China’s economy is more dependent on foreign countries than on the Chinese. The threat to China is greater from the Chinese than from abroad. This is the picture you get when you compare the GDP with the state budget in the economy that, during this decade, is expected to surpass the U.S. and become the world’s largest. China sells more to foreigners than to its own people. The armed police, intended to quell domestic uprisings, this year has a larger budget than the military. This indicates the complexity of the amazing success story that China represents, and which in the future will probably be called the world’s political change of the 2000s.

First, a historical perspective: for a long time, China was the world’s largest economy along with India but, with the dawn of the Industrial Revolution, India’s textile sector was destroyed and later the more diversified Chinese economy. The beginning of China’s descent was in the Opium Wars of the 1840s, when Britain fought for the right to sell opium. The wars’ origins lay in China’s demand for payment in silver for their exports, not in the goods the Europeans had to offer. China has, throughout its history, lacked deposits of most coin metals except copper, and therefore wished to import silver rather than necessities; such demands, Europe had already experienced during the reign of the Roman emperor Tiberius.

Today’s problem of global imbalances and China’s exchange rate is not new but, at the beginning of the 1800s, Europe had an acute shortage of silver, when the flow stopped from a newly independent Latin America. Instead, the British began to smuggle Bengali opium into China in exchange for the silver that was already there, and which in turn was used to officially pay for the purchases. Which then restrained the money supply in China – a situation that quickly deteriorated and which for the empire may have been a bigger disaster than the public health effects of opium.

The fall of the empire in 1911, the civil war and Japanese occupation of the 1930s, the communist takeover of 1949, with the resultant command economy and the Maoist Cultural Revolution all served to extend China’s relative disappearance from the world economy – with a turnover of $14 billion, China’s total foreign trade in 1975 was less than half of Sweden’s that year. This year it is about $3,700 billion, or nearly 8 times Sweden’s GDP.

This reversal can be attributed to Mao’s post-Confucian empire – control of the masses with ideologically trained cadres, not mandarins – being replaced by Deng Xiaoping’s government of technocrats. The young Emperor Guangxu tried to introduce technocratic government as early as 1898, but he was deprived of all power by his grandmother Cuxi. Deng’s endeavours were thus successful thanks to Mao’s approach to strengthening China by lifting it through ideology and a policy of self-sufficiency policy that proved counterproductive. China’s communism rested, from the outset in 1921, on nationalist rather than communist basis: to restore China’s sovereignty and greatness. Therefore, the ideology’s inhibitions fell flat in the face of reality. The reforms Deng started in 1978 – and which opened the way for initiatives from the bottom – proved successful, especially after Deng’s reorientation of reform policy after 1989. Further, still today the Communist Party’s Central Committee’s Politburo Standing Committee is composed of nine engineers. In the change of leadership that lies ahead in 2012/13 many of them are expected to be replaced by economists and lawyers.

The result is reflected not only in the fact that China’s foreign trade today is 264 times larger than it was when I was watching the Chinese economy as a secretary at the embassy in Beijing. China has not only passed the U.S. but also Japan and Germany and has thus, after a few centuries, regained its position as the world’s largest exporter. So it is probably only a matter of time before China’s GDP is also the world’s largest, and this is for two reasons:

1. After three decades of sustained growth in GDP of about 10 percent, it is assumed that it will remain around 8-10 percent throughout this decade.

2. With the world’s largest surplus against foreign countries ditto currency reserves, the value of the Chinese currency yuan will rise, either because the exchange rate is allowed to rise or that inflation raises the price level in the yuan. This also raises the GDP’s value in dollars.

Today China’s GDP is over 6.5 trillion dollars, while the U.S.’s is just under 15 trillion. To overtake the U.S.’s GDP, therefore, China’s economy must grow two or three times. The Economist magazine estimates that this will happen in 2020, these things being equal: that the U.S. does not grow strongly after the current crisis or that the dollar plummets drastically; with its buffer of strong external finances, it requires, for China’s part, a major internal upheaval with strong capital flight, or a wave of global protectionism in order to prevent this development.

With such a large GDP, the Chinese are each going to have a per capita share of over $11,000: China has, then, found its way into the middle-income category. To get there – from poverty to middle income – is plain sailing. But it has been shown that when a country reaches this level there are completely new demands on its institutions for continued growth – to strengthen productivity and resource use – instead of getting stuck in the ’middle income trap’. And this is where China’s problems may begin.

Can China’s state manage this transformation? As such, it has a decade to lay the foundation for continued growth – but has it the political space for the necessary modifications?

