China: Risks to watch for 2023 and beyond 

The policies of the US and others also however accelerated efforts to develop Chinese versions of key technology and develop a higher level of self reliance. On one hand this move away from international supply chains could support local businesses, produce innovation, and strengthen national resilience. On the other hand, however, there is the risk that China loses its connectivity with international research, develops technology that is not aligned with international standards, is inferior, and is simply not attractive to the international market. This could have a profound impact on the value of Chinese exports and undermine its efforts to move up the manufacturing value chain. 

Recent efforts by Beijing to rein in its technological firms including the likes of Alibaba, Tencent, and other significant companies are also notable from a technological risk perspective. Beijing has apparently assessed that some of these companies were becoming ‘too big’, overleveraged, and possibly, too powerful within China. The Chinese government efforts to rein these companies in may however have gone too far. By reducing the level of support for international Chinese tech companies, China may be inhibiting its ability to keep abreast with its technological competitors and shape international standards and markets. 

What to watch in 2023

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The risks highlighted in this report are all dynamic and interconnected and present significant challenges to the Chinese economy. This makes it important to watch how they evolve through 2023 and beyond and how the Chinese government seeks to manage them. While it is impossible to predict how each risk will manifest there are indicators that interested parties could watch for in the coming years. While quantifying these risks is extremely challenging these indicators could be rated for likelihood against a range with pre-determined ‘high risk’ zones (Appendix 1).   

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What to watch for in the Chinese real estate market: 

• How companies such as China Evergrande Group, Country Garden Holdings, and Sunac China Holdings manage their debt and if they default; 

• News of underlying quality and safety issues with property developments from marginally viable developers who have taken short cuts. This may highlight: (a) unsafe and poor quality construction (b) overleveraged and highly risky developments (c) corruption at various levels of government. 

• Social unrest occurring in China specifically relating to real estate issues. This could include from Chinese citizens who either cannot afford housing and/or have incurred significant losses from real estate investment, revelations about corruption, and quality and safety issues.  

• The Chinese government’s response at the city, State, and central government levels. The extent of this intervention and the unintended consequences that emerge;

• The impact of a significant downturn of the domestic Chinese real estate market on Chinese investment holdings internationally and whether this generates capital flight inwards or outwards. 

What to watch for in the relationship between China and the United States:

• Overall, whether the US government perceives strategic advantage or necessity in the pursuit of economic penalties and constraint of China for a range of reasons. 

• The US pushing China increasingly publicly around trade imbalances and unfair trade practices by China. Related to this are the availability of options to defuse and concessions from both sides to enable meaningful progress.

• Technology competition becoming more evident. Growing distrust in the US and among like-minded countries (following US lead) around Chinese technology companies. This distrust may become increasingly connected to national security, supply chain risks, but also protectionist policies around strategic industries. This may include areas such as such as artificial intelligence, semi-conductors, 5G networks, and big data capabilities. 

• The impact of trade disputes and strategic competition on Chinese technology companies, their development programmes, increasing tension and balkanisation of international standard development, and challenges and decline in the international market for Chinese technology 

• Rapidly changing sentiment towards China within the US business community. US businesses perception and confidence in China may deteriorate for a number of reasons including: This could be on the back of concerns around the reliability of supply chains, Chinese government market interventions, the US/China trade dispute, and access to an affordable workforce. Specific issues such as the Chinese Cyber security and Data protection laws may also create concern for US business. 

• Tensions over Taiwan and the South China Seas. A miscalculation by either side during an air or sea patrol cause rapidly escalating into limited conflict. It is understood that the development of protocols to de-escalate such incidents is a high priority for US Secretary of State Blinken. 

• National security incidents continuing to feature. The Chinese spy balloon incident of early 2023 was an example of heightened sensitivity around such issues and could cause distractions to the resolution of other bi-lateral issues. 

