What Happens When Evergrande Collapses?

The markets are watching closely for what seems to be the inevitable collapse of Evergrande, a massive Chinese property developer that is almost certainly unable to service its debts. A default would have tremendous repercussions for the Chinese financial system–and with it, the Chinese economy and the global economy as well. All the immediate focus is on the financial implications of a massive default of a highly-connected property firm, both for China and for the rest of the world. But the political implications of Evergrande’s collapse are no less interesting.

So what happens to Chinese politics when Evergrande collapses? About five years ago, Jeremy Wallace and I asked a question like this in a paper called “Hard Landings and Political Change in Nondemocracies” (PDF). This paper was never published (and Jeremy and I tried valiantly to place it), probably because the paper is nonstandard in the way that it tries to answer the question using qualitative and quantitative evidence and the fact that China is different.* But our argument rests on the premise that we can learn from the experiences of things like the collapse of Evergrande, even those that don’t happen in China, to develop some insights about what would happen in this specific case.

So what will follow politically from the collapse of Evergrande? One place to look is East and Southeast Asia, and to the political upheavals that followed from the serial collapse of the exchange rates of Thailand, Indonesia, Malaysia, and South Korea during the Asian Financial Crisis. These financial crises became political crises for the simple reason that politics shapes financial markets, and the financial turmoil affected economic actors with political power.

What we learned during 1997 was just how financially interconnected these economies were, just how many politically powerful individuals and groups were using preferential access to credit as a cash machine, and just how liquidity-constrained these actors were when their cash machines quit spitting out bahts, won, rupiah, and ringgit. What might have been just a property crisis in Bangkok or an exchange rate crisis in Jakarta turned out to be a financial meltdown that affected everyone. And the very same political actors who had happily supported the incumbent governments at the time started demanding that these governments do something–anything!–to get the cash machines back up and running.

And when it turned out that governments could not help them, even as they tried, these powerful actors began to look for new governments who could.

Now, the specifics of the Asian Financial Crisis differ from whatever crisis Evergrande’s default may create. Thailand, Indonesia, Malaysia, and South Korea suffered from having open capital accounts and fixed exchange rates, coupled with enormous amounts of unhedged foreign currency debt. The details differ across the four cases, but at the end of the day the problem was how to stabilize currencies and keep interest rates low at the same time.

China does not face this problem; and in fact, one reason why it doesn’t face this problem right now is because it looked to the south and east in 1997 and said “no thanks” to an open capital account. So the financial crisis management problem that China faces will be different; if Evergrande defaults, it will need to unjam the credit markets that will seize up in response. And it will need money to do that. And there will be some powerful economic actors who do not want to spend that money, as well as some who will be desperate to spend that money.

The Xi regime will, in turn, need to find a way to placate both set of actors, or crush one. From an outsider’s perspective, it will not look politically contentious, because the regime will suppress any mention of dissent or discord. But behind the facade, there will be intense disagreement, and we will not be able to know just how precarious the situation is until it is too late. If the Xi regime cannot find a way to either placate those powerful actors who demand protection, or to crush them entirely, we will see these actors start to abandon the Xi regime altogether.**

One response might be that China’s institutions are different: they are so strong, the party so unified and hierarchical, and so pervasive within Chinese society that a political crisis like this is impossible. I couldn’t rule it out. But one lesson that studying financial crises hammers home is that time and again, people vastly overestimate how much durable political loyalty institutions create when the going gets tough. China’s political institutions created enormously powerful and wealthy people, but those people are not loyal to those institutions, they are loyal to their wealth and power.

This script was written long ago, and the actors have changed over the years. It is the story of how an authoritarian juggernaut turns into the “sick man” of its part of the world. It happens quickly, and in retrospect it seems inevitable. But it’s still a waiting game right now; we won’t know, and foreign observers like me have predicted at least twenty out of the last zero Chinese economic and political crises since Tiananmen. But it remains the case that after, say, just five more sleeps we may wake up to an entirely different kind of Chinese politics.

NOTES

* Read the last three words in that sentence in a grumpy comparativist voice.

** My prediction, if it gets this far, is that in at least one public statement Xi will describe those who are demanding policy change as “rats.” You know the crisis is serious when the rat talk starts (see Indonesia and Mexico, among others).