At the conclusion of his latest book – The Origins of Political Order – Francis Fukuyama points to the Western societies’ powerful trinity of a strong state, the rule of law and accountability, which laid the foundation for the success of capitalism. He poses the question of whether China can continue to grow without this trinity, but withholds his response in a real cliffhanger: it comes in the next volume.

Taking the example of Denmark, Fukuyama points to the Scandinavian countries’ development of this trinity. The factor of accountability points to the responsibility that grew out of the ecclesiastical parishes’ own management of church property during the Roman era of the 500s, when the churchwardens were beginning to be chosen to perform that task. Bo Rothstein has pointed out how this was accomplished in Sweden and England for centuries through the choice of the churchwarden being irreversible, and how this built in accountability.

I would add to the structure of parishes the parliaments, and their respective constitutional regimes that have characterised much of Europe. It appears that capitalist industrialisation emanated from the countries where these traditions were strong, which is thought-provoking when the Nordic countries in the current crisis appear to be ”northern lights”.

China’s state tradition goes back some 2,500 years. It has not always been strong, earlier in time access to its offices was reserved for an elite circle of hereditary landowners, who were drilled in the Confucian mandarin examinations. This state was driven from the top by imperial power, all in accordance with Confucianism’s five relationships of superiority and inferiority (prince/subject, father/son, husband/wife, older-/younger brother and older-/younger friend) where the superior must show kindness, and the subordinate obedience. Laws were dictates the emperor used to rule his kingdom with the power of Heaven’s mandate. As in the Muslim world’s caliphate system, there was no accountability to a parish, and that is the case even today, as little as the rule of law. Ultimately, it is thus power, not law, that is in force in China: the party’s general secretary is not only the president but also the chair of the Central Military Commission, and from there controls society’s violent power.

The consequence of this arrangement is widespread corruption, a weak judicial system and weak protection of property rights, as well as restrictions on intellectual freedoms – the latter is increasing now in a manner somewhat reminiscent of Indonesia during the last year of Suharto’s reign. Improvement before the coming generational shift is unlikely, and after that it remains uncertain.

The five-year plan that began this year aims to rebalance the economy; though there is doubt about this in the IMF’s forecast for the coming years. Probably there are strong vested interests at a high level, represented by, for example, the export lobby – leading representatives of the export industry with strong party links – who have an interest in the existing order and are capable of slowing the conversion.

The conditions for an extension of the rule of law and the introduction of accountability would therefore appear too underdeveloped, and not least because the next generation of leaders belong to the so-called ‘small princes’, i.e., the children of old party grandees. Could such a regime be expected to have a mandate to cut off the branch its fathers sat on? Gorbachev is not popular in China.

The implication of this is that the state may have difficulty in strengthening its role through higher taxation, so long as it cannot build a political legitimacy based on accountingDo you mean ’accountability’?Do you mean ’accountability’?. This is likely to hamper the regime’s ability to restructure the socialist market economy, which constitutes its power base, but which is likely to hamper its ability to take China out of the middle-income trap.

And it seems that the problem of China’s Confucian legacy is deeper than that. The Chinese leadership appears to have combined the Confucian ruler/subject relationship with the Leninist principle of democratic centralism (read top-down). Through education, the young Chinese are nurtured according to performance, something that continues in the workplace and involves a type of competition that precludes cooperation.

This seems to relate mainly to the young men, while young women’s situation is characterised by traditional Confucian attitudes to women. Many young Chinese women now receive education, and many of them find it easier to find work in foreign companies than young educated men, who seem more drawn to the state. Furthermore, many of these educated women refuse to marry according to the traditional order of submission to the man and mother-in-law, and staying home to take care of the child.

One could say that China’s modernisation, combined with the one-child policy, makes Confucianism’s core – the five relationships – about 60 percent obsolete: father/son – unless there is a son who could continue the bloodline; husband/wife – when the woman is self-sufficient; so too the brother relationship when there are no brothers. Moreover, if the traditional ruler/subject relationship is undermined by corruption in the party hierarchy, there remains only the relationship between friends. And the Christian idea of ??equality offers a better basis for the need for reciprocity, trust and existential questions in the knowledge economy than the Confucian superior/inferior system, as in Korea. China thus has a growing, culturally based management problem.

This shows that a traditional Confucian and communist values-based China, which managed to go from poverty to relative prosperity, is at the threshold of prosperity and will face a huge political and cultural challenge, and possibly a new cultural revolution. Before these internal challenges are met, it is feared that an increasingly tumultuous and frustrated China will emerge – a regime that resorts to increasingly nationalist rhetoric and makes threats to peace, for example, in the South China Sea. The Communist Party’s priority seems to be entirely justified: the major threat to the regime lies with the Chinese themselves, in addition to the big problems. Until these issues are solved, it is less likely that China will succeed in breaking out of the middle-income trap and become the world’s leading economic superpower.

