China has raced to prop up threatened industries and preserve jobs, but will these moves drive a global recovery?

Hope never dies, particularly not when it can give the stockmarket a boost in uncertain times. When the financial crisis rolled out into a general economic downturn last year, the theory of “decoupling” raised its head, offering the prospect that China and other big emerging economies would be able to continue to grow in such a way as to keep the global economy afloat. That proved not to be the case as the BRICs (Brazil, Russia, India and China) felt the strain of sharply falling external demand and the tightening of capital flows.

But now it is back, buoyed largely by the not-as-bad-as-we-feared data coming out of China. Goldman Sachs, which first coined the BRIC acronym, has forecast that China will romp back into double-digit growth in 2010 and that its health plan will be a big driver of world recovery in the coming years as Chinese people stop saving in case they fall ill and spend their money on consumer goods instead. Meanwhile, Brazil will, according to the optimists, soon pull out of a short-lived recession, India will benefit from a stronger post-election political situation and Russia will be all right as sunnier times send up oil and gas prices.

All very comforting, on paper at least, and boosted by an improved forecast for 2009 growth from the World Bank. But, looking at the main source of the optimism, China, reality is rather less alluring. It would be amazing if the total of more than $1tn that has been thrown at the economy in fiscal and monetary stimulus this year does not produce astronger growth figure for the second quarter than for the first. Given the slice of the immensely enlarged volume of bank loans that have gone into corporate treasuries and the stock market, it would be surprising if companies do not look healthier and the Shanghai exchange index does not retain the increase seen this year – helped by a ban on new share issues that is only now being lifted.

Getting China out of the downturn was the prime political necessity for the Communist party and government this year. Though they do not face elections, party leader Hu Jintao and the prime minister, Wen Jiabao, cannot ignore public opinion, and have scrabbled since the end of last year to prop up threatened industries and preserve jobs. As a result of their largesse with abundant state funds, they may reach 8% growth by the end of 2009, bearing out Wen’s statements about China’s economic medicine being the right cure for the country and enabling Hu to claim that the benefits of one-party rule have been demonstrated. But that is only the start of the story.

The trouble is that the medicine looks much like a short-term palliative and that the increased sway the party is assuming over the economy is a distinctly retrograde step. China needs to change its post-1978 model to reduce its dependence on fixed-asset investment, property and exports while significantly increasing domestic consumption, moving industry up the value chain and boosting services. (That forms the essential backdrop to the Cif debate about China’s longer-term future, which seems at the moment to take too little account of economic, social and political realities.)

The growing conservatism of Hu’s regime and the emergence of consensus rule in the politburo may be welcomed as a switch away from the mad utopianism of the Mao era and the political stasis of the Deng years. All the indications are that the next leadership team of Xi Jinpingand Li Keqiang will be equally constrained. The interplay of interest groups and factions also tempers authoritarian decision-making at the top. But the combination of economic reform is likely to move China on to a more cautious path.

Thus, $580bn is being poured into a two-year infrastructure programme – which looks a lot until you examine the detail. Most of it would have been spent anyway – on earthquake relief in Sichuan or the much-need improvement of the railways and power grid. The central government is providing, at most, only a third of the funding: the rest comes from provincial governments and from loans. Since a lot of local authorities haven’t got the cash, the bank taps have been turned on: loans in the first three months of this year were as big as for all 2008.

The result, as regulators recognise, will be an increase in the bad loans that China spent much of the first part of this decade eradicating after a similar splurge during the Asian economic crisis at the turn of the century. The build-up of liquidity will fuel inflationary pressures with the prospect of stagflation next year. Tightening is probable in 2010, bringing with it the danger of business contraction that contributed to the present downturn as a result of the tougher monetary policy applied at the end of 2007 to check inflation.

Nor are infrastructure projects the most efficient way of creating jobs and, by their nature, they have a limited life. While they were meant to soak up the huge inventories of steel, iron ore and cement build up last summer, the exuberant reaction of companies to the stimulus package means that these stockpiles are growing once more. The big excess capacity problem that bedevils China is not getting any better. Slack external demand still drags down exports and, as other Asian countries (notably Japan) suffer, the volume of semi-finished goods sent to the mainland for final assembly and sale on world markets will decline.

Industrial policy is aiding big state firms, which will keep up employment levels in return and follow the leadership’s directives; private enterprise and small and medium-sized enterprises are not getting much of a look-in. Tax breaks that seek to help export industries risk cushioning low-margin, labour-intensive firms that China should not longer need. Household and corporate savings have shot up, hindering the consumption boost China requires. Though the property market is recovering from the sharp decline last year, buyers are still cautious. While the health programme contains big figures, its first years will be spent on building clinics, not providing services that would help to reduce precautionary savings, and the amount budgeted looks puny when divided by 1.3 billion people over 12 years.

The challenges to the regime abound. The rural revival the leadership wants will be sidelined so long as it continues to put land reform on the back burner for ideological reasons. A demographic black hole looms with a low retirement age, a fast-growing population of old people and a declining workforce due to the one-child policy. Wealth disparities, which Hu set out to reduce, have widened. Scores of mass protests occur each year – last weekend a crowd took over the middle of a town in central China after the mysterious death of a hotel chef and big squads of armed police had to be sent in to restore order. Meanwhile, in the political and legal spheres, any talk of relaxation of party control has gone out of the window – judicial reform has been rolled back and the crackdown on dissidents and the media continues apace.

This does not mean that the collapse of China predicted 10 years ago is any more likely than the people’s republic ruling the world, as Martin Jacques forecasts. There is no alternative to communist rule, which is why I think it will be able to get away without applying the enlightenment values Will Hutton believes it needs to espouse. What Hu and Wen are doing is quite understandable. They have to get through this year and hope for a better 2010 with a flourish of improved data in the coming months. Confidence, says the prime minister, is more valuable than gold. But the whole policy approach looks decidedly retrograde, more a matter of muddling through than of following a new policy prescription to move the Deng economic revolution forward. That can only hold the mainland back as it digs itself into the hole of its outdated model.

– Jonathan Fenby