For three decades discussion of China’s economy has been overwhelmingly positive. Benefitting from what Leon Trotsky called the privileges of backwardness, China’s transformation has been remarkable since the reforms of Maoist state capitalism started under Deng Xiaoping in 1978. Contrary to neoliberal myth, average growth rates of nearly 10 percent a year have been achieved by a combination of state production and state orchestration of private capital. China has become the world’s largest exporter — increasing exports from $10 billion to $2,100 billion annually — and the second largest economy.

China has accounted for around a third of global economic growth in the weak recovery from the 2008-9 crisis. Half a billion new workers have joined the labour force since 1978, drawn initially as low-paid rural migrants to export processing zones established under Deng. They produce masses of surplus value for the world’s capitalists, thereby injecting a degree of dynamism into a system whose advanced heartland remains relatively stagnant.

Under the vast Made in China 2025 industrial policy, China is forging ahead in a range of new technologies, including cloning, semi-conductors, the quantum internet, artificial intelligence and robotics. President Xi Jinping sees science and technology as “the main battlefield of the economy”, and in these sectors China is a magnet for the world’s brightest scientists. Research spending increased over 30-fold between 1995 and 2013. In 2016 China’s scientific publications outnumbered those produced in America for the first time. One million patents were filed in the same year, 40 percent of the world total. China’s digital payments market is 50 times larger than America’s.

An ultra-modern infrastructure is being rapidly developed under a $1 trillion programme. Ten years ago China had no bullet trains or track suitable for them. Today it has more track than the rest of the world combined. Similarly with motorway construction: in Guizhou province alone nearly as many miles have been built since 2013 as Britain’s entire network. And, in the year to October 2017, residential floor area completed in China was equivalent to building an area the size of Rome every six weeks.

China is no longer a mere low-cost assembly plant for the rest of the world. But the Observer is mistaken in recently arguing that “if China set its sights on a target, nothing will get in its way”. China may be planning an extensive space exploration programme but it cannot escape the gravitational pull of the capitalist system and its laws.

Doubts

In 2007 former prime minister Wen Jiabao described China’s economy as “unstable, unbalanced, uncoordinated and unsustainable”. Since then continued but slowing economic growth has been accompanied by deepening problems and doubts.

In their drive to catch up with rivals, China’s rulers ensure that up to half of annual output is invested, against a Western average of 20 percent. But this increases what Marx called the organic composition of capital, the ratio between dead labour embodied in plant and machinery and value-producing living labour. This results in diminishing returns on investments, many of which are unproductive and unprofitable. One illustration is China’s “ghost cities” — grandiose developments that fail to attract firms. Much of this investment is on infrastructure, but the productive economy still lags way behind its rivals.

There were ten industrial robots per 10,000 workers in China in 2015, 100 in the US, 300 in Germany and Japan and over 500 in South Korea. After decades of rapid growth China’s capital stock per worker is a quarter of South Korea’s and only a fifth of the US’s. Productivity remains relatively low — $20,000 per worker in 2015 compared with $110,000 in America and nearly $80,000 in the EU. Accurate profitability figures are hard to find, but most suggest they are in single digits (estimates range from 4 to 9 percent for the private sector and 2 to 4 percent for state firms).

State-owned enterprises (SOEs) remain an essential part of the Chinese system. They provide the Communist Party with a power base for sections of the leadership, produce industrial outputs for infrastructure development, and in declining regions like the north east, keep millions in jobs. Here, half of industrial jobs are in SOEs, compared with a national average of 17 percent, while in the export-oriented coastal zones, like the Pearl River Delta, SOEs have virtually no presence.

But in narrowly financial terms SOEs are an economic drain. They account for a third of investment yet generate just 10 percent of GDP, have 40 percent of the assets held by enterprises but make just 20 percent of profits, and are laden with debt. Yet SOEs still make up 80 percent of stock market value, indicating that many of China’s largest companies remain directly state-owned. None of the others escape state influence.

Privately owned hi-tech firms like Tencent and Ali Baba are now in the world’s top ten and seen by the party leadership as a long-term challenge to the privileged position of SOEs and to the party itself. But under Xi Jinping the state has reasserted its power over private capital. The major hi-tech firms have been forced to fund the restructuring of the nationalised China Unicom in return for access to its networks and customer base. The government has also placed limits on the payment systems and financial services of the high-tech giants, which had begun to act as quasi-banks and may well have been engaged in money laundering and tax evasion.

