China is too big for a Soviet Union-style collapse, but it’s on shaky ground

China's economy is currently experiencing a challenging phase. The rate of economic expansion is decelerating, and the bursting of its property market has had a significant impact. Additionally, unemployment rates are on the rise.

Why does it matter, you may ask? All nations go through challenging times when the consequences of their previous actions catch up with them. Eventually, there is a shift in the economic cycle and the recovery process begins. China, being the second largest economy in the world, has experienced tremendous growth over the last forty years. It holds a crucial position in the global economy and has made significant investments in cutting-edge manufacturing and artificial intelligence. Admittedly, it faces its own set of issues, but it will likely overcome them without significant damage.

However, there exist nations that never bounce back. The Soviet Union was a centrally planned economy that experienced a swift downfall towards the end of the 1980s. Looking back, it was apparent why the ultimate crisis was imminent, but it didn't appear so when the Kremlin was positioning SS20 missiles across Eastern Europe some years earlier.

Here's a different perspective to consider. The prosperous period of China's economy has come to an end. Recent occurrences, such as the devaluation of the currency, decreasing prices, and financial troubles within the residential housing sector, indicate a more significant underlying problem. To address this issue, the ruling Communist party will have to implement fundamental changes to the economy, which will require them to relax their strict political control. Xi Jinping, China's leader, portrays himself as a powerful figure and is unlikely to make any compromises for the sake of freedom and democracy. Eventually, China will head down a similar path as the Soviet Union.

This might seem unlikely, which it is, to some degree. The Soviet Union had a considerably smaller economy compared to China and was not as well connected to global supply chains. China has a significant impact on the global economy, unlike the Soviet Union.

According to Dhaval Joshi from BCA Research, China has been responsible for 41% of global economic growth in the last decade, which is nearly twice as much as the 22% contributed by the United States. In contrast, the euro area only contributed 9% to the world's growth.

To rephrase that, considering the recent decade, China has contributed 1.1 percentage points to the world economy's 2.6% real growth rate. In contrast, the United States and the euro area have only contributed 0.6 points and 0.2 points, respectively.

China accounted for a major portion of global economic expansion due to its economy rising at a rate of approximately 8-9% annually. However, its growth rate has now decreased by half, resulting in its contribution also dropping by half to roughly 0.5 points. Additionally, it is predicted that China's growth rate will continue to decline in the upcoming years. A few economists believe that by the end of the decade, China's trend rate of growth will be around 2%, parallel to that of the United States.

These predictions may all be too early to say for certain. Beijing's objective is to achieve slower yet more stable and sustainable economic growth. Consequently, policymakers should refrain from immediately reducing interest rates, increasing government expenditure, or coming to the rescue of an excessively stretched real estate industry, whenever they sense any signs of trouble. The optimistic argument for China is that its system, characterized by restricted economic liberties and political oppression, has proven effective since the Deng reforms in the late 1970s and will persist in the future with some adjustments.

In 1985, when Mikhail Gorbachev assumed leadership in the Soviet Union, he adopted a two-pronged strategy. "Glasnost" aimed at fostering transparency and openness, while "perestroika" focused on revamping the economy to overcome a prolonged period of stagnation. The downfall of the Soviet Union can be attributed to the greater emphasis placed on glasnost rather than perestroika. Chinese leaders took note of this lesson and prioritized economic restructuring but showed less enthusiasm for embracing openness and transparency.

So far, prioritizing the increase in the economy rather than democracy has been successful for China. Nevertheless, despite the assurance from Beijing's decision-makers that everything will remain fine, there are indicators that support the pessimistic view on China's growth potential. It's not only because the anticipated robust rebound after the removal of pandemic-related restrictions has faded away, as the economy was already showing signs of slowness even prior to the emergence of Covid-19.

In a publication by Foreign Affairs, Adam Posen, the head of the Petersen Institute for International Economics, stated that China has been experiencing persistent economic struggles similar to the long-lasting effects of Covid-19 since the middle of the previous decade.

Starting from 2015, the proportion of bank deposits compared to China's GDP has increased by 50%. On the other hand, the consumption of long-lasting goods by individuals in the private sector has decreased by approximately one-third since early 2015, and this decline has persisted even after the economy reopened, instead of experiencing a rise due to accumulated demand. Additionally, private investment has plummeted by two-thirds since the first quarter of 2015, with a further decline of 25% since the onset of the pandemic.

According to Posen, these patterns demonstrate the collective economic choices of individuals and businesses, indicating a growing concern in China regarding the potential loss of their possessions. Consequently, people and companies in the region are becoming more inclined towards maintaining immediate cash flow rather than making long-term investments. Posen also suggests that these anxieties have been intensified by the strict and prolonged lockdown measures implemented in China.

China faced significant challenges prior to the Covid pandemic. It grappled with an increasingly elderly population and, despite experiencing substantial growth for over four decades, it remained classified as a middle-income nation. The growth rate was artificially inflated due to inefficient public investments and financial incentives provided to economically unviable businesses that would have otherwise failed.

That being said, observing various nations worldwide reveals that authoritarian governments can maintain their control over the country even during periods of sluggish economic growth or high inflation. If change were to occur in China, it is likely to happen gradually rather than swiftly, and in such a case, we should appreciate this approach. The abrupt downfall of the Soviet Union was succeeded by an economic upswing around the globe. However, if China were to experience a sudden collapse, it would result in a worldwide economic downturn.