The China syndrome: Year of the rabbit

As another Chinese New Year dawns this week, Jonathan Fenby assesses the world's second-biggest economic power - and charts the risks ahead

China enters its lunar new year on Thursday in anything but rabbit fashion. Having overtaken Japan to become the world's second biggest economy late in 2010, it has just unveiled economic figures that underline its continuing ability to deliver high levels of growth (10.3 per cent) accompanied by a string of superlatives – from having the world's biggest car market (13.8 million sales) to holding the largest cache of foreign reserves ($2.85trn). Goldman Sachs forecasts that the last major power ruled by a Communist Party will surpass the United States by 2027. Others see this happening earlier.

For many Americans, China's ascendancy appears already to be a fact: though the US economy is well over twice as big as China's, a recent poll of Americans showed 47 per cent naming China as the world's leading economy compared to 31 per cent who opted for their own country. The US magazine Forbes recently named the Chinese leader, Hu Jintao, as the most powerful man on earth. In a recent article, the historian Niall Ferguson wondered if, when they met at the G20 summit in South Korea in the autumn, President Barack Obama saw a thought balloon over Hu's head reading: "We are the masters now."

But such prowess conceals a series of challenges facing China. The challenge of the Year of the Rabbit will be for the leaders in Beijing to get to grips with a series of major problems, ranging from economic rebalancing to China's environmental crisis, from yawning wealth disparities to foreign relations. In this, one of their biggest obstacles may be the very record of success chalked up since Deng Xiaoping launched market-led economic reform in 1978. And all this in the run-up to a wholesale change of top leadership personnel at the end of 2012, as the fifth generation of Communist leaders moves into the saddle. How the nine men (and they are all men) now in charge and those who will succeed them perform will be of vital importance not only for the People's Republic but for the world.

It may seem tempting to assume that the outcome of that test is bound to be positive, given the success China has achieved over three decades in which more people have been made materially better off in a shorter space of time than ever before in human history. China drives world commodity markets, affecting economies from Angola to Australia. Chinese companies are buying into Sweden's Volvo car firm, power companies in Brazil, dairy farms in New Zealand and an oil refinery in Scotland, while also hoping that Washington will lift national security obstacles to their purchase of US hi-tech outfits.

With its rapidly swelling band of very rich people (at last count it housed 320,000 people with assets of more than £1m and scores of dollar billionaires in a population of 1.3 billion), China has become a magnet for Western luxury goods. It is the biggest market for fine wine from Bordeaux. Chinese buyers have sent prices for antiques they want to repatriate spiralling up, including £53m for a Qing dynasty vase found in a London attic. Smart Paris shops ration the number of items they will allow each Chinese tourist to buy. In the US, hotel chains are serving congee porridge for Chinese breakfast.

The low-priced goods that flow from China's manufacturing industry, with its combination of cheap labour and cheap capital, have been a boon to the countries of the developed world for three decades as the mainland has added hundreds of millions of workers to the global labour force. Even if they sometimes provoke protectionist reactions, these cheap exports have helped to hold down inflation while China's bond purchases out of its foreign reserves have provided the United States with loans to cover the federal deficit. That has kept down interest rates, leading to the charge that the consumer-and-housing boom in the US that led to the crash was really all China's fault – which is like blaming wine-growers for alcoholism.

Away from the economy, the sheer size of China and its population mean that the statistics from the mainland easily take on enormous proportions. It leads the world in cigarette smoking, mobile telephone and internet use. The country's biggest municipality, Chongqing, above the Three Gorges of the Yangtze River, contains 32 million people. State media report 13 million abortions each year, and the biggest manufacturer of condoms produces six billion annually.

The three decades of economic growth have seen the emergence of a middle class estimated at between 80million and 100 million people (depending on the definition). Discarding Maoist class warfare, the Communist Party has co-opted the middle classes by offering economic advancement that enables them to afford increasingly expensive homes, buy cars, pay for private health and education, and take holidays abroad. By keeping their interests in mind, the regime has been successful in seeing off the assumption that economic liberalisation would bring middle-class pressure for democratic political reform as happened in Europe and the United States. To be crude, one might say that the last thing a prosperous middle-class family in Shanghai wants is to see 700 million peasants given the vote.

