By Timothy Ang

Since the onset of the reform era almost four decades ago, China has relied on heavy investment and credit expansion to achieve unparalleled economic growth as an emerging economy.

Now, as China settles in as a major economic power, pressure points are appearing that suggest it is time for the country to make its long-awaited transition to a new growth model.

Slowing demand, tariff threats and the emergence of large asset bubbles have left Beijing fighting fires on all fronts.

In his latest book, Red Flags: Why Xi’s China is in Jeopardy, veteran economist and commentator George Magnus examines the root of these structural weaknesses and argues how a failure to adequately reform could stunt China’s economic aspirations.

China Economic Review caught up with George to get his view on the current state of affairs in the Middle Kingdom.

CER: Red Flags centers around a ‘rebalancing’ in China’s economy. What do you mean by that?

GM: This is really about whether China’s growth model is sustainable, and what must be done to make it so.

The infamous anonymous article that appeared in the People’s Daily in May of 2016 carried the message: “We can’t go on like this,” referencing growing issues such as surging debt levels that cannot be maintained indefinitely. At the National People’s Congress of this year, we had clear signs of recognition by those in Beijing that economic policy has to switch to different objectives – not just narrow metrics but a more fundamental health.

In a way, this is stating the obvious. The investment-driven development model that brought China out of poverty cannot exist in perpetuity. You eventually stumble into misallocations of resources, capital inefficiencies and so on. This need to move away from reliance on investment to a consumption and services-based sector was the theme of the 13^th Five-year Plan.

By ‘rebalancing,’ economists mean moving China to a development model more in line with its current status and that facilitates its aspirations as a leading global economy. It has to be smarter, rather than just accumulating capital and labor resources, i.e. the strategy of a poor country.

CER: Where are the warning signs in China’s current debt profile?

GM: First things first. When we talk about China facing some massive financial crisis, it’s imperative to stress that there is no reason to think that it will look like anything we’ve yet seen in the Western or emerging world before.

We’re talking about a very large country with a state-owned banking system, with the associated assumption that no major financial institutions will be allowed to fail. The way in which stability, or instability, manifests itself in China is likely to be different to how it did for the West.

Indicators like China’s debt-to-GDP ratio, or the speed with which it clocked up debt, are warning signs, certainly, but there are no clear fault lines at present.

Also, the bulk of the problem is still RMB-denominated, so the risk of China undergoing some kind of Thai, Korean or Indonesian-style crisis is relatively slim. Strict controls prevent any wholesale withdrawal of capital in the same way as the Asian Financial Crisis, or more recently in Turkey or Argentina, which should give some discipline to China’s domestic markets.

CER: Should markets be worried?

GM: That’s not to say that China’s debt pile is not a problem. I see the vulnerability in two places: firstly, how the debt is funded; and secondly, how the overhang will weigh on economic growth. As for the first one, this is something the authorities have had in their cross-hairs since late 2016. We have seen a clampdown on the more egregious forms of risk-taking and a reduction in the issuance of financial products such as WMPs (wealth management products) and treasury management products, which were used to fund large-scale projects.

It’s not clear to me that deleveraging has gone far enough, however. And throughout the course of 2018, as the consequences of deleveraging have become more evident, we have seen incremental retreats from stricter controls over leveraging and lending. The government seems keen to get their hands back on the wheel, so to speak.

And of course, how do you get rid of the debt? Bad debt is bad debt, it’s not going to magically disappear. You can evergreen it, use accounting regulations that don’t recognize it, but the impact of bad debt will be a significant cap over economic growth, as we’ve seen in the rest of the world for the past 10 years.

The bottom line: what is the government’s appetite for slower growth as it pursues a deleveraging policy? Most economists will say, it’s not a choice of whether or not the government will do it, but how long it will take and what the economic growing pains of that will be.

The danger is that it is dealt with in a disorderly fashion, in a much more abrupt way. Perhaps investment drops too significantly, or property prices begin to wilt, as per the hints popping up around the economy. Then we will have to pay close attention.

CER: China has been described as suffering from ‘policy incoherence’ – trying to meet too many objectives at once. What do you think the government’s economic priorities are right now?

GM: If you have a GDP target of near 6.5% and are trying to pursue serious deleveraging of the economy, then you will hit roadblocks. These two goals are fundamentally incompatible. If, on the other hand, the government was to say that it planned to phase out GDP targets over the next few years, for example, then this would be in line with the sentiments of the NPC and tell us a lot about macroeconomic intentions.

The problem is there isn’t clarity of what they’re trying to do over the next 5-10 years. This is somewhat disconcerting. While the rhetoric of reform and opening up is still quite loud, in practice I don’t see much evidence of China moving in that direction. If anything, the reaffirmation of role and primacy of the party in commerce and industry goes against the fabric of what’s being touted.

CER: What do you make of the recent wave of measures to shore up the financial sector and private business? Could we see more stimulus on the way?

GM: I think you can take Liu He at his word, that among him and other senior economic officials, there is a visceral distaste about repeating what happened in 2015. They don’t want that level of intervention again.

