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ZNY CCCCC ZZH
O 220941Z FEB 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 5267
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

C O N F I D E N T I A L SECTION 01 OF 05 BEIJING 000645
SIPDIS
SIPDIS
E.O. 12958: DECL: 02/22/2033
TAGS: PGOV PREL ECON SOCI CH
SUBJECT: HU JINTAO´s CHINA OVER THE NEXT FIVE YEARS
Classified by Ambassador Clark T. Randt, Jr.
Reasons 1.4 (b) and (d).

Summary
-------

¶1. (C) Chinese policy and politics over the next five years will be
driven by the Party´s determination to preserve its monopoly on power
through continued rapid, market-oriented, economic development and
incremental, but limited, political reform. Concern over social
stability will remain the primary guide for the leadership as it fine
tunes the pace and scope of its reform and development efforts.
Party General Secretary Hu Jintao has linked his legitimacy to the
reform and development legacy of former paramount leader Deng
Xiaoping and appears to envision a future China that enjoys the
benefits of a market-based economy and limited civil society governed
by an efficient, accountable, and responsive authoritarian one-party
state. Under Hu´s leadership, economic development and assertive
nationalism remain the twin pillars on which Party legitimacy rests,
with no solid ideological consensus to shore the regime up in times
of national crisis. The leadership´s social contract with the
Chinese people is fragile, and Hu´s "vision" is vulnerable. A major
economic setback or inability to manage nationalistic expectations
could lead to serious social, or even political, instability. A
report on U.S.-China Relations follows septel. End Summary.

Hu Jintao´s Political "Vision"
------------------------------

¶2. (C) Party General Secretary Hu Jintao has linked his legitimacy to
the reform and development legacy of former paramount leader Deng
Xiaoping, reinterpreting Deng´s agenda to fit current political and
economic realities. He has pushed aside the criticisms of China´s
hardliners, or "Leftists," who want to slow or even reverse market
reform, as well as calls from more progressive reformers who want
faster, deeper and more extensive political reform. Hu appears to be
working toward a future China that enjoys the benefits of a
market-based economy and limited civil society governed by an
efficient, accountable and responsive authoritarian one-party state.
To get there he envisions, in addition to robust economic growth,
gradual and limited political reform achieved through tinkering with
internal Party mechanisms to enhance good governance, reduce
corruption, improve the quality of cadres, check the arbitrary power
of Party bosses, and expand participation in decision-making more
broadly among the rank and file.

Hu´s Economic Program
---------------------

¶3. (C) As Party chief and concurrently China´s president, Hu is also
responsible for long-term economic policy, expressed in the form of
"five-year plans." The 11th Five-Year Plan, adopted in late 2005,
called for a 7.5-percent growth rate for the duration of the plan.
In addition to quadrupling GDP as compared to 2000 by 2020, the
leadership is striving for a shift from export- to consumer-driven
growth, the continued retreat of the state from large swaths of the
economy, manageable inflation and unemployment rates, a significant
increase in rural incomes and the absorption of rural surplus labor
(including the integration of migrant workers in cities), labor
stability, reduction in the wealth gap, significant technological
innovation and development (especially IT), continued infrastructure
development, and significant progress in reversing environmental
degradation and the inefficient use of energy.

Economic Challenges
-------------------

¶4. (C) The reality on the ground is often at variance with the
central leadership´s goals and policies. Although China´s economy
has averaged over nine percent annual growth for a generation, this
"growth at all costs" model is showing wear. The Chinese economy is
facing numerous challenges, including excessive fixed asset
investment, slowing exports, inflation at an 11-year high, rising
labor costs, a widening urban-rural income gap, a wide array of
environmental challenges, and galloping energy consumption. Premier
Wen Jiabao stated that 2008 will be "a most difficult year" for the
economy due to "uncertainties in international circumstances," which
include high energy prices and economic slowdowns in China´s main
export markets. At the same time, China´s policy community is
debating whether China has become too open to foreign investment.
China has in some cases reverted to the blunt instruments of a
state-directed economy to respond to these challenges, including
price controls on food and energy and measures to foster national
champions while restricting foreign investment in key sectors.

