BEIJING—This Saturday, rookie Chinese President Xi Jinping will launch what is being billed as the most important conclave of Chinese leaders since 1978, the year that Deng Xiaoping transformed China from a dying Red giant into a market-driven dynamo. ("Seek truth from facts," rather than communist ideology, he said.) The historic "Third Plenum" of Xi's term is meant to signal that he has consolidated power, decided on a direction for the country, and achieved consensus with the political class. Xi, a pragmatic, worldly apparatchik who likes to reminisce about the happy sabbatical he spent in Iowa as an agriculture student, is by all accounts immensely popular with the people, though of course true political polling doesn't exist in this still-censored country.
Although China's growth has stumbled this year in tandem with the global slowdown, Xi's ambitious reform agenda hopes to power its continued rise. China is already the world's second-biggest economy, after the United States; its purchasing power, as it shifts from a producing economy to a consuming economy, commands deference across the world. Xi pledges an economic and political transformation to weaken special-interest groups—including big, slow-moving state-owned enterprises, corrupt officials, huge bureaucracies, and kleptocratic local governments—that have acted recently as a drag on the country's otherwise remarkable economic ascent.
China's apotheosis, in other words, seems unstoppable. When the Pew Research Center surveyed 38,000 people in 39 countries over the summer, it found that the vast majority "believe the global balance of power is shifting.… China's economic power is on the rise, and many think it will eventually supplant the United States as the world's dominant superpower." In Washington, the Obama administration has touted a "pivot" of U.S. interests to Asia that Beijing believes is intended to counter its ascent.
Yet there are just as many signs today that China is in deep trouble. America and the rest of the world should be less concerned about a rising China than about a sputtering—or even a crashing—China that could someday turn the world economy's greatest growth center into a global albatross.
Start with this week's confab, the third time Xi will lead a plenary session of the Central Committee. Despite all the triumphal talk, it is less a coronation than a reckoning. Leaders, starting with Xi, have come to realize that as China's economy matures, its get-rich-quick machine is slowing down. This year, the economy is set to grow at 7.5 percent, its slackest pace in 23 years—a dream for any other economy (and more than twice the rate in the United States and Japan) but a sign of danger here.
As the film of smog reminds big-city residents several times a week, growth has come at a cost. Mounds of debt, from municipalities (which owe $3.1 trillion) on up, dog the country, as does a declining private-sector cash flow; a real-estate bubble fed by a growing and scary "shadow banking system" that China's own regulators have likened to a Ponzi scheme; and a raft of looming Communist Party power skirmishes. So the government can't simply stoke the flame: "We are making too many bubbles if we keep stimulating the economy," says one high-ranking party official who asked to remain anonymous. "A slowdown is inevitable. When you look at productivity, you can see that the way we were producing GDP was not always healthy."
Already, China may be stumbling toward a precipice. "The real economy is slowing; the speculative economy is growing," says Patrick Chovanec, an asset-management strategist based in Asia and a former professor at Tsinghua University's School of Economics and Management in Beijing. "They're riding a tiger, and they don't know how to get off.... China is well along the process of a hard landing."
Economists and China hands increasingly say the nation needs political reform—the freedoms that will spark an innovative rather than imitative economy, and a legal system that will enforce the rule of law, critical to a developed economy. (How long will citizens trade the right to political self-expression for economic enrichment, they wonder?) Yet 35 years after Deng's historic plenum, the sclerotic authoritarianism left over from a bygone era may not prove supple enough to master the challenge. It's more than a decade since China joined the World Trade Organization, but the rule of law is still not a priority, and the system of accountability is a running joke around the world. The richest top 50 Chinese politicians have amassed some $95 billion in wealth, nearly 100 times more than the collective assets of the 50 wealthiest members of the U.S. Congress, The Economist reported. "You've taken an extant model as far as it can go," says Jonathan Pollack of the Brookings Institution. "Therefore, unless there is political will to shape different kinds of outcomes, then we may be dealing with much more troubled economic performance."
