Catching rising damp

**After the glare of a US presidential campaign that left no aspect of the candidates unexamined, ** political anoraks now turn their focus to the 18th Communist Party Congress in Beijing, where murky backroom battles will determine the new members of the Politburo. These nine men and women will face the unenviable task of steering China through a new phase in its development – one beset with problems that stem from the fundamental conduct of policy in Beijing.

Commentators tout 65-year-old vice president, Xi Jinping, to be the incoming chief. Analysts have long predicted a hard landing for the world’s second largest economy, but while growth has slowed to 7.4 per cent per annum in the third quarter, it still remains on target. Even if the economy performs satisfactorily in the near future, however, China’s new generation of leaders cannot put off addressing the imbalances that have lain at the heart of economic growth for the past few decades.

Many of today’s issues arise from the unsustainably high level of investment in China – nearly half of all economic output. Attempts at rebalancing the economy towards higher levels of consumption were ditched in the wake of the financial crisis and the slowdown of the global economy, when a massive stimulus package and state-directed lending were deployed to revive falling demand. Some experts argue that China’s capital stock measured on a per capita basis is relatively low and still offers scope for expansion, but this ignores the high value of capital stock as a percentage of GDP, placing China above developed economies such as the UK.

Excessive levels of investment arouse concern because they represent an inefficient allocation of resources towards projects that are not financially viable in the long-run. The Chinese real estate market appears to be one such candidate, with house prices having risen continuously between 2005 and 2011. While prices plateaued during the summer, there is still a risk of a readjustment. Chinese homes are on average 8.6 times the average income; in wealthy countries this figure is closer to four. The European Central Bank points out that the trend towards urbanisation remains strong, keeping prices elevated and depleting the overhang of unsold housing, but cautions that consumers may readjust expected future earnings following stagnating growth and be less willing to stump up excessive amounts for housing.

A further source of economic instability is the dominance of the state-owned enterprises (SOEs), which benefit excessively from government largesse. The state is heavily involved in the running of these businesses and, while some are profitable, they are generally more poorly run than private enterprises. Often clustered in industries like telecommunications and finance, they enjoy protection from excessive competition, regulatory privileges and access to cheap credit. The upshot is that private companies are crowded out of the market, discouraging innovation and ultimately stifling growth. SOEs too pose a challenge to a closer integration of China into the global financial markets.

Resolving these issues requires substantial reform that will strike at the very core of the Communist Party’s modus operandi. If news of Wen Jiabao’s family’s jaw-dropping personal fortune is anything to go by, there will be enormous resistance by powerful insiders who hold the reins of political and economic power.

Discontent with the status quo is rising. The perception that the rot goes all the way to the top is becoming entrenched in ordinary citizens’ view of government. To stop it, China’s next leader must muster up the courage to loosen the Communist Party’s stranglehold through muscular, market-based reform.