Opinion Pick your poison

It is commonly believed outside China that the ruling Chinese Communist Party needs at least 7 per cent of growth per annum to ward off social unrest. The basis of this speculation is that growth at this level will create enough jobs for new entrants in the labour force. Unfortunately,this theory has never been tested because average growth rate in China in the last three decades is roughly 10 per cent (even though in some quarters growth dipped below 7 per cent). So we do not know whether persistent slow growth will indeed lead to social unrest.

In all likelihood,slower growth poses other more potent threats to the Chinese government. The political perils of unemployment may be grossly exaggerated. In other words,China needs high growth not because of the need for job creation,but for other reasons. When you look at the job growth data in China,you will find that employment generation has been slowing despite high growth — due to the rising capital intensity of the economy. If the ruling Chinese Communist Party is truly scared of slow job growth,it would have done something a long time ago to channel investment away from capital-intensive projects to labour-intensive ones.

That Beijing has persisted in investment-led capital-intensive growth model suggests that something else is driving Chinese leaders’ political calculation in deciding whether to prop up growth or fight inflation.

High growth rate in China is critical not simply because it creates jobs,but because,more importantly,it provides the grease to keep the one-party state and an inefficient economy running. Politically,investment-driven high growth allows the Communist Party to allocate hundreds of billions of capital to its supporters (bureaucrats,state-owned companies and local governments). Of course,a significant portion of these resources is siphoned off into the pockets of the ruling elites. This rent-allocation scheme is made possible by high growth. If growth slows down,the competition for rent among the ruling elites will intensify,causing disunity,a very dangerous outcome for the Communist Party.

Investment-led high growth also allows the Chinese government to conceal the inefficiency of its state-owned companies. Based on scholarly research,most of these companies have razor-thin profit margins and must rely on volume to maintain profitability and service their debts. Should growth slow,their losses will mount and their bank loans will become non-performing,making the banking system much riskier.

Compared with the perils of slowing growth,rising inflation poses different political risks for the Chinese Communist Party. Here the conventional wisdom is more or less correct. Economically,rising inflation eventually will lead to a hard-landing (collapse of growth). Politically,rising inflation generates widespread social discontent. Two unique features of the politics of inflation in China are particularly noteworthy. First,inflation may hurt the poor harder than anybody else,but it also harms the urban middle class in myriad ways. The party is not afraid of Chinese peasants rioting over rice prices,but it is deathly scared of (more privileged) urban residents complaining about skyrocketing consumer prices because the centre of political gravity in China is urban,not rural. Disturbances in cities can threaten the foundation of the party’s rule.

Second,inflation performs a magic coordination function — it signals to different social groups that things are not going well. As a result,social unrest under inflationary circumstances tends to be larger in size and involves more diverse groups. Just witness the large-scale riots in China in the past two months and you would notice that their participants ranged from ethnic minorities,migrant labourers and farmers,to disgruntled urban residents. It is hard to prove that inflation was the primary driver of social unrest,but it is reasonable to suspect that it has played a critical role.

So it is easy to see that slower growth in China tends to endanger the unity within the ruling elites and the health of the financial system while high inflation can spark large-scale social unrest. For the moment,Chinese leaders have opted for fighting inflation first. Beijing has raised the interest rate (although it is still too low),allowed the Chinese currency to appreciate gradually (it is rising at roughly 10 per cent a year in real terms against the US dollar) and tightened the availability of credit (by raising the bank reserve ratio to more than 20 per cent). China can afford to do so,at least temporarily,because growth rate is high enough.

But it would be foolish to believe that sound economic policy will triumph bad politics. Leadership transition is under way in China. If economic tightening hurts the elites too much,they are sure to complain. Because Chinese leaders are selected by members of the ruling elite,not elected by the voters,elites who are unhappy about slower growth will use their power and influence to force the government to loosen up economic policy. What this means is that China’s macroeconomic policy will remain murky and uncertain for the next two years.

The writer is a professor of government at Claremont McKenna College in the US