Is it time to abandon China? (Political Risk)

Is political risk in China growing as the new administration takes a hardline on many issues?

 

Given all the bad news being reported from China—a slowing economy, mounting debt, rising costs, an increasingly hostile environment for foreign companies, and a political clampdown—we have prepared this series of blogs with the intent of providing some perspective to the dire headlines that draw so much attention. This is the 4th in a series of 4 blogs.

 

Is political risk growing in China?

 

Summary

Freedom of expression and access to the internet have been curtailed in China in recent years. Because China is still at a relatively early stage of development, economic liberalization remains the primary driver of societal and political improvement. As long as China continues to offer more freedom and opportunity in the economic realm, political development will follow, as it has in Taiwan, Singapore, and other countries. The likelihood of societal instability resulting from opposition to the recent restrictions seems unlikely. On the other hand, there is the chance that the new internet restrictions will impact non-political spheres like business, technology, and science in a way that forces China to reconsider its approach to the internet.

 

China was more open than many think

Foreigners tend to think that there is absolutely no room for freedom of expression or criticism of the government in China. There was a time, mostly during the latter half of the 2000’s, when that perception was largely a misperception. A Chinese person couldn’t call for the ouster of the government or a specific government official. But otherwise, discussion of many issues, including economic and social policy, was fairly open, particularly on the internet via blog and microblogs.

 

Restrictions increasing: Not so open any more

That has changed. Many argue the change began in 2009, under the previous leadership. Certainly since the current leadership took office in 2012 there has been a considerable transformation in the political atmosphere. Tolerance of criticism is way down. Debate is more limited. Rules for blogging and microblogging are stricter; accounts have been closed. Access to key foreign websites (like social media platforms) has been restricted. Most recently, the government announced that it will no longer tolerate VPN service in China. VPN’s (virtual private networks) are used in China to get around the restrictions that limit access to overseas websites. The vast majority of Chinese don’t use VPN’s. VPN usage tends to be restricted to more sophisticated computer users and those engaged in international activities. Still, the government recently took actions to disrupt VPN service and has said it will continue to do so in the future.

 

Perhaps nothing capture the current atmosphere more than the following. The Central Committee of the Communist Party issued an order calling for all units to remove from any public documents or educational curriculum any reference that could be interpreted as endorsing “Western values.”

 

Of course the government maintains that these measure are necessary to protect national security and domestic stability.

 

Given the above, it not unreasonable for foreign businesspeople to wonder what the implications of this changing political environment might be as relates to their activities in China. Below are some points we think are worth considering.

 

VPN service providers fight back

Controlling the internet might be more difficult than China thinks

 

Shortly after China took action to disrupt VPN service, the VPN service providers reported they were back in business in China. Of course this happens all over the world—just as someone figures out a way to control the digital world, someone else figure out a way around it. In the end China might find it more difficult to control the internet than it thinks, which might prompt China to either rely more on political or criminal punishments or to back off the idea of stricter control.

 

Unintended consequences might have a huge impact

Politically motivated measures might end up hindering business, technology, science, and other spheres

 

In the aftermath of the recent VPN disruptions, a wide variety of Chinese citizens, from business, science, academia, the arts, and others spheres, voiced their concerns that the new restrictions, if they hold, will greatly restrict their ability to engage in international cooperation which in turn will limit their ability to succeed. The European Chamber of Commerce issued a statement saying that its members will be much less interested in setting up R&D facilities in China if connectivity with the rest of the world will be limited. China has a history of removing restrictions only when it has to do so in order to protect economic development. In the past most of the restrictions were either economic or social. In this case the restrictions are more specifically political. But if they impact other government priorities, like growth and technology, maybe China will be forced to reconsider its internet policy. Time will tell.

Political clampdown might be a counterbalance to the corruption crackdown

Maybe Xi is appeasing the Party by limiting public criticism

 

Since taking office Xi Jinping has orchestrated a massive campaign against corruption which has resulted in the arrest and ouster of thousands of officials, including at least 60 relatively high ranking ones. Critics say Xi is simply targeting political adversaries. While politics is no doubt part of the motivation the sheer size of the campaign would seem to indicate that at least part of it is a sincere attempt to root out a particular vice that makes ordinary citizens highly resentful of the government. Given the corruption crackdown, there are some who make the following argument. Since Xi is going after party members himself, he has instituted the restrictions on expression in order to prevent the public from attacking the party at the same time. The idea is that this is a trade-off he needs to make as political cover for the anti-corruption campaign. Of course, one can only speculate about such a possible motivation. But if it were true, it might mean that Xi is not committed to the political crackdown for the long-term, but rather only during the most intensive phase of the anti-corruption campaign. I certainly wouldn’t bet my life that this is Xi’s motivation. But it is possible and might represent a ray of hope for a change of position down the road. Time will tell.

 

Economic liberalization is still the critical factor

Democracy best served by continued economic development

 

With a per capita GDP of less than one-fifth of the US and roughly 50% of the population still living as subsistence farmers, China is still in the early stages of development. Continued economic liberalization will not only lead to prosperity in China it will produce the cultural changes, particularly as relates to the rule of law, which support eventual democratization. Without economic liberalization and growth, China would be “democratic” like India and Russia, that is, “ineffective” democracies without the rule of law. With economic liberalization and growth, China will end up more like Taiwan, Singapore, and South Korea—increasingly prosperous with a rule-of-law based, democratic government. (Note that Taiwan, Singapore and South Korea are all also countries that tackled economic reform before political reform, unlike India and Russia.) So whether your interest is China’s economic development, political development, or both, the key factor at this point is economic liberalization. If China backs away from the free market, then the country will likely head into serious trouble.

 

Capital and the upwardly mobile are the key

As opposed to the mass revolt, the greater risk for the government is a lack of opportunity

 

When assessing political stability in developing countries like China, many are tempted to think that the greatest risk to the government is a popular uprising. In China the chances of that occurring are small. A much bigger risk to the Chinese government is if those who are actively seeking opportunity—entrepreneurs, professionals, college graduates, and those who deploy capital—lose confidence in China’s future. If that happens the government will lose its greatest claim to legitimacy—growth and prosperity. Some are reporting that capital is already fleeing China. That is an exaggeration. There are other reasons, besides political discontent, why China’s capital flows have shifted somewhat. It is very premature to say that capital is fleeing the China. But for those looking to see which way the wind is blowing relative to political risk in China, capital flow and the attitude of the upwardly mobile are important leading indicators.

 

No logical replacement for the Communist Party

The Chinese want better (and more honest) government but they don’t necessarily thirst for “democracy”

 

Most China observers would agree that communism, as an idea or principle, is dead in China. A movement to turn back the clock and re-collectivize society is an extremely remote possibility. At the same time, unlike a place like Hong Kong, China has not developed enough such that there is broad societal thirst for democratic rights and principles. More than anything else, the Chinese want a better life and are fairly convinced that their recent rise from poverty is a result of moving toward the free market. They want the prosperity to continue, they’re pretty sure liberalization has to continue as well, and they want their government to be more honest, less wasteful, and more effective (like the citizens of every other country in the world). Given these parameters it is likely that China will continue to be ruled by a single party government for the foreseeable future. Considering that the Communist Party already occupies that position it seems unlikely any organization will unseat the party in the near future. If there is any political maneuvering, it is more likely to occur within the party, as opposed to the removal of the party from power.

 

To summarize, I certainly wouldn’t say that the political clampdown is a positive development for China. Rather, I would say that, as long as China continues to make progress in other areas, the impact on China will not be overwhelming. There is always the possibility that some of the restrictions won’t hold for long. That would be welcome news.