When it comes to geopolitics, the present leadership in Beijing has shed Deng's advice to adopt a low profile to avoid rattling other major powers while China concentrated on its own growth. Hu Jintao, the Communist Party leader and State President, presented himself as President Obama's equal on a state visit to the United States this month. Late last year, China tussled with Japan over maritime disputes. It is building up its military strength, including the test flight of a stealth plane. When the pro-democracy dissident Liu Xiaobo – jailed for 11 years for advocating democracy - was awarded the Nobel Peace Prize last year, Beijing unleashed a barrage of attacks on what it depicted as an anti-Chinese "farce", undermining its "soft diplomacy" charm offensive and showing that it has no qualms about thumbing its nose at world opinion when it considers its national interests to be at stake.

So it is all too easy to assume that we must be living in the Chinese Century, in which the mainland will displace the West as the dominant force, and the "Beijing Model" will be lapped up by developing nations round the planet. At a time of uncertainty and confused politics in the West, China appears to some as a better organised, more rational state, the praise echoing the admiration philosophers of the 18th-century European Enlightenment felt for the imperial system of the Middle Kingdom on the other side of the world.

For the financier George Soros, "China has not only a more vigorous economy, but actually a better-functioning government than the United States". In their 2010 book, China Megatrends, the best-selling American futurologists John and Doris Naisbitt portray the country as the source of "an entirely new social and economic system" which will challenge Western democracy. The writer Martin Jacques entitled his book on China's renaissance quite simply When China Rules the World.

On the other side there are, of course, sceptics who prophesy The Coming Collapse of China, to quote the title of a book by the American Gordon Chang first published 10 years ago. More recently, the hedge fund manager Jim Chanos has predicted that the country is "on a treadmill to hell" because of its over-extended property sector. Surprisingly, perhaps, some of China's top officials also have doubts. In 2007, the Prime Minister, Wen Jiabao, warned that the economy was "unsteady, unbalanced, unco-ordinated and unsustainable". Last August, Wen broke ranks again to say political and legal reforms were needed to maintain economic progress; otherwise, he predicted, China was headed for "perdition".

Yet the China bulls have all the evidence of the last three decades on their side. The collapse of China, first forecast a decade ago, still looks unlikely. By and large, foreign leaders accept China for what China's leaders say it is. Beijing insists on the need for governments to respect one another's interests, concerns and sovereignty, as Hu did pointedly during his recent visit to Washington – in other words, "keep off our turf". The onward march of the dragon seems too inevitable to quibble with.

But the changes needed may prove even more testing than those launched by Deng after he won the power struggle following the death of Mao Zedong. The reality is that China is unfinished business. This is hardly surprising given that the process started by Deng in 1978 has had to reverse more than a century of decline marked by internal weaknesses, regime change, civil wars, ineffective government, warlordism on a national scale and foreign interventions, not only in the shape of the European traders in their treaty ports but also the much larger-scale and more brutal Japanese invasions in 1894-95 and 1931-45.

The Chinese regime naturally takes pride in the way in which the country has, to use Mao's phrase in 1949, "stood up again". Under Deng and his successors, Jiang Zemin and now Hu, it has done so in a much more convincing fashion than in the Great Helmsman's 27 years in power, during which wholesale land reform was followed by vast political persecution campaigns, the disastrous Great Leap Forward famine that killed up to 45 million people, and the chaos of the 10 years of the Cultural Revolution. Since Mao's death in 1976, the leadership has ditched his adventurist pursuit of revolution and his horribly misguided utopianism to opt for a more managerial style of running a one-party state.

This does not mean that China's rulers have flinched from force to assert the party's authority, notably when the army put down the protests by students and other citizens in Beijing on 4 June 1989 or, more recently, when the regime repressed outbreaks of anger by Tibetans and the Uighurs of the vast western territory of Xinjiang. Though individual liberties have increased, human rights activists and lawyers are relentlessly persecuted, along with anybody seen as a potential threat to the regime. The rule of law is very fragile – China is under "rule by law" in a tradition stretching back to the First Emperor of 221BC, who believed that it was best used to keep the people in line rather than to hand out fairness or justice. The official budget for internal security is almost as big as that of the armed forces.