How far that feeling goes, I’m not entirely sure. It depends on just how effective their alternatives are. If the policy easing and expeditional controls which have been implemented this year result in a stable economy in two years, then I imagine a slower growth rate will be tolerated. I can’t foresee Beijing toying with credit expansion of the scale we saw three years ago.

This reiterates the same principle as before: how much growth are they willing to lose to form a healthy, sustainable economy. Does China have the nerve to take a hit, then get back up with a reform package to take the economy on a different path for next five years? We don’t know.

CER: How will US pressure compound the problems raised in the book?

GM: The impact on China so far is basically a rounding error. It’s already offset by the easing measures put in place for domestic reasons.

If the tariffs go up to 25% as the Americans intend, and extend them to all Chinese goods, then we’ll see a significant effect on China. The 2018 effect is around 0.25% of GDP, but this could widen to 1% or more by the end of 2019 – not an insignificant hit to growth.

The trade war is not a make or break issue for China in itself, but it’s an untimely affair. It certainly has the potential to amplify existing headaches, such as the weakness of the yuan and capital flows.

But most of all it risks diverting global supply chains. Foreign firms will be looking at their long-term relationship with China and how they do business there, compared with surrounding regional alternatives. The disputes with the US, after all, are likely to be a long-standing affair.

CER: What changes must China make to avoid falling into the middle-income trap?

GM: What economists focus on is total factor productivity (TFP) – the amount of a country’s output not caused by traditionally measured inputs of labor and capital. All economies tend to come to rely on TFP for economic growth as they mature, since there are limits on how much capital you can accumulate and how much the labor force can grow, particularly in an aging economy like China’s.

The result is you have to get smarter. You have to deploy labor and capital to get quality rather than quantity.

Most Western countries, and China since 2008, have succumbed to a period where TFP growth has slowed down. Crucially, the periods where TFP has been on fire in China coincide, not by chance, with the periods of greatest reform and opening up, i.e. the early 1980s, ‘90s and following entry to the World Trade Organization. Therefore, it is a concern that the future of reform has had this question-mark placed over it.

The key to getting TFP lively again is whether an economy has institutions that create the competitive and regulatory environment in which incentives are rewarded and private initiative is encouraged. If you took a snapshot of China in 2018 and asked whether it looked like a country trying to foster this – probably not.

George Magnus is an independent economist and commentator, and research associate at the China Centre, Oxford University.

Since the arrival of Xi Jinping to the presidency, the path of Chinese policy seems to have taken a U-turn. Markers of liberalisation seen in China over the past 30 years are slipping away as the party reinforces its centrality in business, media and the everyday lives of individuals.

According to Fordham University academic Carl Minzner, the authoritarian turn in Beijing not only has enormous political implications, but will also have far-reaching, long-term effects on China’s economy. In his latest book, End of an Era, he argues that abandoning the policy consensus set in place by former leader Deng Xiaoping risks harming China’s prosperity and derailing the country’s rise as the world’s superpower-in-waiting.

In a conversation with China Economic Review, Minzner lays out why he thinks the growing role of Beijing in the economic and political spheres could mark a turning point in the country’s history.

CER: In End of an Era, you write that in recent years China has been “closing down.” What do you mean by this?

CM: Ironically, we are at a time when China’s impact on the outside world is possibly the greatest it has ever been. However, I do think that China is closing itself from outside influences.

While on the one hand it’s certainly true that the party has become more sensitive to outside, particularly Western influence, this isn’t solely the state’s policy. There is also a considerable motivation from Chinese citizens away from the 1990s mentality where everything foreign was golden – international schools, American brands – towards a greater satisfaction with life in modern-day China. We see this in TV shows, domestic box office numbers, even in academic standards and attitudes towards learning English.

But the government’s stance is without a doubt more inwards looking. Thinking back to the 1990s, in the run-up to China joining the WTO, there was this big hang-up on meeting international standards, which filtered down all the way through society. At this time, foreign ideas acted as both a stamp of quality and a useful way to address latent problems in Chinese government like monitoring local officials and tackling corruption. Now, on the flipside, there is a little bit of a suspicion attached to what is ‘foreign.’

Despite China’s increasing global presence, there has been a heightened sensitivity since the end of the reform era towards what comes in. China wants to export itself, its culture, its brands, its governing style, to other countries, but the internal setup needs to remain Chinese. This is one of the big shifts we’re seeing take place at the minute.

CER: What were the economic/political conditions that led to this retreat from liberal reform?

CM: The first thing to clarify is that the title of the book is ‘End of the Reform Era,’ not ‘End of Reform.’ So, if we talk about the reform era, the post-1978 society which clearly demarcates itself from the Maoist period that preceded it, there were three defining characteristics: economically – rapid growth; ideologically – a certain degree of openness to the outside world; and politically – a relative degree of stability marked by partial political institutionalisation. This is not the same thing as liberalisation, just that the rules of the political game post-78 became much clearer and organised from what had existed before. This included no cult of personality, decentralisation of power to a wider group of individuals, clearer rules of succession, and the lack of basically anything that resembled a mass movement.

If you compare all three factors with today’s China, it’s clear that such a period is coming to an end. China’s economy is slowing down, the party has changed its tone towards foreign ideas and influences inside the borders, particularly in business and academia, and of course those partially-institutionalised rules of the game are coming undone.