• Cyber security issues. Ongoing exploitation of US networks by Chinese cyber actors that causes significant loss of US confidential information and/or access to this information or system. Publicity and unintended consequences from this activity provides further cause for a US response. 

• Regional tension and flare ups. The underlying tension generated between the US and China acting in each others geographic spheres will continue to grate both sides. Specific incidents could cause tension too such as North Korean miscalculation, suppression of public sentiment in Hong Kong, location of Chinese military/spy base near US territory, or development of new Chinese bases in Asia-Pacific. 

• The US to continue highlighting human rights within China. This is likely to focus on treatment of ethnic minorities such as the Uighur's and could lead to leading to tension and an inability to resolve wider bi-lateral issues. 

• Sentiment towards China in the US deteriorates. Any one of the issues noted could generate a negative perception of China and providing impetus to US political leaders to respond. 

Regional bi-lateral relationships to watch: 

• Escalation of tensions in the Taiwan Straits. The increased volume of Chinese air and maritime forces in the Taiwan Straits raises the probability of a miscalculation and/or incident involving the military forces of Taiwan, the US or another ally. A serious incident would require rapid de-escalation and even if conflict was avoided it would provide grounds for new measures against China. 

• Signs of increased US political support for Taiwan through elected representatives or government officials. This could include informal/formal visits to Taiwan and military support and exercises. The nature of these visits could be indicative of how the US views Chinese strength and believes there is a window to press an advantage and build longer term stability in the Taiwan Straits. The Ukraine war has provided a clear illustration to China of the political and military risks with an attack upon Taiwan and this will hearten the US and its allies. 

• Escalation of the territorial disputes with India. Another serious incident along the Line of Actual Control (LAC) would significantly harden Indian resolve and bring with it the possibility of: military conflict, India moving away from non-alignment to ‘take sides’, and a detrimental impact upon Chinese business interests in India. 

• An escalation in any one of a number of existing territorial disputes in the South China or East China seas could lead to increased tensions and conflict. This could involve the Philippines, Vietnam, Indonesia, Taiwan, Japan and their respective allies. While Chinese military superiority is assumed over its neighbours, the impact if such a conflict could be significant on the Chinese reputation and interests. 

• Ongoing tension between the US and China corresponding to increased tension within China’s other key bi-lateral relationships and/or in the region. China could suffer a loss of stature towards regional leadership. Non-aligned and predominantly ‘trade’ based bi-lateral relationships could also become increasingly vocal regarding other socio-political issues as public sentiment shifts against China. 

• The rapid build up of the military capabilities of China’s neighbours in response to China’s territorial claims and military activities. These capabilities will increase the likelihood of a more assertive response by these nations to China. 

• Increasing levels of economic competition between China and its neighbours as they perceive opportunity to attract foreign manufacturing and investment away from China. Specific industries and regions in China could be particularly impacted as industry shifts away to new regional locations. 

• Cyber intrusion activity undertaken by Chinese based actors causes significant impact in the target industry and/or country. The extent of the activity could cause hardened policy settings against China and Chinese interests. 

• More countries to restrict market access to Chinese technology companies to their telecommunications, 5G, and other advanced technology projects based upon security risks. 

• Strategic concerns about Chinese developed technology and its connection with the Chinese government limits the international demand for collaborative projects, standards development, and market access. This could impede Chinese research and development and reduce the international demand for Chinese goods and services. 

• Reputational damage to China if further incidents should occur in the disputes in the South China Seas. Falling sentiment towards China across the region could lead to public support for measures to counter China through trade and other means.

• Further outbreaks of COVID or any other similar health emergency is attributed to China and causes ongoing political, economic and social disruption. As well as the direct impact upon supply chains, bi-lateral and regional trading partners may accelerate the exit from Chinese suppliers. 

• More international companies to shift operations out of China and to the likes of India and Vietnam and other regional locations as a direct result of the US-China trade issues, rising costs, Chinese government policies and concern with supply chain security. 