Other problems: The ever-worsening environment regularly shuts down cities as officials scramble to reverse the darkness-at-noon phenomenon. The birth rate, thanks to the one-child policy (which Beijing is expected to relax soon), is just 1.58 births per woman—a looming demographic time bomb. Pension assets are only about 1 percent of gross domestic product, compared with around 70 percent in the United States, meaning people will be less willing to take risks and the burden of support will fall on a smaller, younger generation. "The Chinese people are worried they will be old before they are rich," says Victor K. Fung, chairman of the Fung Global Institute in Hong Kong.
So while Xi's agenda looks impressive, in fact it is evidence of the party's anxiety. Under his "383 plan"—so named because it covers three main areas (the market, government, and corporations); addresses eight key sectors; and deploys three packages of reforms—Xi is seeking to transform China from top to bottom as it nears the end of its phase as a developing, manufacturing-driven economy over the next two decades. Among other changes, Xi wants to open up the services sector, cut red-tape administrative approvals, promote more competition, reform land laws, liberalize banking (including interest rates and the exchange rate), set up basic social-security nets, rein in state-owned enterprises, and promote innovation, including green technology. It's quite a list. Elites here say their country needs a version of America's Progressive era.
U.S. experts and officials are skeptical about Xi's goals, especially key items such as curbing the power and corruption of the state-owned enterprises that still dominate the economy. Many party officials worry about loosening the shackles; they cite the precedent of Mikhail Gorbachev, whose reforms got ahead of him and unraveled the Soviet Union. "I don't get the sense there is much discussion of SOE restructuring and privatization," Robert Dohner, deputy assistant U.S. Treasury secretary for Asia, said recently at a luncheon at the Center for the National Interest in Washington. And even if the intent to change is genuine, it's still a long list of very complicated tasks with very high stakes. As the Chinese themselves point out, the easy part is already done.
While the party remains firmly in control, social unrest laps at seemingly stable islands like Beijing and Shanghai. Chinese social media reveal deepening cynicism about government (albeit not outright revolt). Only a week ago, a discontented family of three Uighurs—an oppressed group of Turkic-speaking Chinese from the country's far west—plowed a car into a crowd at Tiananmen Square, killing themselves and two bystanders. For decades, China has urbanized many rural poor as a way to pump low-cost labor into its vast manufacturing machine. The policy has forced the government to create 10 million jobs per year (on pain of civil discontent and lost legitimacy) and keep 200 million migrant workers around the country tethered to second-class lives under the hukou system of household registration. And, in the past four years, more than 50 farmers have immolated themselves to protest the land seizures that come with urban sprawl.
Previously touted reforms, such as the Shanghai free-trade zone—billed as a model—have amounted to nearly nothing so far: Almost no foreign companies have invested there. To little notice, since last June the People's Bank of China has been injecting TARP-sized amounts of money into the ailing shadow banking system (at least $70 billion in the third quarter), suggesting that if China possessed a more market-based system, it might have crashed already. "Reform of lending here is probably more important than opening to the world," says Ye Yu, an analyst at the government-funded Shanghai Institutes for International Studies. "The Chinese financial-services sector is not mature, not flexible. It's rigid. Its interest rate is still fixed, not market-driven. And the financial infrastructure doesn't have deposit insurance." In fact, the Bank for International Settlements recently pointed to a dramatic increase in overseas dollar borrowing by Chinese companies that suggests a panicky demand for credit.
In a study published earlier this year, Oxford University economist Linda Yueh found that most of China's economic progress "is essentially the result of one-off dividends that flowed from the reforms that began in 1979, namely the disassembling of many SOEs and the relocation of millions of farmworkers from the country's rural interior to the cities and factories along the coast." Those moves explain more than 85 percent of China's total factor productivity, which measures how efficiently an economy turns labor and capital into output. Without new sources of productivity, all the government can do is invest more with diminishing returns, as appears to be happening now.
None of this indicates that China is trending toward hegemon, or even toward a fully developed economy.