CER: How did the reform era shape China’s economic development?

CM: If you’re describing the full sweep of the reform era in China, one of the big events has been the re-emergence of deep inequality. From the pre-reform era society where inequality was high but China was universally poor, through the mid-1980s when China had a much more equal society under Deng Xiaopeng and was getting richer, until the 1990s when we see almost US-level inequality arise.

Take Shanghai, for example. Thirty years ago, anyone who was an average state employee would have received some sort of government-sponsored housing as part of their compensation package. Fast-forward to the “privatisation” of land by the end of the decade, and these workers, in essence, own their own apartment. When the property prices in a place like Shanghai triple, quadruple, quintuple in the early 2000s, anyone on the property ladder was at an enormous advantage and could sit back while their net worth kept going up and they were free to think about second properties and other investments.

Migrant workers from rural areas, however, had a different experience. Yes, during the agricultural reforms of the 1980s they saw their wealth improve somewhat, but by the 1990s more and more of China’s growth is being channelled and enjoyed by a narrower slice of the population. And what do you see going on in your daily life? School fees for your children are increasing, rural healthcare had pretty much fallen apart by the 1990s, the hukou system prevents you from sending your child to a school in another region, and so we begin to see the phenomenon of the ‘left-behind’ children. All these multiple, very real impacts on the lives of individuals are a direct consequence of a movement away from economic and social policy reforms over the course of the last three decades.

CER: How does the party reconcile this skyrocketing inequality with its Marxist roots?

CM: Since 1978, Beijing has jettisoned many of its earlier socialist practices. In 1980s and 1990s, rural communes were abandoned, market pricing introduced, and negotiations opened to facilitate China’s entry into the global free trade club of the World Trade Organization.  But one of the biggest shifts away from anything resembling Marxism is best embodied by the party’s adoption of the theory of the ‘Three Represents’ in the late 1990s – essentially redefining the Communist Party itself as a vehicle to represent the newly emergent capitalist class. So, in a society where the divide between rich and poor – even if you believe the official statistics – has surged over the course of the reform era to levels resembling those in Mexico, Peru and the United States, and where 1% of the population owns one-third of the wealth, Beijing’s nominally socialist ruling authorities have aligned their interests with the wealthy and middle-class urbanites over those of the migrant workers and rural poor. 

That being said, this doesn’t mean that there has been an abandonment of the classic socialist goals of, say, providing social welfare. This goes back before Xi Jinping, to Hu Jintao and beyond. Leaders are very aware of the looming gaps that were left in society during the 1990s and know that this has to be addressed through active means, such as the removal of school fees or improvement in access to healthcare.

The problem that repeatedly arises for policymakers, however, is an inextricable tension between the urban middle classes and the rural populations when you have to ask one group to sacrifice some of its wealth to benefit the other. Shanghai and Beijing benefit from extreme preferential treatment compared to the poorer provinces, because they are willing to resist when social welfare picks at their pocket in some way. This is well demonstrated by university places. Residents of these two cities enjoy very high quotas for entrants into the best schools, disproportionate to their populations, as there is pressure on the government to keep it this way.

CER: In the book, you compare China today with other East Asian nations a generation ago. What are the structural differences between the Chinese mainland and Taiwan that have restricted it from making the same transition to a liberal market economy?

CM: The short answer is that the CCP authorities in Beijing have a much greater dominance over all sectors of life in mainland China than the Nationalist Party (Kuomintang – KMT) ever did in Taiwan.

Even at its most authoritarian, the Nationalist grip over Taiwanese society was subject to important limits. Taiwan’s post-World War Two economic boom years saw the emergence of entrepreneurs and firms with but loose ties to the ruling KMT apparatus. A range of religious groups, particularly the Presbyterians, escaped its full control. Such things created important constraints on the KMT’s controls and helped contribute to a rebalancing of economic and political actors in society. So, for example, Nationalist Party-owned enterprises and their role in the economy are steadily marginalized as Taiwan undergoes transition in the 1980s, 1990s and early 2000s.

In contrast, on the mainland, the CCP’s grip has been much stronger – largely because the pre-1978 period witnessed the eradication of all organized national social and economic structures outside of its own walls. This means that the party power structure ends up generating a much stronger gravitational attraction vis-a-vis all of the resources and entities that develop in the reform era boom that follows after 1978. Sure, it doesn’t look that way initially in the 1980s and 1990s. Indeed, that’s the period where observers start to imagine that various pieces of mainland Chinese society, whether civil society groups or private firms, might somehow attain escape velocity and exit the party’s orbit. But by the late 1990s, you see pretty clearly with the development of the ‘Three Represents’ that the party intends to co-opt and absorb private entrepreneurs.

And by the early 2000s (as mentioned above), you see the revival of state-owned enterprises and the role of party committees in private enterprises and society at large, and the increasing difficulties of private firms in terms of getting access to loans. That’s the inverse of the Taiwan example – it’s how the political controls start to steadily reabsorb the space for markets and private enterprise, as state corporatist models and Leninist party controls increasingly balloon within the mainland Chinese economy. 

