China: Confronting the Brutal Facts [White Paper]

CHINA
CONFRONTING
THE BRUTAL
FACTSFACTS

Contents
The Threat Within? 4
The Great Brain Robbery 5
The White Elephant in the Room 6
Running Out of Road 7
Ruling by Repression - The Developing
Police State in China 8
Where To From Here? 10
In Conclusion 11
Sources Recommended Further Study 12
About Innovolo: 13
DISCLAIMER13

The largest population in the world
The second largest economy in the world
(behind only the USA)
The third largest landmass in the world
The largest gold producer in the world
A virtual monopoly on the global
production of “rare earth” minerals
A military superpower, possessing an
estimated 280 nuclear warheads
The largest foreign exchange
reserves in the world
At first glance, the headline statistics that
we usually use to measure the power of
a country certainly seem to be mighty
impressive in the case of China:
And yet, like so much about China, the brutal
facts behind the impressive headlines paint a
very different picture. And it all revolves around
that first statistic - the 1.4 billion people that make
up China’s population.

The Threat Within?
With characteristic perceptiveness, Winston Churchill observed many decades ago:
“Dictators ride to and fro on a tiger from which they dare not dismount. And the tiger
is getting hungry.”
With China, the tiger in question is very big and very hungry. Per capita income in the PRC
is just $11,000 per person, compared to $43,000 in the UK and $65,000 in the US. Stop
and consider that statistic for a minute. Imagine that your income was multiplied by a factor
of four, or five. Imagine how different your life would look. That’s how the average Chinese
worker would regard the disparity between their income and yours.
This puts China smack bang in the centre of the “middle income trap” - where a growing
economy gets stuck, and often fails altogether, to make the transition to a high-income
economy.The first part of the journey, from low-income to middle-income, is relatively simple.
You just need strong government oversight, an almost endless stream of obedient and
extremely cheap labour, and a world market hungry for products that can be manufactured
on a vast scale in labour-intensive industries.
But to take your economy over the next hurdle, from middle income to high income, is
far more challenging. It requires a movement away from basic, assembly-line tasks and
a leap into the knowledge economy, innovation, and high-tech, high-skill manufacturing.
In other words, it is a movement away from mass-volume industries where the greatest
differentiator is price, and into value-added industries where customers are willing to pay a
premium for the technology, the prestige, or the originality of the goods.
4© Copyright Innovolo Ltd 2020

The Great Brain
Robbery
With a limited ability to develop their own high technology or innovate, China has instead
spent years copying or stealing the intellectual property of other nations, particularly
the United States. Via a network of university involvements, commercial acquisitions, and
old-fashioned espionage and theft, China has been quietly and effectively appropriating a
wide range of technological know-how and intellectual property that it then deploys through
its own network of state-owned or state-affiliated companies.
“National Champions” such as the vast telecommunications behemoth Huawei are, with
the backing of the full CCP state apparatus, able to create and sell equipment at prices that
severely undercut their competitors, making it difficult for developed countries to resist. For
years, China was able to get away with this behavior, through an efficient lobbying system
and by hiring highly experienced, well-connected, and influential people to “front” their
efforts in Western nations. For example, in the UK, Huawei have appointed high profile
names such as Lord Browne, the former chief executive of BP, and Sir Andrew Cahn, a
former high-ranking government official, to their “Advisory Board.”
But the advent of the Trump administration in 2017 brought a new spotlight to bear on
China’s long-held practice of IP theft, and by 2019, amid an increasingly rancorous trade
war between the two superpowers, China’s ability to acquire the new technology they so
desperately need through these channels became increasingly restricted.

The White Elephant
in the Room
When you break down what is behind the extraordinary growth over the last 10 years
in China, you find that there are two main drivers: investment and exports. Consumer
spending is, by comparison, a minimal driver of growth. This fact points to the extremely
structural nature of China’s economic problems - and the reason why they’re going to be
increasingly difficult to resolve.
No doubt you’ve read about or heard rumors of virtually-empty cities in China - vast
metropolises that remain largely uninhabited years after their construction. But this is only
part of the story. There are also shopping centres, stadiums,
roads, railway stations, airports, bridges and many
more construction projects that were built
from 2009 onwards, at a cost of trillions
of yuan, which are classed as
“ineffective investments” - or, in
other words, white elephants.
According to some estimates,
as much as half of all internal
investment by China has only
served to produce jobs and
consume materials produced by
other parts of the economy, such
as steel, concrete, and glass.
But the actual output of all that
investment is in many cases a
complete waste - sitting unused
and empty. If you factor this wasted
investment into China’s apparently
extraordinary growth, the widely-
quoted 6.5%-10% annual growth rate
would actually be closer to 5%, perhaps
even less.
And the vast majority of these projects are debt-financed. According to traditional measures
of economic analysis, China is now so heavily indebted that it has reached the stage where
adding further debt no longer acts as a stimulus, and in fact only serves to increase scrutiny
of the ability of the country to service its existing debt mountain.