IMAGE VS. REALITY
When the weather is nice, this city makes you feel like anything is possible. Paris shows off with a few broad boulevards that cross the warrens, but every avenue in Beijing is like a parade ground—people are walking quickly to work; sitting on stoops and chatting; hawking street-side snacks and handbags; and honking their car horns. It thrums in the way only a city of more than 20 million can. The skyline announces China's rise with a panorama of peacocking "starchitecture": in the foreground, striking buildings designed by famous people for a lot of money; in the distance, apartment towers as far as the eye can see.
But Beijing has more and more bad days, too, when the sense of organic possibility yields to a feeling of cancerous claustrophobia. Without wind or rain, the air chokes with fumes. The apartment towers vanish, and the showy glass buildings blur. Eyes itch and redden by mid-afternoon. Traffic snarls. (Each weekday, cars with plates ending in certain digits are forbidden to drive.) Surgical masks proliferate. The sun hides behind a smoggy veil. People see, talk, and smell through a gray medium. Some parents admit they don't let their children play outdoors. The World Health Organization says the safe pollution rate is 0-50 micrograms of dangerous airborne particles per cubic meter. Above 300, the U.S. Embassy warns: "Everyone should avoid all physical activity outdoors." Beijing's rate technically tops out at 500 on the embassy's scale (20 times the safe rate); it was 426 during a visit last week, and reached an actual 755 earlier this year.
The Chinese, still aglow with pride over the successful 2008 Olympic Games, are acutely aware of the environmental stigma. (China's major cities are anathema to some of the world's most-sought-after scientists, entrepreneurs, and tech experts.) Xi Jinping knows that the key to reining in runaway industrial pollution, as with so many other things, is cracking down on corrupt violators, especially in the provinces, where corporations will go into smaller towns and simply buy up local officials. "In China, it is very important for the central authorities to set tough targets and for senior leaders to clearly signify their concerns so that priorities are understood by local authorities," says Christine Loh, Hong Kong's undersecretary for the environment. So far, no provincial leaders have been dismissed for failing to meet cleanup targets.
Similarly, Xi's approach to corruption is anything but innovative; instead, it recalls the party purges of the 1960s and a return to Maoism. Last summer, a senior Chinese official actually demanded that 30 foreign firms, including General Electric and Siemens, write "self-criticisms," as if it were the Cultural Revolution all over again, Reuters reported. The official insisted they confess any antitrust violations and warned that if they resorted to a legal defense, their penalties would only stiffen. Recently, Xi's government showily tried rising party star Bo Xilai and sentenced him to life imprisonment for embezzlement, abuse of power, and accepting bribes. It's more semiotics than justice—an attempt to demonstrate that the party is still legitimate and can reinvent itself. It may also buy Xi the political capital he needs to push through economic reform. "The optimist case would be that in China, when you're prepared to move right on economics, move left on politics to buy yourself some running room," says Pollack.
Xi's approach may not work, especially when it comes to the rough treatment of foreigners. For a long time, the Chinese have been able to get away with what trade negotiators used to call "The Lecture." Because of the vast size of China's 1.3 billion-strong market, the Chinese would insist that foreigners do business according to their rules. Most foreign companies—whether computer makers envisioning 1.3 billion desktops or deodorant firms contemplating twice that many armpits—would quail before the implied threat.
China is still a huge, sought-after market, but it is no longer considered such a uniquely attractive place to invest, in part because of the increasing cost of its labor relative to other new or opening markets. Rapid advances in robotics, artificial intelligence, 3-D printing, and other technologies have also eroded China's advantage by reducing labor costs everywhere. Not surprisingly, multinationals like General Electric and Apple have begun to manufacture again in the United States. Foreign CEOs "are saying they're unhappy, that the cost of doing business has gone up," says Bill Reinsch, president of the National Foreign Trade Council. "But whereas for the past few years the problems were generally or mostly in the [intellectual-property] area, now they're talking about the overall cost of doing business."
