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How China’s slowdown could catch up with Russia

In recent decades, writes Vladislav Inozemtsev, Russia’s economy, society, and geopolitical standing have become prisoners to China’s success — to a far greater extent than the authorities and ordinary citizens are prepared to recognise.

Last week, Beijing celebrated the 70th anniversary of the People’s Republic of China with great pomp and fanfare. The commemorations attracted much attention, given that in the last half century China has been the catalyst of some of the most significant economic and political developments in the world. Over that period, the world’s most populous country accomplished an economic miracle, becoming its largest industrial power and elevating 800 million people out of poverty. China has shown that if the authorities are determined to make their country prosper, there is no power on earth which can stop them. Before these changes, nobody would have expected the Chinese to take such an impressive place in global markets, but they fought tooth and nail to do precisely that. In 2018, the country oversaw the production of about 65% of the world’s smartphones, 60% of its computers and office equipment, launched ships which handled 43% of the world’s cargo tonnage, transported 33.4% of the world’s new cars to customers, built 2.78 billion square metres of housing, 5,900 kilometres of modern multi-lane motorways, and 2,200 kilometres of high speed railway lines.

However, China’s recent economic trends have generated concern as well as optimism. Growth rates, which steadily decreased from 7.6% to 6.9% between 2012 and 2018, sharply decelerated to 6.2% in the second quarter of this year and will almost certainly decline further to less than 6% in the near future. Meanwhile the practice of pumping credit into the economy, which has long troubled experts, has risen sharply: by the end of 2018, corporate and household debt exceeded 300% of GDP. The overall assets of China’s banking sector have grown five times since 2008, compared to less than 20% for the USA, EU, and Japan over the same period.

Naturally, this slowdown in China’s economic growth cannot but cause concern in Russia. While China’s other neighbours for the most part see these tendencies as a long awaited chance to reorient themselves away from western investments, Russia regards developments in the Chinese economy only with concern and uncertainty. Today China is Russia’s most significant trading partner, accounting for 15.75% of all foreign trade; since 2015 it has also been the largest consumer of Russian oil (making up 27.7% of total exports in 2018), and a supplier of essential technological goods. Moscow held high hopes for its relations with Beijing after Russia’s rupture with the West, which largely failed to materialise. Nevertheless, the strategic partnership between the two countries in economic affairs and in the international arena remains very strong. China is a partner with immense clout, and it is fair to say that today Russia has no alternatives to that partnership.

In recent years Russian experts’ assessments of the problems facing the Chinese economy have generally concerned two main topics. On one hand, experts spoke of the upset to trade between the two countries (which has only partially been the case; the closure of western markets to China could only make Chinese imports to Russia cheaper and better quality.) On the other hand, their negativity seems justified in light of the fact that problems in China will have knock on effects for a wide range of commodity markets (for example, in 2017 China consumed 51% of the world’s coal, 52% of its steel, and more than 56% if its cement.) In my opinion, the time has come to start considering the likely impact of China’s economic woes on Russia in a broader context.

Firstly, few people today doubt that a crisis in the Chinese economy will trigger powerful shocks which will reverberate across global markets. The collapse of the current model of trade and investment will cause large scale asset sales across the world. To a large degree these will not be felt so much in China itself (today the Shanghai SEE Composite exchange stands at 50% of its record highs recorded in 2007) but in the USA and Europe, where equity prices are between 1.9 and 2.1 times higher than the indicators recorded on the eve of the last financial crisis. The start of an exchange panic will undoubtedly prompt investors to return to the dollar as the least risky asset, in turn exerting powerful pressure on the currencies of developing countries. One of these currencies is the Russian ruble. Thus a massive retreat from speculative investments will lead to a decrease in prices of Russian shares by 30-50%, alongside a rise in contract violations and a massive demand for the repayment of foreign loans. In countries dependent on exports, a rise in the dollar exchange rate will cause real incomes of the population to decline, prompting a further reduction in investment. In other words, the first spark to the Chinese economic crisis will occur not in Beijing, but in Frankfurt, London, and Washington. The shock may well be comparable to what the Russian economy experienced in 2008-2009.

