As China’s economic growth slows, many are noting similarities between China and Japan before and after the collapse of the latter’s bubble economy. Will China really follow in Japan’s footsteps? Wu Junhua of the Japan Research Institute disagrees, suggesting that the biggest risk facing China’s economy is “Sovietization,” not “Japanization.”
“Sovietization” Has Hindered China’s Development
At a time of growing concerns about China’s economic prospects, voices are escalating about the possible “Japanization” of China’s economy. Although many of the problems facing China today, such as an aging population, deteriorating housing market, and accumulated debt, are quite like those faced by Japan before and after the collapse of the bubble economy, the two countries have very different political systems, as well as different economic structures and stages of development. Therefore, it is highly unlikely that the Chinese economy will Japanize. What should really be taken seriously is the risk of the “Sovietization” of China’s economy. In fact, China is already showing signs of repeating the mistakes of the Soviet Union under Leonid Brezhnev (1964–82).
Looking back at the history of the former Soviet Union, we can see that during the rule of Nikita Khrushchev (1958–64), when he launched criticism of Joseph Stalin, political regulations were loosened and the economy showed a certain degree of vitality. In the military field, the successful launch of the first artificial satellite, Sputnik 1, showed technological progress going beyond that of the United States at that time. After Brezhnev came to power, the arms race with the United States was further intensified, but the economy fell into severe stagflation. After coming to power, Mikhail Gorbachev (1985–91) held high the banners of Perestroika (reforms) and Glasnost (opening-up) and tried to revitalize the economy through partial democratization of the political system, but with little success, and ultimately failed to avoid the collapse of the Soviet Union.
Needless to say, it is too early to say whether China will come to the same end, but China’s economy already shows signs that are very similar to that of the Soviet Union under Brezhnev. After the development stage of reform and opening-up, China’s economy, which had once been “de-Sovietized,” returned to the old path of “Sovietization,” and China once again faced the economic difficulties it had known before its reform and opening-up.
China After Reform
Looking back at China after reform and opening-up from an institutional perspective, the late 1990s can be divided into two halves. In the first half of the period, two policies were implemented politically: party-government separation (divorcing the functions of the Chinese Communist Party and the government) and government-enterprise separation (splitting the functions of the government and business). Economically, township enterprises (operated and managed by township-level governments and collectives in rural China) sprang up, and China’s economy began to “de-Sovietize,” with the retreat of state-owned enterprises and the advance of the private sector. However, in the second half of the period, the pattern reversed, with the advance of state-owned enterprises and the retreat of private enterprises, and the process of de-Sovietization came to an abrupt halt. This went against the marketization trends of the times, and soon caused strong repercussions in Chinese society. A fierce debate broke out around 2001 over this reversal.
The backdrop to this debate is the reform of state-owned enterprises that began in 1998. Under the guidance of the principle of “grasping ‘the big’ and letting go of ‘the small,’” the policy support has strengthened some large state-owned enterprises—“the big”—and at the same time divesting removed support from “the small,” more than 500,000 small and medium-sized state-owned enterprises. This change was once widely regarded as a major achievement of China’s economic market-oriented reform. Nevertheless, the real purpose of “big vs. small” is to shift the burden of poorly run state-owned enterprises with a large number of excessive personnel to the market in the name of reform, prioritize resources on making large and powerful state-owned enterprises larger and stronger, and rebuild the economy so that it is dominated by state-owned enterprises. One of the consequences of this shift is the re-Sovietization of China’s economy, and the “soft budget constraints” that plagued the economy before the reform have once again become a stumbling block to economic development. “Soft budget constraints” are a concept proposed by János Kornai (1928–2021), a Hungarian economist and later a professor at Harvard University, in response to the fundamental pathology of the socialist economy. The term refers to the economic phenomenon of state-owned enterprises continuing to survive with the help of government subsidies when they encounter financial difficulties, so that they lack the enthusiasm to improve their business operations.