With its economic – not political – reforms under Deng, China created the conditions for her miracle, but it was the outside world – as a market or as a producer – who sparked it. Similarly, China’s continued growth still depends – in addition to purely internal factors – on the reactions of the outside world. That the Chinese economy is becoming the world’s largest is a given in terms of the population size, but to become its leading economic power puts new demands on China as a country, a people and a culture, and not least on its regime. This will create challenges that no Chinese regime has experienced over the last 4000 years.

This is related to the control of the economy’s upper echelons, which, as part of the socialist market economy – the term the regime uses to define China’s economic system – are important cornerstones of Communist Party power. Crucial to the system is that land, labour and capital, as well as raw materials and energy, are under the political regime’s control. By these being provided at a loss to companies the regime wants to promote, China has gained considerable international competitiveness at the expense of the domestic market.

But resources do not go to companies that can use them most effectively, but to those with the best contacts – something that must be changed so that China does not get stuck in the ’middle-income trap’. This occurs around that particular level of per capita GDP that China reaches when it becomes the world’s largest economy (there are some other thresholds as well).

Resources must therefore go to those who can most efficiently use them. More capital must therefore be directed to small and medium enterprises that can use it more efficiently, not state giants. This requires that the financial system is separated from the state – the Politburo can no longer be the highest credit committee. This process would also require a foreign exchange liberalisation, not least to become a leading power in the international financial context, as an issuer of an international reserve currency.

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Today’s foreign exchange regulations have been made possible partly by government control over capital allocation, and partly its control over the undervalued exchange rate that has given China a significant export advantage. Additionally, it prevents – on the other hand – the kind of capital flight that drained the Arab world of money and led to economic stagnation, popular discontent, and ultimately the ‘Arab Spring’. Instead, a lot of capital was forced to remain and do some good at home by sustaining growth. The abolition of exchange controls is thus very much a large political risk for the regime.

Further hampering state land ownership, for example, is the productivity development in agriculture, from where much of the Chinese inflationary pressure comes today. And not least, the labour market has to be liberalised, if only to strengthen the social stability that is now being undermined – the harsh treatment of workers by creating a couple of hundred million second-class citizens. China’s problem is that the ‘socialist’ in its market is no longer going to work, nor the monopoly of power, because they undermine the efficient use of resources based on free pricing and free markets. The necessary reforms will thus rather undermine the Communist Party’s power system.

It may seem a strange assertion in these times, but China’s market economy must be capitalist, not remain socialist. This process of change seems to have begun, but not by the regime: the emergence of a market-based, semi-informal, and completely unregulated banking system with free and high pricing of capital, in addition to the state with a 6.5 percent interest rate, is already trying to undermine the regime’s power that, through the state banks, controls the economy. What exactly this capitalist challenge will mean for the socialist market economy, power apparatus, and China’s future, it is too early to say.

At the same time, a rebalancing of China’s economy is occurring. Growth in the world’s largest economy may not be, in the long run, based on the ever-growing export market. So dependence on foreign market growth must be reduced, not least to prevent protectionist countermeasures, such as those currently adopted by the U.S. Senate that affect precisely growth – this is a second prerequisite for China to grow further.

But all this means that the government must increase tax revenues to offset the revenue losses that reform entails. This raises a larger question, which could create a China ‘Tea Party’: ”No Taxation without Representation”. Of the more than 20 percent of GDP – by international standards a low number – to which the overall state budget amounts, the income- and profit tax is under a quarter (IMF forecast 4.7 percent of GDP in 2011). Unless the state absorbs a much larger share of profits from state enterprises – thus inhibiting either companies’ international competitiveness or the possibility of higher wages increasing consumption – other direct and indirect taxes must be raised significantly.

China is approaching resource constraints in terms of land, labour and capital, while social inequality – between rich and poor, urban and rural, coastal and inland – is becoming increasingly troublesome, and demands increased state efforts such as healthcare, schooling and infrastructure.

Deng Xiaoping described China’s ongoing transition as ”crossing the river by groping for the stones” to reach what is by all accounts the regime’s overall goal to restore China to the world’s leading nation. Brick by brick, the Chinese government has managed to bring its country closer to the river’s other shore, but has had to stay in shallow water.

Remaining are the reforms that put the regime into deep water, that take it where the stream goes – the economy must flow on its own merits. Whether the current regime has what it takes to bring China to the other side of the river; or whether it loses his footing, goes under the water and is washed away; or whether it simply gets stuck in the mud along the way, is a very open question. China will become the world’s largest economy, but not necessarily its next economic superpower.