As economic activity continues to cool in China, my thoughts are increasingly turning to the potential social fallout of waning growth. Reduced demand from China’s key export markets is having a significant impact on manufacturing activity, leading to the closure of factories and consequently, rising unemployment. Indeed, it has been reported that more than 60,000 businesses have closed down so far this year, while in the province of Shandong alone, nearly 700,000 people have lost their jobs.

After years of stellar growth and rising prosperity for its citizens, how will China cope with the harsh reality that good times can’t last forever? Widespread social unrest is an increasingly realistic possibility. Indeed, the country’s entire politico-economic system is built upon the continued prosperity of its population, since as long as people are happy, there is little reason to challenge one-party rule. However, what if job losses lead to greater disturbances? In a worst case scenario, could we see unemployed masses gather in Tiananmen Square and other urban centres, demanding greater employment protection – or dare I say it, even a democratic political system?

Perhaps with such fears in mind, the Chinese government has unveiled a raft of measures aimed at protecting businesses and workers perceived as being particularly vulnerable to the ongoing global economic slowdown, including another export tax rebate hike (the third this year). In addition, in perhaps the clearest indication yet of the authorities’ rising panic, they have issued a ruling that companies in the provinces of Shandong and Hubei must seek official consent if they want to lay off more than 40 people.

Support Measures Could Trigger Deflation
Yet, these initiatives can realistically only ever hope to be stop-gap measures to keep manufacturing activity and thus employment figures afloat in the short term. China is facing a fundamental weakening of demand for its goods as its major export markets plunge towards recession, if indeed they are not there already.

In fact, I would suggest that these measures could actually make matters worse. The recent edict limiting job cuts in Shandong and Hubei suggests that Beijing could well implement further, more draconian regulations on employment if the downturn becomes more severe, in order to prevent social upheaval.

This would see overcapacity build in the manufacturing sector, which in turn could potentially lead to wage cuts as employers seek to reduce costs kept artificially high by laws prohibiting the shelving of under-utilised workers. Indeed, there is already anecdotal evidence of this happening, with the BBC reporting that the An Jia baby cot factory in Dongguan has cut wages by as much as 75%. This would have a significant deflationary effect if it were to become common practice, and consequently could spark the unrest originally sought to be avoided, as workers’ incomes fall and standards of living accordingly drop.

It is therefore also possible that in order to prevent such repercussions, Beijing could impose strict controls over wages. Indeed, China’s Ministry of Labour has already told local governments not to increase minimum wages in order to avoid putting any additional pressure on companies already feeling the pinch. If this scenario were to play out, it would leave a number of businesses with the choice of either having to operate at a loss or shut down. The latter option would merely bring us full-circle, as workers are laid off, while the former would only be possible with massive government assistance.

The latter path would draw alarming parallels with Japan’s reaction to the sharp slowdown and stagnation it witnessed in the 1990s – the so-called ‘lost decade’ – in which the government ran up such massive deficits, that public debt swelled to more than 150% of GDP. However, I must point out that Japan was a far richer and more developed country in the run up to its lost decade than China currently is, meaning that an equivalent ‘lost decade’ for China would be felt far harder.

Another reaction, however, could be for Beijing to meet any unrest from disenfranchised workers with force. To be sure, tough times lie ahead for Chinese policymakers.