Systemic risks to watch through 2023 and beyond: 

• Ongoing weakness in the Chinese financial sector related to shadow banking, non-performing loans, and over inflated assets. The failure of large and/or key institutions could create wider contagion and systemic failure. 

• Government interventions within the financial sector could transfer considerable risk to government institutions and jeopordise the utility of the tools available.   

• The vulnerability of big and small Chinese banks because of their high levels of institutional interconnectivity and concentrated exposure to highly vulnerable Chinese real estate

• The impact from the loss of ‘easy credit’ within China upon small, medium sized enterprise upon their viability and ability to scale and compete internationally

• The unsustainable use of land sales and real estate development by many local and regional adminstrations to generate revenue resulting in levels of debt that result in the loss of services. 

• More information emerging around the levels of household debt levels becoming an increasingly political issue as Chinese citizens blame government policies for the failure of the economy at the macro and micro levels. Portions of the Chinese population may begin so question whether the CCP and political system has the capability to adequately manage China’s future development. 

• Capital flight from China re-emerging as an issue that undermines the Chinese economy. Beijing may again seek to strengthen its oversight and capital controls. 

• Very large Chinese companies increasingly look for ways to shift operations outside China to avoid Beijings increasing interventions. 

• Ongoing challenges with the efficacy of taxation system with its low tax base and  inefficiencies not supporting Beijing to make the policy decisions it may need to. As the economy contracts, the tax base will also shrink. 

• The unavailability of low cost labour in China providing opportunities to other emerging low cost labour countries to absorb China’s work loads. There may be increasing numbers of manufacturers seeking to shift all or part their factories offshore. 

• Related to rising labour costs in China are the unmet expectation of the growing Chinese middle class who have experienced a long period of sustained economic growth – and now find it harder to find a well paying job. As well as the obvious risk of social tension, this will impact Chinese consumer confidence and consumption. This can be observed with spending on luxury goods and services and discretionary purchases.   

• The underling authoritarian characteristics of CCP apparatus becoming more evident in the nexus between national security and the economy with Beijing making decisions impacting the economy for declared national security reasons. Some decisions will risk significantly undermining Chinese competitiveness and attractiveness to investors. 

• Incidents arising from the implementation of the 2023 anti-espionage law involving foreign nationals will heighten concerns amongst international businesses and investors around the risks of doing business within China. International companies operating in China will need to be cautious if/when national security incidents in the likes of the US become publicly known and Beijing looks for reciprocal responses. 

• China’s aging population and ‘negative population growth’ will put increasing long term pressure on healthcare, pensions, and formal and informal social systems. The result may manifest in a number of different ways and particularly upon Chinese youth who may become increasingly unsatisfied with their prospects. 

• Rising social inequality and an urban-rural divide may become more evident. Many Chinese workers who have been laid off in the cities may return to their home towns. This may cause more general discontent with the economy and the Chinese government itself to spread further across the country. 

• Youth unemployment continuing to rise as the Chinese economy stagnates and finds a new equilibrium that may not provide the same employment and lifestyle expectations for young Chinese.

• Loss of individual or family wealth through a collapse of the Chinese property market is likely to cause pockets of social unrest. This will be particularly acute where the levels of excess, corruption, and general recklessness become publicly known. Beijing may feel the necessity to impose harsh penalties upon the perpetrators to make an example. 

• Increasing levels of unrest within China including labour disputes and strikes, particularly in the manufacturing and industrial sectors where workers may be seeking working conditions and higher wages.

• Public exposé of significant cases of corruption, the abuse of power, and questionable political accountability will continue to test the stability of the Chinese political system at multiple levels. 

• The removal of limits on Presidential terms and resulting concentration of power within a ‘great leader’ will be shown to have inevitable challenges. Decision-making processes can become heavily dependent on the leader's preferences, will cause a reduction in the diversity of perspectives that may be objectively better. The rejection of official advice and ‘free and frank’ policy processes will be evident with the dismissal of the visible heads of Chinese government departments and spokespersons.  