Secondly, the crisis in China will not be so much the result of banal disagreements between Beijing and Washington about payment of fees or duties. Instead, it will be an expression of the new realities of international cooperation in technological development. If the current simmering conflict boils over, it is highly likely that American and Chinese hi-tech companies will attempt to develop their markets autonomously, with the help of their own distinct competitive advantages. In this scenario, we could start to hear more talk about two competing models of globalisation, which in turn demands from Russia and other countries that they make a clear choice to prioritise one partner and one model of technological development over another.. Until recently, as far as technology was concerned, the global economy was fairly uniform: American giants such as Microsoft, Google, and Apple received respectively 52%, 54%, and 61% of their revenue from foreign markets — comparable to figures for Chinese technology giant Huawei (48%). The Chinese could count on the import of nearly 82% of the microchips used in the country’s computers, tablets, and smartphones, while American companies could rely on China, Korea, or Taiwan to assemble most of their hardware. If these broad principles become history, the global economy would change significantly — leaving Russia to make a rather difficult choice.

Thirdly, unlike the Asian financial crisis of 1997-1998 (as well as smaller downturns such as Mexico in 1994, Russia in 1998, and Argentina in 2001), the next crisis will combine both economic and political components. In the past, the USA (and to a lesser extent western Europe) frequently came to the aid even of those countries whose rapid economic development challenged their own prosperity, as in the cases of Mexico and South Korea. In other words, the fact that the global economy relatively successfully weathered the storms of the crises of the last 30 years was largely thanks to the non-confrontational relations between the affected countries. In contrast, the current slowdown in the Chinese economy takes place amid a rocky geopolitical confrontation between Beijing and Washington. As Moscow has clearly chosen the side of the former, any serious political conflict could result in economic stability being used as a bargaining chip — an outcome which would be extremely dangerous to Russia. I have no doubt that China is in a much more vulnerable position than the USA, meaning that Moscow has staked everything on the weaker rather than the stronger side. So while Russia’s relations with China could be understood as an attempt to build an “alliance of autocracies,” these ties nevertheless did not undermine Moscow’s attempts to integrate into a relatively homogenous global economy. But that could all change, and very soon.

Fourthly, the onset of serious problems in China could have significant repercussions for the domestic political situation in Russia. For many years, the authorities and pro-Kremlin ideologists have attempted to present China to their citizens as a good example of a country which has enjoyed successful economic growth in the absence of western-style democracy and “technocratic good governance.” This argument also justified the Kremlin’s attempts to nationalise sectors of the economy and strengthen the influence of bureaucratic regulation. If China’s economic problems become particularly bad, and the pace of growth slows to at least 4%, this will trigger a chain reaction of bankruptcies of banks, enterprises, and individual citizens. Living standards will reduce, the real estate market will collapse, and infrastructure projects will be cancelled or left unfinished. The socio-political consequence would be disillusionment in everything implemented under the recent, prevailing models of economic development. Thus the fact that the current economic slowdown takes place against deteriorating relations between China and the USA is extremely dangerous for Beijing: the communist authorities will under no circumstances alter course and get the population to adapt to lower growth rates. Instead, they will continue their attempts to pump more money into the economy and double down on their commitment to previous paradigms. That path would provoke a full-blown economic crisis in no more than three to five years. In such a scenario, the Russian political elite would be in dire straits, facing the obvious obsolescence and bankruptcy of a model they had not so long ago presented as an ideal to imitate — presented, no less, halfway through a notorious Russian “transition” period. They would face a tough test; their response to serious problems in China could be to resort to the same “conservative solutions” chosen by the Russian government in response to the Arab Spring of 2011.

In summary, we can once again wish wisdom to the Chinese leadership and prosperity to the Chinese people. In recent decades, Russia has become economically, geopolitically, and socially hostage to China’s successes to a far greater extent than the authorities and population are prepared to recognise. If the current equilibrium in the global economy and geopolitical arena is completely destroyed, rather than reviewed gradually and delicately, then Russia will probably bear the brunt of the dangerous consequences (with the exception, of course, of China itself.) For a small boat during a storm, being alongside a huge ship is not the safest place to be.

Photo: Scanpix