¶5. (C) The negative effects of runaway growth are becoming apparent
to observers in and outside of China. Income inequality approaches
that found in Latin America, with urbanites making 3.3 times that of
rural residents according to 2007 statistics, as compared with 2.47
to 1 in 1997. A dependence on coal for 80 percent of electricity
generation and excessive reliance on heavy industry for industrial
output have created extraordinary air and water pollution problems
that are expected to worsen considerably. Years of economic
transformation from public to private sector economic activity have
shredded the social safety net and injected instability into people´s
lives, resulting in suppressed consumer spending as the public saves
for the healthcare, education, and retirement it fears will prove
unaffordable. As a result, China´s economic growth is not
consumer-driven, but instead comes primarily from investment
(infrastructure, industry expansion, and property development) and
its enormous trade surplus, which has helped push foreign exchange
reserves to USD 1.5 trillion. A lack of foreign exchange regime
flexibility has worsened these imbalances, holding down the value of
the Renminbi and thus creating incentives for growing coastal/export
industries rather than interior/domestic sectors to bring prosperity
to where it is most lacking.

¶6. (C) Coming to grips with the domestic effects of inflation is the
government´s top economic priority and was a major topic at the
October Party Congress. Inflation reached a new eleven-year high of
7.1 percent in January (the CPI rose 4.8 percent in 2007) in spite of
monetary tightening and "soft" price controls. Agricultural prices
explain most (85 percent) of the spike, the impact of which is felt
disproportionately in poor and rural areas where families spend a
greater percentage of their budget on food. A second trend of
concern to government officials is the slowing of export growth,
which could actually prove over time to be a deflationary force given
large increases in industrial capacity. Manufacturing jobs in
southern China in lower-end industries like textiles are now being
lost due to slackening demand for exports, in part tied to rising
wage costs and the appreciation of the Renminbi.

Slim Chance of Overcoming Challenges
------------------------------------

¶7. (C) Continued economic growth is likely, but Hu´s odds of
overcoming the negative effects are not good. Implementation of
central policies remains a serious problem, as central authorities
and local government officials clash over priorities in China´s
economic development. Despite the codification in the Party
constitution of Hu´s "scientific development" emphasis on balanced,
sustainable, less resource-intensive development that addresses
social and environmental needs, many local Party leaders continue to
give priority to economic growth. China´s second- and third-tier
cities are rushing to build their own unique urban identities,
launching projects of questionable economic value in order to compete
with other cities for attention. Local officials guard their own
vested interests, and many regions still rely primarily on
state-owned enterprises to fuel growth, often to the disadvantage of
prospective foreign investors. Efforts to improve China´s social
safety net have been largely inadequate to support social services in
poor areas, and funding is sometimes diverted to local officials
through corruption. Moreover, all indications are that environmental
degradation continues apace and energy consumption continues to rise
amidst little progress toward resource efficiency.

Nationalism: Double-Edged Sword
-------------------------------

¶8. (C) Along with rising economic development, nationalism is one of
the two pillars of regime legitimacy. The marked increase in China´s
international prominence and national prestige over the past decade
has prompted an upsurge in patriotism and nationalism among coastal
urbanites and reinforced longstanding student nationalism. There is
a growing sense of national pride at China´s emergence as an economic
and political power. China´s urban population, particularly educated
professional and business elites, are increasingly critical and
sophisticated, knowledgeable about the outside world, and exposed to
multiple sources of information. The Party has been compelled to
carefully manage sporadic, emotional urban demonstrations by students
over international issues, primarily anger at Japan, even as it
sometimes stokes such nationalist sentiment to serve its own ends.
The Taiwan issue remains the most explosive of nationalist issues.
While ordinary Chinese may not rank Taiwan at the top of their
day-to-day concerns, Embassy contacts report that emotions toward
Taiwan run deep and would quickly come to the surface in times of
crisis, with major implications for leadership legitimacy. The
political cost to the Chinese leadership for mismanaging a crisis
with Japan or "losing" Taiwan would be high
.
Social Stability the Overriding Concern
---------------------------------------

¶9. (C) As a result of these and other problems, social stability
remains the touchstone by which the leadership judges the
effectiveness of its policies and adjusts the pace and scope of
reform and development, and is the most effective indicator for us to
watch in determining the health of the regime and its policies. The
Party closely monitors all activity and groups it perceives to be
potentially destabilizing, and has demonstrated impressive resilience
and adaptability in maintaining its power in the face of growing
social and economic problems. Despite tens of thousands of
demonstrations and protests every year, mostly in rural China and
mostly over corruption involving land grabs, the protests remain
localized and citizen wrath is still directed at local, not national
officials or the Communist Party itself. Moreover, the protests have
not thus far been part of larger coalitions that cross local
jurisdictions or involve linkages across social sectors or classes.
The regime intervenes vigorously to prevent protests from crossing
jurisdictional lines. The authorities have kept the lid on the
simmering pot of social instability through shifting tactics and a
mixture of populist rhetoric, monetary compensation, high-profile
sacking of the most egregious examples of corrupt or incompetent
officials, and, when deemed necessary, lethal force. Some tactics
are coercive, such as when People´s Armed Police fired on rural
demonstrators in Guangdong in late 2005, killing several. Security
forces crack down quickly and severely on any sign of organized
dissent or separatist activity by such groups as the quasi-Buddhist
sect Falungong, the underground China Democratic Party, or Tibetan
and Uighur activists calling for independence.