And foreign companies won't jump in to capitalize as readily on (decreasingly) cheap labor without an independent judicial system through which to contest erratic regulatory enforcement and appeal corporate seizures. "We need more social forces to play the role of whistle-blowers, watchdogs," says Chen Dongxia, the president of the Shanghai Institutes. At the same time, Reinsch says, "the growth of new U.S. foreign direct investment in China is going to decline," because "it's quintessentially American to look for next big thing. China is, in that sense, old news."
WHAT CHINA NEEDS
Unlike Gorbachev, Xi has a much better shot at remaking a system that is still very dynamic. And the United States will gain far more from wishing him success—and helping him to achieve it—than by rooting for his failure or trying to contain him, which many Chinese intellectuals believe is the real intention of the Asia pivot. American officials don't deny that the "rebalancing" of U.S. interests, including the announcement last year that 60 percent of American naval assets would shift to the Pacific by 2020, is largely about China. The United States is simultaneously beefing up its partnership with India, renewing military ties with the Philippines, and assembling a Trans-Pacific Partnership for trade that doesn't include China—but could, if Beijing agreed to labor, intellectual-property, and environmental restrictions that it has previously spurned.
American strategic worries about China are not entirely without merit, of course: China's cyberassaults on U.S. infrastructure, including the Pentagon, for instance, are unrelenting. But in interviews here this week, on a trip sponsored by the nonprofit Committee of 100, a U.S. organization committed to better bilateral understanding, it's clear that Beijing is far more concerned about its internal problems—one reason, perhaps, it has been so slow to invest in a "blue-water" navy or other traditional means of force projection.
That's why America ought to be shoring China up right now, not seeking to contain it. The United States has its own political and economic problems that have kept growth under 3 percent since the 2008 financial crisis. So does Europe, which continues to grapple with its collective failure to stimulate growth. By these reckonings, the Chinese look less dysfunctional. Their system has lifted hundreds of millions of people out of poverty in just three decades, easily the most stunning human-development achievement in world history, and it is still the primary source of growth in the global economy. The government has definitely delivered—which is why ordinary citizens harbor a fair amount of goodwill and patience, and why the party will likely remain entrenched for a long time. "In 10 years, China will invest $500 billion overseas, import $10 trillion from other countries, and send 400,000 students abroad" who will bring home the best practices and ideas, says another high-ranking official, summing up the government's vision. Probably China will muddle through the coming decades at a slower but still successful rate of growth.
The best thing U.S. and Western policymakers can do is to keep pushing the Chinese along the path they've lurched down since the days of Deng—toward opening up, rather than cracking down. One means at hand: the Trans-Pacific Partnership, which is intended to force Beijing into guaranteeing IP and other rights. "The Chinese attitude toward TPP has evolved from deep geopolitical suspicion," says the Shanghai Institutes' Ye, who compares it to the way WTO accession forced change. Now the party is "deliberately using TPP as one of the major external driving forces to push forward the tough domestic reform agenda." The U.S. also needs to cajole Beijing to float its currency freely rather than pursue beggar-thy-neighbor devaluation policies that have allowed China to maintain its export might. And, of course, Beijing isn't nearly as serious about capping carbon emissions as many other large economies are.
Obama administration officials say they are, in fact, rooting for the Communist Party to pull off its transition. "Broadly speaking, we want a prosperous and successful China," an administration official tells National Journal. Most Chinese, in turn, acknowledge how deeply entangled the U.S. and Chinese economies are—and will remain. They say, with apparent sincerity, that they are mainly seeking to emulate America's prestige and success, not surpass it. Despite efforts, wishes, and pledges, the renminbi will never be a global reserve currency, meaning that nations won't acquire boatloads of Chinese debt to finance the country's development. And as a buyer of U.S. debt, China is unlikely to find an alternative, despite recent calls for the "de-Americanization" of the reserves after the shutdown and debt-ceiling standoffs. One major institutional investor says that, while Washington has disappointed China, so have emerging markets.
In the end, China doesn't need to be a rising hegemon. It only needs to succeed.
CORRECTION: An earlier version of this story suggested that Deng Xiaoping's historic conclave took place in 1988; it was actually 1978.
This article appears in the November 9, 2013 edition of National Journal Magazine as The Myth of the Dragon.