Running Out of Road
In short, before the global COVID-19 pandemic started to spread in late 2019, the wheels
of China’s apparently unstoppable economy were already beginning to wobble violently.
Predictions suggest economic growth reducing to 4% or less this year and as low as 2%
by 2025. Debt is already 330% of GDP. The country is also sitting on a demographic time
bomb - the 1980 “one child policy” was lifted in 2015, but the birth rate has barely increased
since then. Despite the economic growth over the last two decades, China remains a
fundamentally poor country in terms of GDP per capita and is fast running out of options to
keep the steady increase in living conditions demanded by its citizens.
It’s still too early to predict the direct impact of the Coronavirus on the Chinese economy,
but first quarter growth tumbled by 6.8%. Besides this, the CCP also has to deal with a
banking system that is fast becoming insolvent and vastly over-inflated real estate assets
- another bubble just waiting to be burst.
The pandemic has also thrown a harsh spotlight on China’s broader activities on the world
stage. Japan, Australia, India, the United Kingdom, and the United States have led other
nations in starting a complete reassessment of their approach to handling the PRC. Early
in June 2020, a new international panel of lawmakers called IPAC - the Inter-Parliamentary
Alliance on China - was formed, with a mission to “reform how democratic countries deal
with China.”
On the 5th of May 2020, the US Government released an official paper titled “United States
Strategic Approach to the People’s Republic of China” in which outlines in stark terms the
strategy that the world’s most powerful country is now taking in its dealings with the world’s
most populous country. The language of the report is (by the standards of such diplomatic
documents) unusually forceful and leaves the reader in no doubt as to the gravity of the
situation. It is reminiscent of George Kennan’s landmark article for Foreign Policy in 1947
which first laid out the strategic case for policies that would have the effect of containing
and restricting the Soviet Union.
The consequences of so many trading partners adopting a much tougher stance on
their dealings with China will take time to materialise, but as they do, it can only further
exacerbate the already perilous state of the Chinese economy. This in turn increases the
risk of a destabilising popular uprising within China, which is the Communist Party leaders’
worst nightmare.
No wonder, then, that China is already lashing out with threats and bluster against nations
including the UK - warning that if steps are taken to remove Huawei from this country’s
5G network, then China will retaliate by endangering other projects they are involved in.
(According to some observers, the threat by China to boycott projects such as Hinkley
Point C and HS2 is one that HM Government should welcome with both hands!)

Ruling by Repression
- The Developing
Police State in China
For decades, the “deal” that the people of China have effectively had with the ruling regime,
the Chinese Communist Party (or CCP), is that in exchange for living uncomplainingly
in a brutal and totalitarian society, they will continue to benefit from steadily improving living
conditions as they move from a largely agrarian, subsistence lifestyle, and into one with
modern conveniences and comforts. In return for this, they have been willing to endure state
oversight of (and often interference with) everything from their day to day communications
to any kind of organised worship or even what kind of physical exercise classes they might
want to participate in.
But the CCP now faces an enormous challenge to sustain the economic growth that they
have enjoyed for so many years. While it’s still too early to be certain, it seems
that the medium-term economic consequences for China of the
COVID-19 virus are likely to add to the struggles that the
ruling party were already experiencing in this implicit
“pact” with its people. When overall living conditions
stop improving for China’s population, the ruling
party faces a potentially ruinous backlash. That
vast population could quickly turn from China’s
biggest strength into its biggest threat.

This overriding concern among party elites is the reason that the CCP is so quick to brutally
quell any elements of societal unrest before it gets out of hand. Heavy censorship of all
kinds of news and social media and state control of everything that has the potential
to influence or direct public opinion keeps a firm lid on potential sources of agitation.
Remember the enormous factory explosions in 2015 in Tianjin? Within minutes of this
disaster taking place, a rolling news blackout was imposed while censors got to work stifling
every possible independent source of information, allowing them to control the narrative
with brutal efficiency.
The CCP regulates and controls virtually every aspect of the lives of their citizens, including
where and how they choose to worship, what they see and hear, and with whom they
can communicate. The slightest sign of dissent or even just poking fun at the leadership
of China is instantly cracked down on with offenders threatened, imprisoned or simply
“vanished” - with family and friends left completely in the dark as to where the individual
went and whether they will ever return. Perhaps most shockingly of all, several doctors
and medical professionals that raised the alarm about the Coronavirus in Wuhan were
arrested and threatened, and later some indeed disappeared from public view altogether,
fate unknown.
The last significant popular uprising in China was in 1989, in Tiananmen Square. Now,
three decades later, the possibility of any kind of unrest arising from within its own vast
population represents nothing less than an existential threat to the CCP. When the regime
stops providing an endless stream of jobs and rising living standards for the Chinese
people, the risk of such societal unrest grows exponentially with each passing day.
With a steep increase in the number of manufacturers looking to reduce or even cease
their production operations in China altogether following the Coronavirus, the risk is that
President Xi Jinping potentially stands to lose what the Chinese people refer to as “The
Mandate of Heaven.” That title might sound faintly bizarre to Western ears, but it’s an
ancient Oriental term that signifies an intangible mixture of public goodwill and broad public
support needed by emperors to rule China for the past 3,000 years.

