Among the most obvious failed intellectual enterprises of the past two decades have been various predictions of China’s coming implosion. Whether by social explosion, elite fragmentation, or hard landing, the assumption was that the existing system would have to break. Now, the Chinese government is no longer kicking the can down the road on reform. They’re making changes, and so there’s much more uncertainty within China—and more potential for both upside and downside.
Reforms might prove to be very successful, improving China’s investment climate and opportunities for integration into the world economy. Still, the government is loosening its hold on key reins of the domestic economy on an historic scale, and that could have serious unforeseen consequences.
There are three pieces in play. First, there is a broad policy to rebalance the economy, easing state dominance of the financial system and increasing the transparency and coordination of state-owned enterprises to make the system more efficient and less dependent on state-directed investment. Second, there’s an effort to rebuild the Communist Party’s legitimacy, particularly at the top, through savvier public messaging and progress on addressing issues of deepening public concern, such as environmental protection and social welfare. Third, there’s consolidation of power and the creation of new party institutions and mechanisms to ensure the first two sets of reforms will work as intended.
In Asia, China-related turmoil seems uncorrelated with other global risks. Certainly there is concern about a hard landing in China, given the country's outsized effect on global demand. But tensions between China and its neighbors, or concerns about internal instability, are unlikely to upend the Chinese economy given the sizeable economic buffers that the Chinese have to offset any shock. Admittedly, should any of these risks break out, the transmission will likely be rapid and chaotic. For now, though, most of these political risks may seem far away for all but the most exotic of investors.
In other words, China is starting something big, dangerous, and all about China. This year, potential knock-on effects from that turning point, internally and externally, are of great importance.
Weak growth in China and elsewhere in the emerging world could significantly