¶10. (C) Party leaders also use incentives and have been quick to
respond positively (if perhaps not effectively) to calls for social
justice. They have adopted policy initiatives and short-term tactics
to address the increasing number of incidents of unrest in recent
years. Hu´s vision of "Scientific Development" and "Harmonious
Society" is designed to alleviate inequality, redistribute wealth and
investment to inland and rural areas, expand public services and
patch social safety nets. The Harmonious Society slogan in
particular, which "takes people as the base," is designed to counter
increasing calls for "social justice" and address the most pressing
social issues that resonate with those left out of the economic boom.
This populist rhetoric has been accompanied by gradual reallocation
of resources to these target groups, including concerted efforts to
improve the plight of migrant workers in cities and the decisions to
end the centuries-old agricultural tax, provide free rural education,
and rebuild the rural health care system.

¶11. (C) Hu´s efforts have had some success. China´s market-oriented
growth continues to foster the emergence of professional, managerial,
and entrepreneurial elites in major cities, the chief beneficiaries
of an expanding economic pie. The urban population in general
appears mollified by expectations that life will continue to improve.
Moreover, the Party´s populist rhetoric appears to be working to
take the edge off the dissatisfaction of the urban poor and rural
residents with promises to close the expanding wealth gap, address
severe deficiencies in health care, social security, and education,
and bring a halt to run-away environmental pollution. An opinion
survey published by the Chinese Academy of Social Sciences in 2007
shows that while trust in the Central Government is high and many
aspects of government are seen as fair, responses on issues closest
to the people -- health care, social security, and local government
-- show the potential for social disturbance is serious.

¶12. (C) Paradoxically, despite generally positive attitude patterns,
successes create rising expectations that in turn pose a challenge to
the Party´s ability to adjust to social change. For example, the
new, urban elite appear to be increasingly willing to engage in
organized public protest to protect their interests against
unfavorable government actions. Recently, thousands of residents in
the coastal city of Xiamen compelled the government to retreat from
plans to build a new chemical plant in the middle of the city, and
residents of Shanghai have forced at least a temporary halt of plans
to extend the Maglev line from Shanghai to Hangzhou. In the
countryside, farmers in at least four provinces are demanding the
return of land seized by the state and redistributed in 1949 during
land reform when the CCP took power. Of 30 major issues covered in a
recent People´s Daily online survey of people´s concerns as the NPC
approaches, the top three concerns were inflation, corruption and
medical services. These were followed by concerns about income
disparities, the social safety net, housing, employment, education,
justice, labor rights, and food and drug safety. Political
performance, public participation and information transparency all
ranked lower.

Political Reform with Chinese Characteristics
---------------------------------------------

¶13. (C) While Hu and Premier Wen Jiabao have repeatedly asserted that
"political structural reform," and even "socialist democracy," remain
an integral part of the Party´s development agenda, they have
explicitly rejected adopting Western models of democracy and have
underscored the need to fashion a unique Chinese-style democratic
order, "democracy with Chinese characteristics." To date, the focus
of the Party´s political reform efforts has been on liited
"democratization" within the Party, with the proclaimed goal of
eventually spreading democracy to society at large. The Party
Congress in October indicated that the Party would stick to its
current policy of promoting "inner-Party democracy" that will broaden
participation of the rank and file in decision making, improve the
quality of cadres, and make the current political structure more
efficient and responsive. The Party will also continue to experiment
with election mechanisms at various levels, inside and outside the
party, designed to ground personnel selection in popular legitimacy
and serve as a check on corruption.

Leadership Transition, Stability
--------------------------------

¶14. (C) For Hu, as for all Chinese leaders, sustainability of his
vision is important. Hu emerged from the Congress with his authority
at least marginally enhanced and a top leadership contingent that
appears to be the most stable in many years. Barring unforeseen
shocks to the political order that would create deep divisions among
them, the succession set in train at the Congress will likely play
out as planned, with two younger leaders being groomed to take the
reins of power at the 18th Party Congress in 2012. The leaders
appear to have reached a consensus that emphasizes power sharing,
balancing of interests, and collective decision-making that could be
an effort to bring greater stability to the policy process and to
facilitate the stable transfer of power. In addition to reflecting a
balance in the distribution of power among dominant political
interests, and greater limits on Hu´s personal power compared to his
predecessors, Party leaders have begun to institutionalize the
transfer of power in a way that greatly lessens the uncertainty and
political danger historically extant in the succession politics of
Communist regimes.

