Are we now Seeing Peak Russia and Peak China?

Analysis

Are there darker clouds on the horizon for Russia and China? Photo by FreshStock / Shutterstock.com

Photo by FreshStock / Shutterstock.com

The question contained in the title is perhaps a strange one to ask at a time when these two countries seem so powerful and aggressive, the former attacking Ukraine and the latter threatening to take Taiwan. Yet just as we saw Peak Japan around 1990, the evidence is mounting that Russia and China are heading down a similar path, for different reasons says corporate finance columnist Les Nemethy.

Russia has punched above its weight politically and militarily, thanks to the largest arsenal of nuclear weapons in the world, a leftover from the Soviet era. But its GDP is merely in the order of magnitude of Spain or Canada. 

Russia’s attempt to annex Ukraine has exposed the limits of the former’s conventional military power. Although Russia’s nuclear threat remains, perhaps the major constraint to its use is the difficulty of creating a winning scenario. 

At a fundamental level, Russia’s decline is driven by demographics. With alcoholism rife, a horrible medical system (according to Rand Corporation, Russia has the lowest male life expectancy of any developed country at 58 years), and a low birth rate.

The U.S. Bureau of Census estimates that Russia’s rapidly greying population will decline from approximately 140 million today to around 110 million by 2050. The above estimate predated the invasion of Ukraine, which triggered the emigration of hundreds of thousands of young males and the death of tens of thousands on the battlefield. 

Many of those emigrating are talented entrepreneurs, IT workers, and the like; it is a veritable brain drain. Russia’s demographic implosion will impact its economic strength and the ability to project political and military power. And it is inevitable: it would take 30 years to reverse.

According to geopolitical analyst Peter Zeihan, it is precisely this rapidly weakening situation that tempted Putin to seize Ukraine before Russia experiences further relative decline.

China: Similar but Different

China, meanwhile, sees a similar pattern of demographic demise, but for different reasons. The “one child” policy in place from 1980-2015 limited the majority of families to one child, making population decline inevitable.

An excess of 30 million more males than females further limits new family formation. According to the Hong Kong-based daily South China Morning Post, the population of China is expected to halve from its current level of around 1.4 billion by 2050. This would indubitably impact GDP and superpower ambitions.

Several drivers fueled the 6%+ GDP growth rates over past decades: 

1. Massive stimulus from rapid debt growth. According to the Institute ofInternational Finance, Chinese debt now exceeds 335% of GDP. Since 2008, debt has been growing far faster than GDP.

2. An enormous construction boom. It consumed close to a quarter of GDP, something likely never to be seen again, given that China’s property sector is way overbuilt and in crisis.

3. China became the factory of the world. Now, however, globalization is in reverse, or at least seems to be taking a pause, with security of supply very much in vogue.

None of this is sustainable. China’s economic growth in the first half of 2022 was a mere 2.5%.

The centralization and autocracy of China’s leadership (including its determination to adhere to a zero-COVID policy) negatively impacts investment, entrepreneurship, capital flows and emigration. 

Chinese President Xi Jinping’s push for “common prosperity” to reduce the income and wealth gap and his call at the recent party congress for “regulating the mechanism of wealth accumulation” will further dampen entrepreneurship and catalyze capital flight.

Changing Mood Music

Financial markets are experiencing asignificant change in mood in China: post-party-Congress Chinese stock market indices and yuan exchange rates are plunging. Unless the government changes its tune, the trend will be difficult to reverse.

While China’s economy is already larger than that of the United States measured according to purchasing power parity (PPP) terms, the Center for Economics and Business Research forecasts 2028 as the date when China will surpass America in absolute terms. In my view, this is far from inevitable.

China may be tempted to seize Taiwan for reasons similar to Russia’s attempted land grab in Ukraine: before its power relative to the United States begins to wane. 

I do not mean to belittle the issues facing America (extreme political polarization, high debt levels, etc.), but, ultimately, the United States has a more powerful entrepreneurial and deeper technological base andmuch better demographics than either Russia or China. America has far more immigration and its baby boomers had more children than those in Russia or China. 

The democratic system allows for renewal and fresh ideas every four years instead of being locked into an autocratic leader for decades. Putin and Xi are on the way to transforming their countries into gerontocracies, states run by older people. 

Intuitively, it makes sense that societies where information flows freely are more innovative and productive. Remember the “open society” thesis for the United States winning the Cold War? 

For the past 30 years, both China and Russia went through a period of relative openness, which allowed them to mount asignificant challenge to the States. Their sudden lurch back to closed systems may sow the seeds of their own demise. They are their own worst enemies.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (www.europhoenix.com), a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (www.businessexitplanningbook.com), and a previous president ofthe American Chamber ofCommerce in Hungary.

This article was first published in the Budapest Business Journal print issue of November 7, 2022.

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