Chinese living standards are approaching the level where democratisation is normally set in motion

The implicit contract between the Chinese state and its citizens under which the latter abstain from political or economic protest provided the government delivers economic growth is under threat. As the countrys standard of living improves social unrest is both increasing and changing character. China is currently approaching a level of affluence which research has shown increases the likelihood of democratisation. Indeed, protests appear to be refocusing from economic to political issues. However, what is at stake is not the overthrow of government but rather the reform of the countrys political system. From such a perspective, violent and dramatic transformation is unlikely. Changes to Chinas present political system are expected to be slow and gradual.

WEDNESDAY 21 DECEMBER 2011

class therefore implies that political demands will continue to increase. Przeworski and Limongi (1997) [see ref. list] suggest that autocracies are likely to undergo democratisation when their standard of living reaches between USD 5,000-6,000 per capita. Assuming that Chinas GDP per capita increases at 7 per cent per annum going forward, in our view a fairly conservative estimate, the country will post per capita annual income of approximately USD 5,500 by 2013-2014.

RISING LIVING STANDARDS INTENSIFY AND CHANGE THE CHARACTER OF PROTESTS. The economic theory of unrest that has so far proved decisive in China has assumed that social stability depends on the ability of government to deliver economic growth. However, rapid growth has not diminished the scale of protests; instead greater economic security has empowered citizens to defend their rights with even greater vigour. In short, economic development has led to an escalation in popular economic and political demands. We think it highly unlikely the Chinese government will be able to continue to contain social unrest by delivering strong economic growth. Economist Paul Collier recently theorised that, unlike democracies, autocracies experience greater popular unrest as they grow richer. Research has shown that middle and high income households consistently attach greater significance to free speech and fair elections than their poorer counterparts. The continuing growth of Chinas middle

This argument is supported by estimates which suggest that the number of so-called mass incidents in China is increasing. The nature of these demonstrations or acts of resistance is also changing character. A decade ago protests mainly concerned layoffs resulting from privatisation of state-owned enterprises and the impact of economic reform. However, in recent years social unrest has focused on a wider range of issues including corruption, inequality, the environment, land sales, and ethnic tensions. The problem currently facing China lies in the administrations unwillingness to allow political reforms, while at the same time facing the growth of an increasingly educated, self-interested, and wealthy population with internet access .
1

This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice. Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of investment business in the UK.

Economic Insights

The most significant protests in 2011 have included the widespread public criticism sparked by the governments clumsy handling of the high-speed train collision in Wenzhou, demands for closure of a toxic chemical plant in Dalian and a school bus accident in the Gansu province. Meanwhile, conflict continues in the town of Wukan, a situation exemplifying how violent protests against government land acquisitions are growing in intensity and regularity. Thousands of residents have staged protests against the sale of farmland to property developers resulting in violent confrontations with the police. Such land sales are important to the political administration, constituting a major source of revenue for local governments. PROTESTS ARE ALREADY INFLUENCING GOVERNMENT POLICY. The Dalian toxic chemical plant was closed down while the school bus accident forced government to improve safety standards. Also likely to result in protests and demands for reform, the healthcare system is inadequate while the elderly require far greater resources. To try to contain protests, the government is likely to increase social spending, a policy fully consistent with its ambition to change Chinas growth model from one based on investment and exports to one where increasing consumer spending is a corner stone. To encourage citizens to save less and spend more, the government must expand social security systems including pensions and unemployment benefits, in all likelihood a protracted reform process. FOCUS OF PROTESTS IS STARTING TO SHIFT FROM ECONOMIC TO POLITICAL ISSUES. So far, citizens have generally focused on concrete issues related to land rights, corruption, wages and the environment rather than political concerns. Few, if any, protests have concerned real democracy problems. However, that appears to be changing. In Wukan, unrest has developed into something more than just a land dispute; citizens are now questioning the local governance of the Communist Party and party officials have been dismissed as a result. The situation in Wukan has not yet been resolved (residents and police remain dead-locked observed by the global media) but indications are that protests may take a new direction, switching from economic to political issues. So far protesters in Wukan and elsewhere have expressed support and appreciation for the Communist Party at national level. What is at stake is not an attempt to overthrow government but instead to reform the political system. A dramatic and violent confrontation is unlikely with changes to Chinas political system are expected to take place slowly.

MEDIUM-TERM ECONOMIC OUTLOOK. We round off this Economic Insight with a brief overview of SEBs view on Chinas economic outlook. Business activity is slowing. The Purchasing Managers Index is at a historically low level. Exports are being hurt by the debt crisis and growth slow down in the euro zone. GDP growth in China is expected to bottom out during the first half of 2012 but recover slightly in the second. SEB expects GDP to rise by 9.1 per cent in 2011 and by 8.0 per cent in 2012 followed by a slight acceleration to 8.2 per cent in 2013. Risks of a hard landing have increased as a result of a negative dynamic connected to the housing market, the financial sector and local government debt. However, our main scenario is that China can avoid a sharp contraction in growth.

Inflation has fallen sharply to 4.2 per cent in November, enabling government to move away from trying to control inflation and instead starting to ease monetary policy. We forecast inflation of 4.2 per cent in 2012 and 4.0 per cent in 2013; the government target for 2011 was 4 per cent.

References Przeworski, A. and Limongi, F. (1997), Modernization: Theories and Facts, World Politics, Vol. 49, No.2.

Andreas Johnson SEB Economic Research + 46 73 523 77 25 andreas.johnson@seb.se