A few things to watch will be the functioning of the real estate market and the space available for private tech companies to see how far these trends continue. Overwhelming short-term demands for maintaining social stability are steadily forcing Party authorities to extend their controls back into areas from which they had partially stepped back in the late 20th century.

CER: What do you think about the recent promises from Chinese policymakers regarding greater reforms?

CM: For market reforms, I don’t think this round of pledges will be any different from those made in previous years. The government considers state control, social stability and the state economy as paramount, so this really reduces its margin of manoeuvrability when it comes to market liberalisation. How do you reconcile the desire to bolster the role of a communist party in the economy with looser regulation and openness to foreign multinationals?

There are some very interesting governmental reforms going on, though, such as the mass restructuring we saw back in March. This was essentially ‘re-partyisation’ of the bureaucracy – a merger of party and state institutions that gives the new body a wider remit with a much stronger party presence, reversing the norms set in the early 1980s when the party decided to grant more management freedom to the state bureaus.

The extraordinary rise of China’s financial technology—or “fintech”—industry shows few signs of slowing. Where once Chinese finance was almost a byword for backwardness, today the country is home to many of the most dynamic financial companies in the world.

Of the world’s 27 fintech unicorns—startups valued at over $1 billion— nine are based in China or Hong Kong, according to a 2017 report by TechCrunch, where they benefit from access to the world’s largest, and one of its tech-savviest, consumer markets.

Payments via third-party mobile platforms have grown at a three-digit annual rate for the past five years. Chinese consumers make more transactions through payment apps Alipay and WeChat Pay today than through cash and cards put together. Peer-to-peer lending, meanwhile, has exploded to become a $190 billion industry serving millions of credit-starved households and small businesses.

But what’s next in store for the industry? Is the recent wobble in the P2P market going to spread? Could a ramping up of regulation from Beijing put a dampener on the market’s red-hot growth? Stomping out risk from the financial system has become a key priority for policy makers over the past year, and the relative freedom fintech firms have enjoyed over the past decade may be about to take a hit.

Analysing these questions is all part of the day job for Zennon Kapron, the head of fintech research and consulting firm Kapronasia. In this interview with China Economic Review, Kapron gives his take on some of the market’s recent developments, and explains why China’s fintech industry is such an exciting space to watch.

CER: Fintech is a term that includes many different sub-markets. Which of these are the most relevant in China?

ZK: The basis of fintech in China is payments. Alipay, the most popular online payment system in China, was set up to solve the issue of trust in e-commerce. When the country’s first online retail giants started, the system was simply ‘cash on delivery,’ and of course there are a number of potential problems and inefficiencies with this. Alibaba launched Alipay to smooth out this process: you order something online, the money goes into escrow, once you receive the goods you confirm and the money is released, and if you don’t say anything within a few weeks it’s automatically released. That really gave both merchants and buyers more confidence and trust in the e-commerce system. This has since developed into m-commerce and offline-retail payments.

At the time Alipay was really gaining momentum, around 2013, interbank lending rates were quite high – with banks borrowing money on a daily basis to cover their capital requirements, etc. – so Alipay worked with Tianhong Asset Management and set up the money market fund Yuebao that trades on this bank lending behaviour. So all of a sudden, what do people have? A wealth management product. This is the second major segment of China fintech.

Ten years ago, if you wanted to buy a wealth management product, you’d have to go through a pretty painful process at the bank. You’d wait in line to talk with someone, who would print out a list of different options for you and there would be a sizeable minimum investment. After that your money would be locked up for six months, a year, maybe two years. Yuebao managed to capitalise on this situation. It offered high interest rates, perhaps 7 or 8%, with near instant liquidity. So someone could invest money one day, start earning interest on it tomorrow, and start withdrawing their gains within hours, even as little as Rmb 1. The result was basically the democratisation of wealth management.

The third aspect was credit. These growing technology companies now had access to a wealth of information on people’s financial situation and their daily spending habits, from how much they had in their accounts, to when and where they spent it. This gave them a really effective means of building an individual’s credit rating, and it was then just a small step to actually offering a lending alternative to the banks.

CER: Why is China so ahead of the curve when it comes to fintech?

ZK: I think there are a couple of different things. First of all, there’s a lot of friction in existing transactions. For example, if you want to make a card payment in China you still have to chip, then PIN, then give your signature; with Alipay or WeChat Pay you just scan a QR code and walk away, clearly removing all of that friction.

The second reason would be the country’s credit system. The People’s Bank of China has a credit database of less than half of the population – some 600 million citizens – and of these only half again have actual details of credit ratings and history. For me, having grown up in the US, I’ve had a credit card since I was young, so Equifax, TransUnion and other credit bureaus have a tremendous amount of data on me. There isn’t the same in China, and the result is huge swathes of this enormous population that do not have a credit history, which opened another niche for fintech lending platforms to move into.

One more important factor is the government’s ‘wait and see’ approach to the industry’s development. Alipay, for example, launched in 2004, but payments platforms were only regulated in 2011. Similarly, peer-to-peer (P2P) companies began to take off in 2007/2008, but regulation for them only really kicked in the last couple of years.

