China has always puzzled the world. And continues to do so, even though China has never opened up so much towards the global community as today. While in the past China’s mysteries were interesting for scientists, explorers and the odd travelling merchant, currently every citizen in the world wants and needs to understand China. But to understand present day China, it is crucial to first look at some of the transitions China has been going through in the past.

Historical perspectives

At the risk of not doing justice to China’s rich history: for centuries, China choose to be self-centered, defining its own development path and place in the world based on its own traditions and believes. Of those, Taoism and Confucianism were most relevant is cementing China’s culture and traditions. The result of these ingredients was a long period of isolation to the outside world, that served China’s internal stability well, but, to be honest, did not provide many impulses and incentives for change and modernisation. Also internally, the hierarchical society, discouraged taking initiative and thinking ‘out of the box’. No wonder that imperial China slowly but surely stagnated, economically and politically, and finally collapsed early last century.

The Chinese Communist Party (CCP) under chairman Mao embarked upon drastic economic and political changes. But this was not a transition for the better. On the contrary, Mao amplified earlier trends of isolation, centralisation and hierarchy. Collectivism and brutal repression caused the economy to fall back further into stagnation and poverty.

Mao’s successor Deng Xiao-Ping inherited one of the poorest countries in the world. Chinese history showed him what this could lead to: civil unrest leading to the fall of the ruling dynasty, in his case the CCP. So change was needed. Subsequently, since the mid-eighties of the last century, Deng embarked upon a dramatic new transition.

Deng’s magic formula

Deng’s recipe turned out to be highly successful: export-led growth, based on abundant and low-cost labour and utilising as many export markets as possible, in combination with investing heavily in the domestic construction sector, created jobs and prosperity. In less than two decades, extreme poverty was almost completely eliminated. Instead, a middle class of unprecedented volume emerged. For the first time in its history, China attracted foreign direct investments and sought access to Western technology. Chinese low-priced products conquered the global markets, providing purchasing power benefits to almost all citizens in the world.

So far so good, one would say. But nothing lasts forever. Over time, unit labour costs increased steadily, while white collar replaced blue collar workers. Too much reliance on the construction sector as domestic growth engine resulted into overcapacity in that sector. Foreign investors realized that the Chinese market was not that ‘open’ for them as they initially expected, and the largest economic and political power in the world, the US, started to fear China as rival super power.

Consequently, Deng’s magic recipe does not work anymore. Due to loss of competitiveness, export and real GDP growth steadily slow down. Due to over-investments in infrastructure, indebtedness of local authorities, companies and households is rising rapidly. Because of lack of level playing field and other structural imperfections in the Chinese economy, incoming FDI stalls and China’s role as reliable trading and investment partner is increasingly questioned by its international partners. At the same time, China faces a rapid aging of its population, with domestic demands for better health care, and pensions systems mounting. And, last but not least, the sizable Chinese middle class demands better education, good job prospects and a clean and healthy living environment.

How to square the circle China’s policy makers are facing? Which new transition to undertake? Clearly, adjustments are needed to rebalance resource allocation and to develop new sources of economic growth. Such adjustments always take time and often policy makers don’t have that. But Chinese authorities saw an ingenious opportunity to, at least, gain some time to develop and start with the new transition. Why not trying to prolong the export-led model for a while through exporting construction projects? Projects that are in quality and price competitive on the global market, and that could satisfy needs in many countries for an upgrade of their infrastructure.

The Belt and Road Initiative

These brilliant thoughts resulted in the Belt and Road Initiative, a string of infrastructural construction projects, so often perceived in the rest of the world as an attempt of China to start dominating and ultimately ruling the world. But nothing is less true: firstly because China never had any tradition of trying to colonise or otherwise dominate other continents. Secondly, because in the last Five Year plans the PCC is very open about what is wishes to achieve: not global hegemony, but simply a sustainable domestic economic development that prevents the Chinese economy from coming to a halt.

Can the outside world be blamed for its misconception of Belt and Road? Not fully; the Chinese authorities, hardly reached out to the outside world to explain the (domestic) logic and background of Belt and Road. No wonder that after centuries of absence in the global arena, China’s sudden appearance in the economy of many countries all over the world, raised may questions and eyebrows, making it easy for China’s rivals to raise suspicion and mistrust about China’s perceived motives.