Stricter state control of private capital is linked to concern over capital outflows. Between 2014 and early 2017 outflows were huge, reflecting business anxieties over domestic debt, profitability and financial risk. In 2016 alone $28 billion left China every month — a huge figure when set against EU firms’ investment in China of only $8 billion in the entire year.

Many overseas acquisitions (in sectors like property, entertainment and sports) were made at ludicrously inflated prices, which the Communist leadership subsequently criticised as “irrational”. The £615,000-a-week contract for 32 year old footballer Carlos Tevez to play in the fledgling Chinese Super League certainly seemed irrational, even before he played just 16 games before returning to Argentina £34 million richer. But, as the Financial Times reported in March 2016, much hinged “on the backing of one man: President Xi Jinping”, a fan who aims to turn China into a footballing power as part of his Chinese Dream for national rejuvenation.

And, from the private capitalist perspective of rationality, inflated prices enabled the movement abroad of large amounts of money as a hedge against emerging difficulties in China. In response, in early 2017, restrictions were imposed on capital outflows, and in summer 2017 the State Council told regulators to curb foreign investments and the Banking Regulatory Commission ordered state banks to reconsider their exposure to the most aggressive overseas investors. Senior government figures have also encouraged firms to invest in Xi’s Belt and Road initiative and to be more patriotic. But patriotism cannot easily overcome the serious imbalances in the Chinese economy.

Central bank governor Zhou Xiaochuan speaking at the 19th Communist Party Congress last October warned of the danger of a “Minsky moment” — the destabilising impact of banking and finance for capitalism. The economist Hyman Minsky found that periods of stability encourage over-confidence and speculation, which in turn increase the danger of a financial crash. Crashes then result not from external shocks but from capitalism’s normal workings.

The bank’s concerns are shared by the world’s business press, which consistently warns of the danger of a 2008-style crash. China’s huge stimulus package in response to the 2008 crisis helped restore confidence to financial markets, but the huge expansion of debt involved has contributed to the emergence of longer-term problems.

According to the Bank for International Settlements, China’s non-financial sector debt has grown from $6 trillion dollars in 2007 to $30 trillion today. China is a major factor in the global increase in non-financial sector debt, which is now 40 percentage points higher than just before the 2008 crash, while corporate debt is 160 percent of GDP, making it the most indebted corporate sector in the world.

In the financial system, loans have grown from 250 to 440 percent of GDP. Many loans are under-performing, particularly those to so called zombie companies that survive thanks to state credit and subsidies; thereby depriving other firms of resources. According to the IMF, in December 2017 zombie debt was 6 to 11 percent of GDP. A respected banking analyst, Charlene Chu, estimates that bad debt in China is up to $8 trillion, suggesting that a third of debts are bad compared with the official figure of 5.3 percent.

Manoeuvre

Since 2008 local government debt has grown from 17 to 42 percent of GDP, and overall state debt has doubled to about 270 percent of GDP. This debt is largely owed to domestic savers, which allows the central bank some room for manoeuvre without facing a currency collapse — it could, for example, issue bonds to cover the debt or buy it from private creditors. That room may be expanded by increased authoritarianism, but in the long term, as the financial commentator George Magnus put it in 2017, these debt conditions “make China a classic risk case for a fall”. Whether directly, via the interconnectedness of global financial markets, or indirectly, via the impact on China as an export market, nowhere will escape the effects.

Warning signs are everywhere. House prices have been rising annually by 10 percent, and in major cities by 20 to 30 percent in 2016. Inequality in housing makes even London seem a haven of relative egalitarianism: the price to income ratio in China’s major cities is over 40, nearly twice that of London (23). For Shanghai’s professor of finance, Ning Zhu, a financial bubble is inevitable. One consequence of exorbitant house prises is that over 50 million homes, 22 percent of urban housing, were vacant in 2013. Mortgage deposit requirements have been increased and developers’ access to state bank loans has been restricted as the state tries to control house price inflation. But it is hard to see how prices can be reduced sufficiently to reduce excess capacity without producing a crash that will damage regime legitimacy as the guarantor of rising affluence.