There are exceptions to this approach, however: Bitcoin was very quickly stamped out. Why? Well,  Bitcoin is a very elegant solution to a problem that doesn’t exist, and it serves very little value to the financial services industry. People speculate on it, but it offers nothing to benefit the wider economy.

Payments, on the other hand, have provided a necessary and visible boost to the economy. In Hangzhou, I met a salesman/repairman who previously only accepted Alipay and WeChat Pay, but had recently started borrowing some Rmb 90,000 a week with MYbank. The government is seeing the benefit of letting small lending companies help mobilise capital to small borrowers.

CER: What is driving Beijing’s recent moves to tighten regulation in the fintech industry? And do you think this poses a threat to the sector’s growth?

ZK: Generally speaking, the government wants to ringfence any source of potential risk. I tend to come down on Beijing’s side regarding a lot of their decisions in this area. The government is taking a very pragmatic approach to the economy and the industries within it, though of course not everything it has done has been positive – not keeping some of its promises to the WTO, for example.

But on the example of the recent 100% reserve requirement ratio for online payment platforms, I don’t think it’s a question of not being able to adequately monitor the risk levels associated with the lending firms – I’m certain there’s the infrastructure for that – but at this point it’s probably a good idea to tighten up a bit for the sake of building trust and stability, even if that cuts back a bit on the revenues of Ant and Tencent.

Do I think there’s any threat from this? I wouldn’t say ‘threat.’ It was impossible that there wouldn’t end up being some regulation eventually. This applies to all the different spaces within ‘fintech’.

CER: The government has hinted it may loosen restrictions on foreign third-party payment companies like Visa and Mastercard. Do you think these companies have a future in China?

ZK: This conversation has been going on for many years now, with the government every couple of years putting out a carrot to tempt the likes of Visa and Mastercard. There’s a lot of talk at the higher levels about opening up the market, but there are a lot of details and red tape that prevent it from being realised. You can tick all the boxes on your application form to the finance regulators, but then fail a security check at the last minute. To make something of a bold statement: I don’t think we’ll see any of the major card providers making inroads into China until 2020.

There’s also the issue of how these companies are going to even market their card to the Chinese consumer base. Up to a couple of years ago, there were dual-branded cards, like Union Pay/Visa, which were pretty simple to acquire and fairly popular. The government discontinued this about a year and a half ago, leaving the only option of a single-branded Visa or MasterCard, which is potentially not as attractive. There have been some attempts by Western companies to differentiate on brand-cache, so if people carry a Visa or Mastercard it looks like they’ve made it, but I really don’t think Chinese buyers will care at all about the brand name on their card. Furthermore, the global presence of UnionPay is on the rise, with global acceptance, at ATMs, restaurants, growing rapidly.

CER: In 2017, we saw around two dozen Chinese fintech companies make US IPOs, yet over half of them have seen their stock drop below the offer price. Why do you think that is?

ZK: When you look at the success of China’s tech giants – Alibaba, JD, Baidu – it makes sense that everyone wants a piece of the market. Everyone wants some exposure to whoever’s going to be the next Jack Ma. But with P2P, where so many companies are now listing, I do struggle to see how companies really differentiate. There is some specificity in terms of markets, like those that target university students, others that deal with predominantly SMEs. And there are certainly a few individuals with top-class management and services. But I think the quality of the firms just isn’t there.

CER: How worried should we be about the recent panic surrounding China’s small P2P lending platforms?

ZK: The fact that P2P lending platforms are failing is not surprising. Many of these platforms had inadequate internal operational processes, poor lending practices, and in some cases, were just complete scams. What will be interesting to see is if retail investors will still want to put new money on these platforms. I get the impression at the moment that many investors are just trying to get their money out. Even if the P2P industry manages to right itself, it may find that all the investors are gone.

CER: What are the most exciting innovations taking place in China’s internet finance space?

ZK: What stands out to me is big data. The ability to analyse massive amounts of information and come up with detailed conclusions about an individual’s financial profile. This has immediate practical applications for the tech companies themselves. As an example, many merchants that use Alipay use a personal account instead of a merchant account. Ant Financial realizes this and will look at a person’s transactions to understand more about who they are. Consider the average person’s Alipay activity: it will look like a huge mesh of transactions from your phone to merchants, to banks, to friends, from friends to you, to companies. From a merchants’ perspective the situation is more of a hub-and-spoke model. So by using big data and analytics, the payment companies will be able to identify who is or isn’t a merchant, and whether or not they are using the correct account.

However, the largest application for big data would probably be in lending to SMEs. China’s banks, despite all being listed, have significant state ownership and therefore lend predominantly to state-owned companies. Why would a bank lend to an SME at 7.5% when it can lend to PetroChina at 7%?

A lot of the applications for big data in China make use of a lack of infrastructure in certain areas, where in the West such infrastructure is already set up. A common credit database would be a good example of that, where in the US, Equifax has been offering reliable credit data for years. That’s not to suggest that one market is ahead of the other, but there are just different requirements.