• The limitations of the great leader model with regard to international bi-lateral relationships with its emphasis on the leaders personality and preferences will be highlighted with China’s inability to make progress on a number of bi-lateral challenges and becoming increasing globally isolated.   

• Longer term challenges such as (leader) succession planning may not be of immediate concern, however, the lack of clear pathways of institutional continuity will increasingly undermine confidence in China (at home and internationally). The unsustainable expectations around the success of the leader, the inevitable failures, and removal of timeframes for a leadership refresh may lead to a sense of resignation and low optimism or ambition for change.  

• Air and water pollution becoming more of public issue within China and of increasing concern to (1) Chinese citizens suffering detrimental health and safety impacts (2) the health system and its ability to manage the impact of this upon the Chinese population (i.e. such as the  significant increase in respiratory illnesses) (3) business and industry in China impacted due to the draconian measures required to manage the levels of pollution and (4) the reputational damage to the Chinese government from the perceived failure of its management of the issue by the domestic population and international stakeholders. 

• Severe cases of land and soil degradation becoming an issue if the extent and impact of cases becomes publicly known. Cases impacting international supply chains will damage China’s reputation as a safe and reliable food producer both within China and internationally. Extreme cases where people, particularly children, die as a result of ineptitude, corruption, or recklessness could cause local and or national outrage in China and lead to severe penalties to the perpetrators. 

• While inadequate waste management is some parts of China may be inadequate it is not likely to create wider risk in and of itself. However, cases of large scale pollution from waste that impacts the health and business interests of a significant group in the population could create anger against government officials. 

• The significant environmental risks relating to the impact of climate change becoming a more prominent and domestic political risk. As with other vulnerable parts of the world, large parts of China will see an increase the frequency and intensity of extreme weather events and natural disasters. While the Chinese government may seek to manage the narrative around climate change, its impact and growing awareness of the issue, particularly amongst younger Chinese will create dissention towards the Chinese government.  

• China’s technological dependence on foreign research and technology leaving China vulnerable to changes in the policies of international competitors. Further escalation of the US/China trade disputes and wider international restrictions around the export of technology to China will continue to have significant impact upon Chinese technology companies supply chains, their ability to meet market demands, and consequently their appeal to international technology manufacturers. 

• Chinese efforts to develop a higher level of technological self reliance leading to a loss of connectivity to international research and standards. This could lead to the development of parallel Chinese technology that may be increasingly incompatible with competitors and have less appeal in international markets.  

• Efforts by Beijing to rein in major technological firms such as Alibaba, Tencent, and other significant companies become more common. While the Chinese leadership rationale for this may be for sound from an internal political perspective, the level of intervention with Chinese ‘champions’ may go too far and undermined Chinas ability to contest technologically  within international markets. Some Chinese technology companies will risk being viewed as unreliable partners who have not kept up with technological developments. It may consequently take some years for some Chinese firms to return to their previous scale and influence internationally.  

Summary

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China has a number of challenging risks to manage through 2023 and the immediate years. Key emergent risks include a significant downturn in the Chinese real estate market, ongoing tension and strategic rivalry with the United States, and tension within regional bi-lateral relationships. The question remains how these emergent risks will trigger and exacerbate underlying systemic risks within China. These include systemic economic, social, environmental and technological risks. Interested parties would be prudent to closely monitor these emergent risks to determine if they are significant enough to cause broader failures within China. 

Arguably, however the primary systemic risk remains ‘political’ with the possible impact of emergent and systemic risks creating an untenable scenario for the Chinese Communist Party and the apparatus established to maintain its political supremacy. While the strengthens of the political system are frequently heralded in China’s rapid development, its converse weakness may become increasingly evident. This could rapidly reduce the social licence the CCP has with the Chinese population as the economic growth ‘opium of the masses’ no longer provides the same offer and the population questions other dimensions of societal value. China’s challenges will be significant through 2023 and beyond.