of its political capital China s financial resilience in terms of both internal strength (for example, currency reserves) and external position given the country s fundamental importance for the health of the global economy Beijing s demonstrated ability to employ an iterative, stepwise, and adaptive approach to policy planning and execution Top-Line Business Implications If China s transition is successful, global multinationals will face a Chinese business environment that is simultaneously more attractive and more competitive. Multinational players are likely to retain advantages in a range of key areas, notably in downstream services, but establishing footholds in local Chinese markets early in the transition will be critical for long-term growth. While China s successful transition to a market-based, consumption-driven economy will create opportunities for foreign businesses to compete in a revitalized and increasingly fair environment, it will also create competitive conditions that will make entry increasingly difficult. Therefore, despite its many risks, this period of transition may well prove to be a critical window of opportunity. Key Risks Many factors could derail China s historic transition. Deeply ingrained instincts to revert to heavy investment at the first signs of declining growth may crowd out precisely the kinds of private sector investment that are needed. In addition, the risk of intentional or unintentional regional conflict in the South and East China Seas remains very real and is rising given what appears to be an escalating appetite for brinksmanship. From a global perspective, executing this historic transition will also be greatly complicated by several inexorable macroeconomic megatrends, including increasing technology-induced labor polarization through the steady rise of automation, the proliferation of big data and predictive analytics in an increasingly quantified world, shifting regional and global trade dynamics, and growing challenges tied to energy and resource management and climate change. Each of these daunting issues will require policy innovations that address both the issues themselves and their linkages to the process of economic transition. 1

3 What to Watch The following items will be important bellwethers of China s progress in its economic transition: Economic liberalization. Perhaps the most fundamental factor to monitor will be China s concrete steps to relinquish government controls and allow free market forces to drive the economy, an essential requirement for the success of the economic transition overall. The early signs are promising. The November 2013 Third Plenum reforms signaled a significant opening of competition in domains dominated by large state-owned enterprises, such as oil and gas, telecom, financial services, business and leasing services, IT, and modern business services. Nevertheless, the steps taken to date are far from radical. Looking ahead, natural monopolies, such as those found in electric power distribution systems and rail systems, are likely to remain state owned for the foreseeable future given their macroeconomic and national security importance. The foundations upon which China s growth was built, namely large-scale investment projects paid for with credit, are starting to shake. Urgent action to correct this imbalance is needed, and China s leadership knows it. Foreign investment and competition. Even for those areas likely to open up to competition, new entrants and investors will be confronted with a considerable challenge of scale given that, for example, investing just 10 percent in a Chinese state-owned telecom company could cost $6 billion to $8 billion. Investments that in other markets would secure ownership, in China may only provide a minority stake with little control over decision making. To anticipate how and to what extent China will address these issues, simply monitoring the extent to which foreign versus domestic private industry is allowed to invest in previously protected industries will reveal a great deal. Development of the service sector. Central to China s efforts to transition to a consumptiondriven economy will be its progress in accelerating the growth of its service sector. China s service sector remains heavily dominated by state firms and features a daunting array of barriers to entry creating a crucial opportunity for policy makers. Services are a vital engine of job creation that are essential for maximizing the employment intensity of growth. Services generate steady streams of growth and employment that balance industrial production in a host of useful ways and represent a crucial hedge against technology-driven labor polarization, as services jobs are much less subject to displacement by automated systems. The measure of foreign direct investment (FDI) in Chinese services, as opposed to FDI in manufacturing-based sectors, will be a primary indicator of success. 2