Blockchain is there too, but I don’t see it having as big of an effect as its publicity might suggest. We’re certainly seeing some rudimentary applications of blockchain by the big non-bank lenders and asset managers. But at the end of the day blockchain’s benefits are inefficiencies, but it doesn’t have the ability to change things as fundamentally as, say, AI or big data.

China’s Belt and Road Initiative promises to become the largest infrastructure-building program in world history by facilitating up to $1 trillion of development projects across Eurasia and Africa. And the project is already having a profound impact on one region in particular: Southeast Asia.

Beijing dreams of transforming the region by realizing the long-term vision of completing a “Pan-Asia Railway” connecting southwestern China with Singapore via countries including Laos, Thailand and Malaysia.

The railway could kick-start a fresh wave of economic development in a region with an acute lack of world-class infrastructure. But China also faces scepticism from many groups in Southeast Asia that question China’s motives and credibility as a lender and partner, as well as the long-term viability of a hugely costly project.

Will China be able to make its high-speed dream in Southeast Asia a reality? In his new book High-Speed Empire: Chinese Expansion and the Future of Southeast Asia, journalist Will Doig attempts to answer this question through on-the-ground reporting in the countries at the heart of the Chinese-led project.

As he tells China Economic Review in this interview, Doig found that the reality of Belt and Road is often radically different to the headline-grabbing announcements he had read about in the press.

CER: Could you give us an idea of the scale of China’s infrastructure investment of recent years in Southeast Asia?

WD: It’s interesting. China keeps the parameters of BRI [Belt and Road Initiative] very vague, and that’s a purposeful thing. It’s easier not to fail when you don’t have very specific goals. People talk about BRI as an infrastructure plan but it’s really not so much a plan, but an idea guided by Beijing that often plays out in these individual, ad-hoc, on-the-ground ways with strong provincial influence.

So, at this point I don’t think the scale of China’s involvement in the Pan-Asia Railway is nearly as big as it seems in press releases, ceremonial ground-breakings and summits, and so on. China is a country that is very conscious of how the world sees it and it often makes these projects seem more prominent than they actually are – indeed, sometimes doing itself a disservice because things seem disappointing if you overpromise.

This has certainly been the case with the Pan-Asia Railway. For instance, China announced that they were building a railway with Thailand years ago, but there is still not an inch of track on the ground. In fact, the only part of the Pan-Asia Railway that exists is a small stretch of railway in Laos that was started in the last year. The Pan-Asia Railway has pretty much been put under the umbrella of BRI to make the initiative seem more important, but the truth is that many of the individual projects were already in the pipeline years ago and would have gone ahead anyway.

CER: So despite the name Pan-Asia Railway, track-building has yet to really dominate the nature of projects going on in the region by China?

WD: Its important to remember that BRI is not just infrastructure. There’s also a large software element to it such as opening up trade routes, controlling supply chains and making borders more permeable. That is probably having more success at present, but it’s less visible than physical infrastructure development would be. You might even say that a lot of the projects going on are not the main focus of China at all, but are just add-ons to the central goal of building stronger relationships with local governments.

CER: What are the drawbacks and potential risks that the Southeast Asian nations take on by accepting the spread of Chinese influence through these infrastructure projects?

WD: The overwhelming dynamic with these projects in Southeast Asia is: these small countries want Chinese cash and investment but are fearful of sacrificing too much bargaining power and valuable assets. However, it varies widely depending on the country you’re talking about. Laos, the one country that China has really made progress on building the railway, is a poor, dysfunctional, highly corrupt country with basically no power right up against the border of China. This has allowed China to enter Laos with relative ease. Thailand, on the other hand, has more money, power, and can more easily push back on China, which we’ve seen.

There’s almost no country in this region, however, or indeed anywhere in the world, that just wants to tell China to take a hike. They want the investment and the attention, but some countries, like Thailand, have instead mastered the art of stalling or distracting from going ahead with deals. Thailand doesn’t need the railway – the reason it will cooperate on its construction is to be friendly with China. But they have continuously showed something of an enthusiastic indifference towards Chinese diplomats, inviting them to events and showing interest but never allowing progress to be made.

In general, China does better in weaker countries, like Laos and Pakistan, but comes across greater resistance where governments are more functional and have more international power. The success of BRI will really hinge on whether or not China can convince these slightly more powerful nations that BRI is in their best interests.

CER: How much of China’s investment could be considered ‘debt-trap diplomacy’?

WD: The idea of debt-trapping is basically that China convinces a country to partner with them on a major, expensive project, with China offering attractive loans as the main financing stream. But for whatever reason – their economy is too small or interest rates on the loans still prove too high – the recipient can’t pay the money back and is forced into an equity swap where it gives China control of the project it has just built, a perfect example of this being the Hambantota port in Sri Lanka. Alternatively, the debtor nation offers support to China’s other geostrategic aims in return for concessions on the repayment, as we have seen in Cambodia.

I’m not so sure it’s happening as widely as reports might imply, however. I recently sat on a panel with two investors in BRI who were adamant that China was not debt-trapping any of these nations. Now, this is of course somewhat expected, but on reflection I think that they’re right. What China is often doing is much subtler: making such high investments in one particular country does coerce it into feeling obliged to support China, without any explicit demands or statements from either side being necessary.