In the meantime, China’s authorities started to use the time provided by Belt and Road to embark upon the next transition of China: that from an emerging economy to a mature and developed economy. The current Five Year Plan clearly indicates the road China aims to follow: less focus on export-led development, and more emphasis on ‘internal circulation’ based on high tech and innovation. This also implies that domestic demand will play a larger role, mainly driven by private consumption. Promoting domestic brands is explicitly mentioned as one of the key elements in this respect. Moving from ‘high speed growth’ to ‘high quality growth’ also implies more attention to solving environmental issues, stepping up the much needed energy transition, and improving health care and pension systems.

Towards high quality growth

The Five Year Plan clearly indicates innovation as the main driver for becoming a modern, high tech driven society. But innovation never came naturally to China. For centuries the country was practically sealed off from the outside world; many western innovations hardly reached China. Additionally, the Chinese education system is still largely based on the Confucian notion of respect for the master, which is good for the group harmony, but not always stimulates a creative and innovative mind-set. So reforming the education system will be the logical starting point to boost the Chinese innovative powers.

Equally important will be to adjust the traditional top-down management style and decision-making processes in companies, so as to give more room for talents and ideas from the work floor. Only through this combination of measures, China will maximise its innovative capacities. But changing the culture and traditions of any nation can never be done overnight. And, unfortunately, the Five Year Plan says very little about creating an environment that is conducive for innovation.

Another important element for China’s current transition, are structural economic reforms: better functioning markets, more level playing field for companies (domestic and foreign), less centralised economic decision making, and more transparency and accountability in economic decision making.  Given the seize and the maturity of the Chinese economy, better functioning markets will be key to any transition. Institutions such as IMF and world Bank have been calling for this already for many years. But again, regrettably, the current Five-Year Plan hardly refers to these kind of reforms. On the other hand, recent actions of the authorities towards ‘big business’ indicate their awareness of the need to avoid the building up of unhealthy market-power and financial risks.

Finally, reform of the Chinese financial sector will be important: improving the standard of its services to the public and its risk management. Due to an over-investment in construction and infrastructure, many local authorities, financial entities, companies and households face high debt levels, with, as mirror image, inflated real estate and asset markets. One day, one of these bubbles will burst, with potential dramatic chain-reactions for the Chinese economy as a whole. The recent financial problems as companies such as Evergrande are clear indications of such risks. Fortunately, the Chinese authorities are increasingly aware of the issue, and appear to be willing to take the necessary steps towards ‘managed solutions’. In more general terms, the authorities aim to step up their supervision on the financial sector. But should they not have taken action earlier?

Global partnership    

For China’s current transition to succeed, it needs the support of the international community. The good news is that international organisations such as IMF and world Bank have already for a long time advocating that China starts a transition away from Deng’s export-led model and towards more domestic based growth. Their advice does not only serve China’s interests, but also those of the world economy as a whole. Because if the current transition of China fails, the world as a whole will suffer: global trade volumes will decline and domestic and international tensions will increase.

The positioning of Europe will be key in this respect. Unlike the US, Europe is fortunately not in a race with China for ‘global hegemony’. Instead, being the most important trading and investment partner of China, Europe can be a crucial ally for China’s current transition. But Europe has its own legitimate wishes as well. A level playing field for European companies, reciprocity in investment relations, more open governance and more respect for human rights are high on the priority list of Brussels. And rightly so, because no relationship can last if it is not a genuine two-way street based on shared values, mutual trust and respect.

Hopefully, a supportive Europe, treated by China as equal partner, can convince the US of the need to avoid a new ‘cold war’ between super powers, characterised by mutual suspicion, trade conflicts and other forms of obstructions. Because this road will only have losers. And because globalisation has progressed so far that we all need each other in keeping our economies going, and in managing current and future global challenges such as climate change. Therefore, China needs support and partnership, while China should realize that with super power status come global responsibilities as well. Let us hope that policy makers all over the world will be aware of this and act accordingly!

Ron Keller
European Senate of Economy and Technology.