4 Scenario Analysis China s Great Transition: 2020 Scenarios The trajectory of China s transition from investment to consumption will be a function of innumerable factors, making it intrinsically and deeply uncertain. To bound this uncertainty and consider a systematic range of potential outcomes through 2020, the GBPC developed four scenarios based on primary research and analysis, expert interviews, and the application of an inductive scenario planning methodology. The parameters of these scenarios included the rate and stability of developed economy economic growth; the degree and nature of global economic integration, trade, and geopolitical stability; the pace of technology-driven labor polarization; and the impact of energy and other resource technology innovation Scenario Snapshot False Start China aggressively advances its program of economic reforms. However, facing slowing global growth and rising unemployment, the Party reverses course in Resuming large-scale investment stimulus and policies favoring domestic SOEs, China alienates foreign MNCs, loses the confidence of investors, and still fails to reignite growth. The result is the collapse of asset bubbles and a full-fledged banking crisis. In 2020, China and the global economy face the prospect of another Great Recession and this time have few remaining policy options. Thread the Needle From 2015 to 2020, sustained economic growth in the developed economies and stabilizing geostrategic dynamics create favorable conditions for China s economic transition. Following a methodical, iterative, and stepwise approach, China is able to implement key economic reforms without sparking social unrest. By 2020, despite moderately slow growth throughout the reform process, China emerges having successfully rebalanced its economy, deflated asset bubbles, and opened its financial system. China s global preeminence is now universally acknowledged. Sealed Off A man-made environmental catastrophe within China destabilizes the country domestically and isolates it internationally, derailing its economic transition and international standing. Following violent crackdowns against domestic demonstrators and continued dissatisfaction with China s environmental record, the international community moves to isolate the country economically, blocking its access to major regional trade agreements. The resulting economic slowdown not only derails China s economic transition, but places the country s political stability in jeopardy. Eastern Empire China s leadership resolutely advances its reform agenda. As the shift from investment- to consumption-led growth unfolds, the economy slows dramatically in the period, significantly straining social stability. The government adopts a more aggressive military posture 3

5 with respect to its territorial claims, stoking the flames of nationalism. When the international community moves for sanctions, China responds by rapidly deepening its economic and security partnerships with Russia and in Africa and Latin America. By 2020, China is established as the orienting center of a new constellation of countries increasingly independent of the United States and Europe both economically and politically. Conclusions China s decision to pursue a managed transition from an investment-based to a consumptionbased economy will reshape the global economy over the next five years. We anticipate that it will execute this transition successfully by adhering to its methodical, stepwise approach to change. Nevertheless, making this transition is intrinsically difficult given its scale and the persistent imbalances in the Chinese economy. In addition, the task is greatly complicated by the global macroeconomic trends shaping the external operating environment. Beijing s primary goal is, of course, to maintain stable growth rates and social harmony during its transition and to avoid a destabilizing hard landing. To succeed, it must navigate social, political, and international pressures in the coming months and years. Specifically, China must avoid the temptation to revert back to investment stimuli at the first signs of a decline in growth and steer away from regional conflict. While external forces will shape China s approach, our analysis suggests that China has the financial wherewithal, expertise, and strategic position necessary to allow it to manage this transition successfully, even in challenging external circumstances. A failed transition, on the other hand, would carry proportionately grave consequences for the global economy in particular, depriving emerging markets in the region and further afar of their most important source of demand, destabilizing a global economy with fragile developed economies still recovering from a major recession, and upending opportunities for global multinationals to expand and grow into an expansive new marketplace. All actors have an interest in China s success in making this transition, particularly if it emerges more deeply integrated into the international system, economically and otherwise. 4

6 Authors Paul Laudicina, chairman emeritus of A.T. Kearney and chairman of the Global Business Policy Council, Washington, D.C. Erik Peterson, partner and managing director of the Global Business Policy Council, Washington, D.C. Rudolph Lohmeyer, director of the Global Business Policy Council, Washington, D.C. The authors would like to thank Terence Toland for his valuable contributions to this report. About the Global Business Policy Council A.T. Kearney s Global Business Policy Council, established in 1992, is dedicated to helping business and government leaders worldwide anticipate and plan for the future. Through strategic advisory services, regular publications, and world-class global meetings, the Council is committed to engaging in thoughtful discussion and analysis of the trends that shape business and government around the globe. 5

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