One place we were seeing this was in Malaysia under the last administration. Malaysia has claims in the South China Sea that overlap with China’s, but since China has such huge investments in Malaysia, it took a much more conciliatory tone on how to resolve the issue, whereas other countries with similar claims have been much more aggressive and resistant to China’s expansion there. This is the more common, and in a way the more nefarious, dynamic.

CER: What was the mood you gauged from the people you spoke to during your travels in the regions that may be affected by the Pan-Asia Railway?

WD: I was surprised at how much enthusiasm there was for China among the local people. I went out there naively thinking that China was imposing itself and everyone was frightened of the growing influence and loss of autonomy. But actually, there was a lot of excitement in these countries, who haven’t received attention from a superpower in the way that China is giving it to them now in a long time. Especially in the business community, less so the further down the economic chain.

In Laos, for instance, which is an incredibly underdeveloped country, I felt a lot of people in the northern areas closer to China where construction has began to take place were quite unaware of the meaning of these projects, and instead were just slightly disapproving of all the Chinese presence, which has transformed towns with migrant workers and their families.

This sort of resentment, from the people that don’t feel that they will benefit from the changes economically, may pose a different kind of problem on a smaller scale for China.

CER: In the months since the book was finished, we’ve seen examples of opposition to Chinese-funded projects in Myanmar, Malaysia and Vietnam. Do you think this is just a temporary setback for China, or the start of a major shift?

WD: I don’t think the pushback is going to be a problem for China – it will find some in certain countries and, although scepticism is indeed growing in some places, China is also at the same time offering such a once-in-a-lifetime opportunity to leapfrog up the development chain that that will win the day for China in the end.

China’s best-case scenario is that it becomes savvier in how it is conducting these deals and projects. Let’s remember that China is still a very recent entrant into the global development finance game with a lot to learn.

CER: Do you think that China’s current method of investment finance in Southeast Asia will be a success in producing the Pan-Asia Railway?

WD: Whether or not a contiguous Kunming-Singapore railway route is built will not determine whether China’s activity in the region is successful. That was never the aim, but just a useful way to package together what China wants to do. Realistically, no one is going to take a train from Kunming to Singapore. So, whilst it doesn’t make much sense as a transportation network, it does make sense as a series of smaller networks that could benefit China’s trade interests.

One example could be the plans to link the Rayong industrial zone on Thailand’s east coast with Bangkok – two places where China has massive economic interests and could pay dividends much higher than the scale of the route might suggest.

China will build parts of the Pan-Asia Railway, but not the whole thing. And that will be just fine for what the government wants to achieve, namely integrating trade areas and opening up new markets for investment.

Will Doig is a journalist covering urban development, infrastructure, transportation, sustainability, globalism and governance. His new book “High-Speed Empire: Chinese Expansion and the Future of Southeast Asia” can be found here.

By Mable-Ann Chang

Last month, China’s leaders unveiled possibly the most radical program of reforms the country has seen since 1978 at the annual “Two Sessions” meeting in Beijing.

Leading the headlines was of course the decision to change China’s constitution to remove the two-term limit on the presidency, opening the door for Xi Jinping to possibly rule far beyond 2022. But there were also sweeping changes to the government affecting over 20 different ministries, as well as hugely significant reforms giving the party much more influence over the government.

There is pretty much universal agreement that the reforms will have a significant impact on businesses operating here, but how exactly businesses will be affected is still unclear.

However, one man with a clearer sense of what the “Two Sessions” announcements will mean for foreign companies than almost anyone else is Andrew Polk, Co-founder of advisory firm Trivium China.

Trivium specialize in unpicking the byzantine workings of the Chinese government to provide insights on where China is heading for their clients, and the firm recently produced an in-depth report on the implications of this year’s “Two Sessions.”

In this interview with China Economic Review, Andrew shared some of the key findings from this report.

CER: How significant are the reforms announced during the “Two Sessions” in historical terms?

A: They’re momentous, about as historical as you can get, frankly. There were two main fronts to the reforms.

The first, obviously, was the scrapping of presidential term limits. Xi Jinping extending his rule beyond 2022 had been expected, but just because it wasn’t surprising doesn’t mean it was any less shocking. He finally came out and said it was going to happen, and that, some people would say, reverses everything Deng Xiaopeng had tried to do post-Mao by trying to institutionalise a peaceful transfer of power.

But the reality of things is that Xi is not necessarily saying that he is going to stay on for the rest of his life, although that’s how we all tend to read it. He may just want more time to finish his program. So, there are a lot of options between Xi stepping down in 2022 and Xi ruling for the rest of his life.

Secondly, there was the government reorganisation. It touched almost every minister under the State Council. There were three new ministries, 21 restructured ministries: the most widespread restructuring probably since the 1980s. Again, historical in nature and scope. Frankly, for your readers and for our clients, this will be more impactful in the short term. Over the long haul the removal of term limits will certainly play into China’s governance and political development, but that’s not going to make a difference really over the next five years. The government reorganisation, however, was having an effect last week.

CER: Could you break down some of the main aspects of that restructuring?