Still, Wen was right when he suddenly went off-message last summer and called for reform, even if he was promptly slapped down by colleagues in the Communist Party Politburo that ranks above his government in the pecking order. The problem is that those who hold the supreme positions in the party have one underlying aim – to ensure the continuation of the regime. Though Mao's face still looks out over Tiananmen Square, their main tool to achieve this has been economic expansion, and they are, understandably, wary of doing anything that could jeopardise continued high growth.

It is not that they do not recognise the need for change. A year ago, Wen's likely successor as prime minister, Li Keqiang, who visited Britain this month, presented a sobering report to a closed meeting of the leadership in which he clearly acknowledged that there must be action on fundamental problems and imbalances such as the relative weakness of consumption, excessive dependence on exports, the unbalanced fiscal system and the low pricing of resources such as energy and water, which leads to inefficient over-use. The basic message of his report, barely reported outside China, was that China had "paid a heavy price" for its economic progress and now needs to set a fresh and more sustainable course.

Officials agree that, in theory at least, the People's Republic has to rely less on investment in huge infrastructure projects, property development and easy credit, which enabled it to get out of its 2008 downturn thanks to a huge stimulus package. It needs to reduce the yawning wealth disparities that have grown up in the past decades; polls are reporting rising levels of alienation over living standards. The leaders must also get to grips with the ecological crisis that poisons the air, pollutes the water supply, destroys arable land and forests and causes deaths from lead poisoning. They must introduce a fair legal system, even if this means putting party officials under the law, and move towards a system of greater accountability, if not outright competitive elections.

But influential industrial and commercial lobbies throw their weight against change. Regional bosses want to continue to build up the local industries that underpin their power bases. At the centre, the party is wary of any change that might weaken its control. Hu operates as chairman of the board, and the same will probably be true of his successor, Xi Jinping. This is not a recipe for the kind of bold changes the country is going to need.

China is so big and varied, and has such a large population that it will always be extremely hard to govern. In more than 2,000 years of imperial history, dynasties came and went. Each had to retain the Mandate of Heaven by showing its fitness to rule; otherwise, in popular mythology, China would be visited by earthquakes, floods, droughts and pestilences to show it was time for change.

Though the country still suffers from recurrent natural disasters (northern China is being hit by a long drought right now), the verdict on the present dynasty is likely to be primarily economic. Keeping the ship Deng launched afloat is not a matter of a political party winning a general election (which the People's Republic does not have) but of preserving the regime as a whole and ensuring the mass of the population values the benefits the current system brings.

The question for the Year of the Rabbit and beyond is whether, in that context, the rulers will have the nerve and skill to alter what has been a winning formula to evolve a new model China without upsetting the basic calculus that underpins their regime. Given China's importance, that is an issue which will affect the planet as a whole in the years to come.

Jonathan Fenby is author of The Penguin History of Modern China and director for China of the research service Trusted Sources ( www.trustedsources.co.uk)

A greater leap forward

1949 Mao Zedong leads Communists to victory over the nationalists after the 20-year Chinese civil war.

1958 The "Great Leap Forward" economic plan is introduced by Chairman Mao, leading to an unsuccessful collectivised farming industry which causes the deaths by starvation of millions due to poor harvests. It is abandoned after two years.

1966 Mao's "Cultural Revolution" begins, bringing wide-reaching change to the country's social, political and economic environment.

1977 Mao's death leads to a political battle for the succession among the "gang of four". Each is arrested for crimes against the state, however, and the former leader is replaced by Deng Xiaoping a year later.

1978 Party leaders conclude Mao's centrally planned economy has failed and undertake a programme of gradual but fundamental reform.

1989 Demonstrations in Tiananmen Square lead to 200 civilian deaths. Sanctions are imposed amid international outcry.

2003 Current President, Hu Jintao, is chosen to lead China, replacing Jiang Zemin.

2010 China surpasses Japan to become the world's second largest economy, behind the US.