Another aspect of financial system dysfunction is the emergence of a virtually unregulated shadow banking sector. At its core are high-yield investment vehicles and wealth management products, which have exploded in the last decade into an $11 trillion market. Concerned about the potential impact on the wider financial system and real economy, regulators have toughened the restrictions on speculative products. Yet they are backed by state-owned banks, which act as retail agents for the products, and buyers logically assume that the state will guarantee their investments.

Dilemma

China’s rulers face a dilemma — they want further economic growth but must contain the debt that has promoted it. What’s more, the IMF has highlighted that debt is having a diminishing impact on the real economy. In 2016 it took four units of credit to increase GDP by a single unit but ten years ago just 1.3 units of credit. Yet in November 2017, the day before announcing new restrictions on financial products, the central bank pumped $50 billion into the financial system to allay investors’ fears about future growth prospects. This has been a recurrent theme since 2008 — whenever stabilising measures produce a whiff of crisis on the stock exchange and prices fall (as in 2015 and 2016) the state relaxes policy and so increases the likelihood of future instability.

China cannot escape the economic laws of motion of capitalism that Marx discovered 150 years ago. Alongside weak profitability and the declining impact of credit on growth, wages have risen quite sharply in recent years in the most buoyant sectors as the supply of migrant workers from the countryside slows and urban workers sense their growing power.

The established pattern of recruiting cheap migrant labour has run out of steam. Many migrants find only low-paid casual service sector jobs in the cities, but few working age people remain in rural areas. Away from coastal China, even cities face labour shortages. In Zhengzhou, Foxconn, manufacturer of Apple’s iPhone, has illegally recruited students in periods of heavy demand due to the absence of the low waged workers promised by the regional government when it enticed the firm to the region: the workers had moved elsewhere. China is facing a sharp decline in the working age population (with associated pressure to increase wages). It is estimated that the decline will average 5 million workers a year in the coming years.

Capitalist rationality is not purely economic but shapes all social relations. The inevitable consequence of marketisation and the relative security of China’s local and national political elites has been an explosion of corruption.

The paying of bribes to party bureaucrats — to get children into good schools or gain promotion, for example — has been part of local everyday life for decades. Today corruption has assumed a new local character consistent with the huge opportunities for enrichment. Local authorities are legally unable to borrow, and so have established arms-length public-private subsidiaries — local government financing vehicles — which can borrow and now account for about half of local debt. They have become key conduits for corruption and the centre of local state-business clientelistic power structures. A favoured method by which local party chiefs help their wealthy friends is to appropriate public land to sell cheaply to developers. But corruption is not purely local — it goes to the heart of the system.

Crackdown

The more far-sighted leaders recognise the potential threat to the state’s legitimacy and under Xi Jinping an anti-corruption crackdown has been launched. Some 200,000 officials have been taken to court and a further 400,000 punished via internal party disciplinary measures, including over 10 percent of central committee members, senior military figures and SOE executives. Corrupt financial regulators (including in insurance and banking) have been sacked.

The crackdown, which Xi hopes will pacify ordinary workers, has produced inner-party dissatisfaction and risks creating as many political enemies for Xi as it removes. Even the immediate aim of cutting the costs to business associated with a culture of back-handers may not be achieved. As the Financial Times notes, costs may actually be increasing as officials become more careful and demand payment into offshore accounts.

The problems the corruption crackdown may face represent in microcosm the wider difficulties the state faces in attempting to reform China’s economy. Leaving things alone risks allowing specific irrationalities to persist, but restrictions in the interests of stability and regime legitimacy may lead to a further growth slowdown and actually weaken Xi’s position.

China’s economy is not about to implode. There is real economic strength and a crash is not inevitable in the short term. But, Ning Zhu argues, “time is running out” as debt and slower growth weaken the state’s capacity to address problems by throwing resources at them. Nor can capital rely on fresh supplies of cheap labour in the future. If and when the developing stock market and housing bubbles burst, as they surely will, the impact on China and the rest of the world economy will be very great indeed.

At this point, the unwritten contract between the Chinese state and society — that we will make you richer, develop China and restore it to its rightful position of power in the world, but you will not demand democracy, freedoms and rights — will be very hard to maintain.