A: I think the best way to frame the result of the two meetings for companies is to put all these developments into four buckets: the first is government restructuring, which we’ll come to; second, personnel changes – new leadership at the very top and new ministers, in many cases at the very top; third is the policy map that they laid out pretty clearly, both for the next five years and for the rest of this year in particular; fourth, which we’ve somewhat lumped together, is the legislative agenda and the constitutional changes.

In terms of the reorganisation itself, I would say that there are a few key changes. The first is the establishment of the National Supervisory Commission. It’s a brand new branch of government, on equal standing with the National People’s Congress, the Supreme People’s Court and even the State Council. Its role is basically to broaden the corruption crackdown, which was previously run by the party. Their goal is to oversee every public official in China. Not just party members, but down to school teachers and doctors. The idea is that the corruption crackdown is going from looking at political correctness to policy implementation. Not only are they going to be looking to see if people are cheating, but also if people are doing their jobs well.

Some people might compare this to setting up Homeland Security after 9/11 in the US. But it’s actually much bigger than that. In reality, it’s more like you took the FBI and made it as big as the three branches of government – it’s that big.

CER: How will the reforms affect companies operating in China?

A: In terms of affecting business, there are two likely possibilities. Firstly, it could lead, in the best case scenario, to more consistent and effective policy implementation. One good example of this is the financial crackdown that we’ve seen over the past year. The authorities have made significant strides in reducing some of the most speculative activity in the financial sector. And the reason for this is that various commissions and regulators were going out to individual insurance companies and banks doing detailed inspections, with the backing of the discipline inspectors. So we saw a very quick movement in this space over the course of a year.

Unfortunately, there’s also the potential for over-implementation of policy. For years a complaint about China was: “the policy is pretty good at the centre, but the localities don’t implement it well.” However, recently we’ve seen the opposite of this. A good example is the switch over the winter from coal to gas: a target was set in the Northeast to increase the proportion of energy coming from gas, so officials went out and met these targets. A lot of businesses ended up shutting down, or a firm in their supply chain did. Households were literally left in the cold.

There’s the downside potential – a local regulator gets a directive from Beijing and just blindly follows it. In a perfect world the reforms would mean that policy is more consistent, which would be a huge improvement for MNCs and the business environment.

CER: There appeared to be two major thrusts to the reforms: one was centralising power in Beijing; and the other was a parallel move to strengthen the party’s grip over the government. How do those two dynamics interact? Do they contradict each other at all?

A: In my view, they don’t. You can view it like this: the first few years of Xi’s program have been about consolidating power at the centre, and the next five years or more will be about China consolidating power at the local levels, making sure that the localities listen to what the centre does.

In so doing, Xi wants the party to have a much more active and clearly delineated presence in policy making and implementation. Historically speaking, the party has always been there, but over the past 30 years there has been this move towards the party being more of a strategist whereas the government handles the details and implementation. Xi is saying that we want the party involved in an official capacity, not hiding in the shadows.

I would even argue that for businesses this could be a good thing. By being clear about the role of the party in decision-making, now businesses know who’s behind it all and who to talk to. If it’s happening, it may as well be happening in the open.

CER: Are you also seeing the party exerting greater influence over the private sector?

A: Oh, 100%. We talk to MNCs whose joint venture partners are being encouraged by the party to rewrite their articles of agreement to put party language explicitly into the JV agreement – that’s a big deal. There’s also a move among Chinese private companies, especially the big tech companies, to have the party take a nominal stake and board seat. That’s really my point: the influence has always been there, it’s now just happening more out in the open.

CER: What has been the general reaction to the “Two Sessions” from companies in China that you’ve spoken to?

A: Confusion. A lot of people just don’t understand how momentous this reorganisation is. They also don’t understand that the announcement of a party reorg doesn’t mean it will get done tomorrow but will be a years-long process with a lot of confusion on the government’s side and for businesses.

There is some consternation among foreign businesses regarding the party more generally, but on an individual basis there is a range of opinion. Some will say that our party cell has been quite helpful in understanding party KPIs, priorities, etc. Others will say that our party cell is more relaxed, and just leaves us alone as long as we tick their boxes. And others will say that our party cell really is weighing in more on strategic decision-making. This is of course the most concerning development.

CER: It appears that some of the reforms could prove to be quite helpful to businesses in the long term, as they will allow the government finally to tackle issues China has struggled to deal with in the past, such as pollution and debt levels. Do you agree?

A: This is what we do at Trivium: try to explain the government’s goals and how it plans to achieve these. The whole point of the reorganisation was to streamline government functions. That’s why the Market Regulatory Administration was set up – it took a bunch of functions previously dispersed among 10 or 12 different entities and put them all under one roof. The goal in the long term is that policy making is more straightforward, more consistent, and that businesses know more clearly who their government interlocutors are, without regulatory overlap and arbitrage, etc.

Will they be successful? This remains to be seen. As I said, there have been wins and losses. The financial and environment stuff has been initially successful, though there is still a lot that needs to be done and they made some mistakes along the way. How it’s all going to play out is difficult to say, but I think getting inside the government’s head and understanding its goals is a much greater starting point than what most people have.