Where To From Here?
For all it’s apparent strengths and advantages, it would appear that China is actually
stuck between the proverbial rock and a hard place. For the last 10 years, China has
driven economic growth with a dangerous cocktail of Ponzi schemes, excessive credit, and
investment in infrastructure “white elephants.” Party leaders were fully aware that this was
unsustainable, but they had no option but to keep pulling the levers of growth to create
and maintain the desperately-needed jobs for both the millions of migrants coming into the
cities every year, and the millions already there.
This brings us back to our opening quote. The lack of legitimacy that the CCP has to
continue their rule is their greatest weakness, and as every day goes by, their options to
stay firmly on top of the tiger they are riding grow increasingly limited.
Various “nuclear options” that might be tried by the CCP (short of actually using their nuclear
weapons, of course) to retaliate against increasing restrictions have been discussed. They
have the aforementioned monopoly on the production of rare earth minerals - but trying to
blockade the shipment of these would inevitably result in a massive surge into investment
for production elsewhere, thereby removing this strategic advantage in the longer term.
Threats in 2019 to dump US treasuries didn’t have the desired effect. Global economists
say that this would also represent a desperate last resort that would harm China far more
than the US in the longer term.
On the topic of the United States, it should not be assumed that a change of administration
there - should this occur in the elections due to be held in November 2020 - will necessarily
bring about a sweeping change in their policy and approach towards China. Both parties,
Republicans and Democrats, have woken up to the threat that China poses and this is
further bolstered by an increasingly demonstrative wave of public opinion against the
activities of the CCP in the wave of the deadly COVID-19 pandemic.
NATO, too, have joined the chorus of concerned voices with a strongly-worded speech
by the Secretary-General on the 10th of June where he drew attention to the fact that
Beijing represents a threat to democracies everywhere and is a global military force to be
reckoned with.

In Conclusion
Sadly, history shows us that dictatorial regimes faced with the threat of an internal uprising
will seek to divert the attention - and antagonism - of their citizens elsewhere.
With the first lethal clashes in three decades taking place on China’s disputed border with
India in June 2020, we could already be seeing the first signs of this strategy starting to be
enacted. There are too many potential flashpoints to list here, but from the South China
Sea to Taiwan to Hong Kong, the risk of trade and diplomacy wars turning into physical
confrontations is escalating at a steady pace.
There are many other topics that we could have taken up in this White Paper, from the
myriad human rights abuses that are carried out by the CCP on a daily basis, to topics
such as the Coronavirus coverup, animal welfare, pollution and environmental damage,
and the scandal of illegal Fentanyl synthetic opioid distribution by China which has resulted
in hundreds of thousands of excess deaths in the United States and around the world.
However, we hope that the information we have shared will serve to give readers a better
understanding of the facts behind the headlines, so that they can prepare accordingly.
Businesses that are in any way dependent on China would be well advised to diversify
urgently, as it should be clear that the potential for supply chain disruption is increasing
at a rapid rate. Even if extra costs are incurred in the medium term, diversification would
seem to be a wise investment when the risks that are outlined in this paper are taken
into account.

Sources
Recommended
Further Study
) White House Paper: US Strategic Approach to the PRC
) IPAC - Inter-Parliamentary Alliance on China
) Lord Browne under pressure to reconsider role as firm faces US criminal charges
) Corporate espionage, theft, and the parallel rise and fall of two telecom giants
) Canadian scientist sent deadly viruses to Wuhan lab
) China has “no intention” of keeping its word on Hong Kong
) China’s Looming Crisis: A Shrinking Population
) China’s drive for digital supremacy is likely to fail
) Bloody clash in the high Himalayas threatens to spark a new Great Game
) The uneasy truce between China and India is effectively dead
) Senior Tories launch ERG-style group to shape policy on China
) Can India keep China at bay?
) China’s threat to boycott Britain’s Nuclear Plan is “Wonderful News”
) Xi Jinping forgets Isaac Newton’s third law of physics in pursuit of China dominance

DISCLAIMER
Opinions expressed in this report are those of the authors. They do not purport to reflect
the opinions or views of Innovolo. The designations employed and the presentation of
material therein do not imply the expression of any opinion or recommendation whatsoever
on the part of Innovolo.
Ⓒ Innovolo Ltd 2020
About Innovolo:
Leading Systematised Creativity™. Innovolo helps people from all walks of life to create
unique products and services from their ideas that will bring them a guaranteed return on
their investment.
Innovolo designs products from baby formula dispensers to fully automated robotics for
university students to blue chip corporations in the UK and abroad, using a unique creativity
framework not found anywhere else, the Innovolation Framework™, a hybrid agile-waterfall
product development and design process that brings our clients results, fast.
For more information, please visit www.innovolo.co.uk

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