Daily Archives: March 13, 2021

Costs of China’s Welfare

In February, China’s President Xi Jinping announced a large and bold plan for a nationwide basically all-encompassing welfare system, arguing it is a crucial issue for state stability “是治国安邦的大问题.”

It is a correct assessment because if there is no social security there will be a potential army with nothing to lose that will feel cast out from the general prosperity and will destabilize the country.

Yet the announcement didn’t specify how all of this will be financed, especially since total state debt – central and local governments plus state-owned enterprises (SOE) debt – may well be more than four times China’s gross domestic product (GDP.)

Who then will pay for a massive overhaul of the social security system? The rich with more taxes? This will create domestic social-political problems as it will break the social contract established after the 1989 Tiananmen crackdown.

That contract encouraged people to get rich without paying taxes provided they stayed out of politics. If now people have to pay taxes, they will be unhappy and at least they will want to see how their money is spent – after all, there is the old problem of “no taxation without representation.”

In old imperial times, the issue was solved brutally: “the rich bribed the officials and didn’t pay taxes, which were paid by the poor. This periodically in each dynasty created a double crunch.”

The state gradually had a financial shortage, as the poor couldn’t cough up enough money. The poor hated and felt cornered by the rich and corrupt officials, and thus they rebelled. The new dynasty redistributed land at the beginning and then someone became richer while others were poor and the cycle started again.

Now, Xi wants a new “welfare system” to take care of the less fortunate. But if the rich have to pay and have nothing to say, their dynamism that drove China’s growth over the past four decades could tumble and eventually economic growth could sputter.

Another way would be to go for an even greater trade surplus, i.e. have the world pay for China’s welfare system. But this will exacerbate existing frictions with the US and other countries already annoyed by China’s surplus and by what they see as currency manipulation to boost exports.

Another potential way would be to tap into a larger spread between interest on deposits and interest on loans. This would de facto further tax middle-class savings.

The middle class is the backbone of Chinese society but if it feels deprived of a just reward on its savings, it may look for other riskier investment vehicles and if they lose their money, they will be unhappy – or will just try to keep their stash out of the banking system.

China’s middle class is the backbone of society.

Another strategy, skirting the above problems, could be to boost internal growth. The next plenary session of the Chinese parliament, the National People’s Congress (NPC) which opens on March 5, is expected to include an announcement that will float non-agricultural land in the market and urbanize some 25% of the population.

This would mean that rural houses, which so far could not be freely bought and sold, could go on the market.

The floating of these assets and the urbanization of some 300-400 million people could drive economic growth for a decade, but could also create immediate social problems. The money earned on the sale of rural houses of newly urbanized ex-farmers could be wasted overnight, and it will not be easy to guarantee full employment for hundreds of millions who could then become an angry, dissatisfied urban proletariat.

Internal social security using artificial intelligence can keep tabs on them, something that people could accept but may not make them happy. Anyway, all of this could be manageable if China had a positive international environment. But if it doesn’t, the situation will become far more complicated.

The NPC also promises SOE reforms, with private capital investment and greater freedom in exchanging capital accounts. These are all moves in the right direction, but they have been attempted in the past and failed to bear huge fruit as they only dent underlying problems.

Private entrepreneurs are loath to invest in SOEs, as it puts their money under state control. Such investment doesn’t buy them state assets and is not a free exchange of the RMB, which would burst the bubble of a system with a massive and chaotically recorded debt-to-GDP ratio (more than four times, as we said).

This all happens when taxing incomes is a great difficulty, according to the finance minister.

A general view of the opening ceremony of the Chinese People’s Political Consultative Conference at the Great Hall of the People in Beijing.

These measures can help China to buy time and move the country to a triumphal 2022 Party Congress.

In the meantime, the US is trying to assemble an alliance of democracies and technologically advanced countries that excludes China and creates a basic backbone for the new Cold War.

In this alliance, technology, military, ideology, strategy and geopolitical concerns will be aligned following a common paramount worry – China’s cumbersome and inattentive growth that stumbles and trudges on legitimate interests of the world and of its people.

It won’t be easy for China to present the Party Congress next year in this atmosphere. In 2007,  there were concerns of a crisis around the 2022 Party Congress and recommendations were made for democratic reforms well before that time to pre-empt the crisis.

After 2008, however, China felt democracy was unreliable and shelved the idea. Some 15 years ago, even modest democratic reforms would have sufficed to buoy the country, given the overall global support for China at the time.

Presently, China would need not only democratic reforms, but also a redefinition of its political and strategic ambitions vis-à-vis its neighbors. That is, China would need to concede political reforms and territory in exchange for peace and development.

But Beijing may feel it doesn’t need that as its system emerged from the Covid crisis stronger than ever and it expects 8% GDP growth for 2021.

Moreover, it conversely sees its main adversary, the US, as confused and fumbling around. All in all, this is a recipe for war.

Improve the social security system covering the whole people
China: In the Name of Law. A New Global Order
China’s fiscal risks are “extremely severe” former finance minister warns

Leave a comment

Filed under chinese culture, workplace insights