Spoilers: What Can Go Wrong?
-----------------------------

¶15. (C) China´s problems are so daunting that the leadership will be
challenged to cope with them even under the rosiest of circumstances.
While the current trend line looks generally positive for the Hu
leadership over the next five years, the Party´s heavy reliance on
economic growth, expanding opportunities and continued improvement in
people´s living standards with no sustaining ideological consensus to
help weather crises suggest that the "social contract" is fragile. A
major macro-economic or geo-political shock that could mobilize large
numbers of people from politically strategic sectors of the
population would present a major challenge to the regime. Severe
unemployment in growth industries, a period of serious inflation, or
a humiliating international incident are examples of events that
could potentially spark a strong backlash against the Party. These
are events that would test the loyalty of the Party´s base -- Party
members and government functionaries -- and of urban elites and
workers in critical industries who passively acquiesce in the Party´s
claims to political supremacy because they have benefited most from
the upward mobility and prosperity of the reform era.

¶16. (C) Our economist contacts do not predict a great unraveling, but
they uniformly see many challenges ahead. There will be huge
headaches in sourcing energy, including finding the imports needed
for further expansion; it takes significantly more energy to grow
China´s economy than it does in a developed country, and the growth
momentum in resource-intensive sectors will bring further
environmental degradation. Local governments will have to be reined
in if they are to play along and modify the growth model in line with
Hu´s scientific development approach, and resistance to date has been
endemic. High consumer inflation could create expectations that
spread price hikes to wages and other goods, discrediting the Party´s
ability to deliver further prosperity, especially among the poor who
spend more of their budgets on food than those better off.

¶17. (C) At the same time, China has created so much industrial
capacity that a global slowdown could actually introduce deflationary
trends to some sectors. Cautious liberalization of the financial
system has forced the public to choose between banks, domestic
stocks, and property for their investments. Consequently, there is
widespread concern about asset bubbles, particularly in equities.
The Shanghai stock exchange, for example is up 300 percent in two
years. A bursting would certainly raise the ire of latecomers to the
party, although most households would weather the storm, given that
they have not spent their paper profits. The recent severe snowstorm
disaster in south and central China resulted in roughly USD 15
billion in damage and widespread power outages and transportation
meltdowns in 17 provinces, underscoring the long road ahead for
China´s infrastructure improvements and the market pricing incentives
needed to ensure they function optimally. Moreover, the storm added
to inflationary pressures in the consumer sector by wiping out large
areas of cropland. And just as China works its way through these
kinds of challenges over the next five years, its demographic bomb,
resulting from a generation of the One Child Policy, will be coming
into view, straining funding for pensions and health care and raising
the prospect that China will get old before it gets rich.

¶18. (C) While these problems are not in themselves
regime-threatening, a severe downturn in the world economy or other
macro-economic shocks could result in inflationary or employment
pressures that could quickly erode Party legitimacy and the support
of its core constituencies. The potentially destabilizing impact of
these social and economic problems would be significantly amplified
if they worsen in tandem with other, unexpected crises, such as the
death or incapacitation of Hu Jintao and/or other leaders, an
earthquake, drought, or other natural disaster, the breakdown of
succession arrangements for 2012 or an increasingly blatant uptick in
the scope and degree of corruption.

¶19. (C) Further potential challenges to regime stability would result
from an expanding rights movement finally reaching a tipping point,
with the formation of a national coalition supported by elements
within the Government, or from an external political shock, such as
an incident of national humiliation. National humiliation or a
failure of the regime to stand up for national dignity, especially if
Beijing backs itself into a situation where it is compelled to use
military force and suffers defeat, could trigger a severe anti-Party
backlash from key segments of the population on which the regime
bases its support. The most visible possible scenario for this to
occur in the near term is a showdown with the United States over
Taiwan, but there are other potential danger points as well, such as
disputes over oil and gas fields in the South China Sea or near
Japan. Such a scenario could lead to a splintering of leadership
solidarity as factions seek to divert blame.

¶20. (C) If Hu Jintao makes even moderate progress toward his goals,
the regime should be able to face down inevitable challenges at home
and abroad in the near to medium term. If China experiences a major
economic downturn or a confluence of other unexpected crisis
scenarios that strain the leadership´s ability to cope or preserve
its legitimacy, the Party will likely be in for a period of serious
social instability.