While the credit crunch was ‘made in America’, it may be China and the ‘made in China’ economic model that becomes the biggest casualty of the crisis.

In three decades, China has become the manufacturing powerhouse of the world, with an export machine that remains highly dependent on the importing health of the US and Europe. Estimates of how much China will slow down in the current environment are almost certainly conservative, just as in the West forecasts about gross domestic product (GDP) contractions and where house prices will eventually settle are being constantly revised downwards.

No safety net

The West’s long history of capitalism and associated crises means that governments are well prepared to deal with them.

Welfare systems and transfer payments provide both a safety net and the automatic stabilisers to maintain demand. China, on the other hand, has spent previous decades breaking the ‘iron rice bowl’ – the system of guaranteed lifetime employment – and presided over a decline in free healthcare and education, particularly in rural areas.

The legitimacy of China’s government rests upon delivering rising incomes and living standards, principally through job creation in the cities, which absorbs excess labour from the countryside.

China’s reform process has yet to tackle the challenges in the rural areas. Communal agriculture has been abandoned but small farmers do not have legal entitlement to their land. Protests over land confiscation by local officials who want to develop it are widespread.

Forcing a change

Could the global slowdown force a change in China’s approach if it is to placate dissent in the countryside? Sitting on $2000bn in foreign exchange reserves, China certainly has the means to carry out an enormous fiscal stimulus but its current proposals are aimed at keeping the export machine motoring rather than creating domestic consumer demand.

This would require China to introduce a social safety net to bring down the country’s huge saving rate that derives from the state of insecurity felt by most families. It is a huge shift in policy but, unless it happens, the next couple of years could be very rocky in China.

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