Massive Stimulus Accelerates China’s Re-Sovietization
China’s GDP growth rate slowed down after peaking at 14.2% in 2007. This means that, although China’s accession to the World Trade Organization has allowed it to take a free ride because of the benefits of economic globalization, its economic growth potential has continued to decline due to the advance of state-owned enterprises and the retreat of private enterprises.
The 2008 international financial crisis, triggered by the collapse of Lehman Brothers, further exacerbated pressure on the Chinese government as it sought to sustain economic growth, but the crisis ended up helping China get out of trouble. The Chinese government was able to avoid responsibility by blaming the financial crisis for sluggish growth, which was actually caused by the advance of the state-owned enterprises and the retreat of the private sector. Ironically, although the massive fiscal stimulus to make state-owned enterprises bigger and stronger runs counter to the marketization of the economy, it was highly praised by the international community, including the United States, leading to an unprecedented level of Chinese influence on the world stage. Since then, the re-Sovietization of China’s economy has accelerated still further.
China’s economy briefly recovered thanks to this massive fiscal stimulus. However, as local governments set up Local Government Financing Vehicles, or GEVs, secured by state-owned land—essentially state-owned investment companies with financing and real estate development functions—as the main drivers of the fiscal stimulus, the harm caused by the “soft budget constraints” that had been traditionally abused in the manufacturing sector then spread to other sectors. As a result, the seeds of a debt crisis were planted while causing a bubble in the housing market.
Sovietization Suppresses Consumer Demand
Sovietization has also suppressed the increase in consumer demand. Since the zero-COVID policy ended, China’s economy has remained sluggish. At the same time, international criticism has grown against China for dumping overseas to absorb its excess capacity, especially in Europe and the United States.
Regardless of whether such criticisms are justified, it is a fact that China’s domestic demand has not been able to keep pace with the pace of its capacity expansion. What happened? Is it because the Chinese government has failed to recognize the importance of consumer demand? Of course not. In fact, as early as the late 1990s, the Chinese government had put forward the policy goal of transforming the economic growth mechanism from one that relied on investment and exports to one that depended on consumer demand. Why hasn’t the transformation been successful so far? Sovietization is one of the main reasons.
As mentioned earlier, the problem of “soft budget constraints” improved for a time as the private sector grew, but Sovietization, which has hindered the expansion of consumer demand, has plagued the Chinese economy.
The Interests of the Party are Paramount
As we all know, China’s leaders are not elected by national vote. As a result, it is far more important for leaders to achieve the agenda of the state (essentially the agenda of the Communist Party) than to improve the well-being of the people. To this end, it is indispensable to expand fiscal revenues. In fact, after the reform and opening-up, except for the de-Sovietization of the 1980s and the special period when the pandemic broke out, China’s fiscal revenue has been growing faster than GDP.
Since the fiscal sector takes the lion’s share, the growth of household income is suppressed in the initial distribution stage, thus limiting the expansion of consumer demand. The communal ownership of land, established by the Communist revolution in the Soviet Union, essentially played the same role in the secondary distribution. Since the late 1990s, huge revenues from land use rights have not only enriched local government finances, but also driven up housing prices. High housing prices have sucked away a lot of household income, resulting in sluggish growth in consumer demand other than for real estate.
Some commentators believe that the weakness in consumer demand is due to President Xi Jinping’s opposition to welfarism; others blame the so-called middle-income trap for China’s economic woes. Both are concepts often used in economic analysis in the United States, Japan, and Europe. Needless to say, it may be more convenient to analyze China’s economy with the concepts that you are used to, and that easily gain attention. However, the application of these concepts is often unclear and specious, leading to erroneous judgments.
To sum up, after the reform and opening-up, China’s economy was once revitalized by de-Sovietization. However, due to the lack of political system reform, China’s economy returned to Sovietization with the increasing pressure of social diversification. If China has fallen into any trap, I believe that this trap is neither the so-called “middle-income trap” nor the “Japan trap,” but an institutional trap.