Saturday, September 15, 2012

How a slowdown of Chinese economy may effect PLA

If you have not been following Asia news recently, you may have missed out on the dramatic slow down recently in the Chinese economy. There are many reasons for this slow down. The most obvious of which has been the extreme unbalanced growth model that China has been on in recent year to exports and investments. With Europe, China's biggest export market, in an economic free fall and America also getting into a recession, China's export is unlikely to pick up in the near future. At the same time, we are seeing a collapse in the real estate caused by the bursting of housing bubble. Local governments are saddled with debts from all of the infrastructure projects, so the investment part of Chinese economy is seeing a collapse and this is confirmed by all of the PMI numbers that have come out recently. While Chinese government may push for more stimulus and infrastructure projects to kick start the economy, this is really a great time to start the de-leveraging process and come to a more balanced growth model with increased consumption making up the growth. I'm not sure how long this period will last, but this is all part of the capitalism. You have the boom and bust period. During bust period, the government will hopefully cut back on some programs and reduce the spending. When it comes to PLA, that should point to a lower growth in the defense budget. This happened in 2009 when the defense budget grew at the slowest pace in a long time. And Chinese government has shown in the past that it is willing to divert money from defense to help economic development. The question is how PLA will adjust to smaller increases in its budget. Which programs will it cut? Or which programs should be cut or reduced?

If we look back in the 80s, when PLA saw its budget cut pretty much every year, most of the programs it embarked on were cut or abandoned very early on. When Su-27s were purchased in the early 90s, there were even many who called for abandoning the J-10 program. That's quite amazing considering that J-10 has been described as China's Apollo project by some. At the same time, many naval projects like 052 and nuclear submarines were delayed while the shipyards continue to build low technology ships due to lack of funding, lack of technical expertise and arms embargo. Of course, the PLA build up of the past 20 years were the results of increased funding, technology transfer from Russia and improved civilian industries.

First of all, what should PLA look into slowing down, reducing or cutting if the procurement and RnD budgets are cut by 10 to 20% vs PLA's current projection levels. Suppose the four services of air force, navy, army and second artillery all get cut around that level, I will look at the two areas I'm more familiar with: air force and navy. I will talk about training and personnel cost later.

In the air force, there are programs that must go on like J-20, Y-20, KJ-2000 (or some future variants of it) and Y-8 special missions aircraft. They will receive proper funding for the foreseeable future. There are ongoing programs like J-10 and flankers series that may see cut in funding resulting in early termination of some variants and shelving of some variants. For example, J-10B has been stuck in the test stage for seemingly a long time and looks to finally be ready for induction. If J-20 becomes successful early, PLAAF may choose to shelve future "semi-stealthy" variants of J-10 to save on development cost and continue to produce J-10B while upgrading J-10A with more advanced electronics and weaponry. In the case of the flanker series, PLAAF may terminate J-11B project early due to its bad performances in the recent red flag/blue flag aerial exercises at Dingxin. The J-16 project could also be cut if SAC continues to have problem actually developing new flanker variants to serve PLAAF. And SAC's 5th generation project may loose PLAAF funding if SAC continues to struggle. There are also many UAV and UCAV projects that are under way in China as we've seen in the recent Zhuhai air shows. Many of these projects are privately funded or for export purposes, but we know PLAAF also has requirements of different types of UAVs and UCAVs. PLAAF may delay the purchase of some of the UAVs while going with more mature and less advanced designs. Of course, these are just my personal speculation and the success of many programs depend not only on their performance but also on the political connection of the people involved in the projects. On top of these core PLAAF projects, there are also the less essential ones that may not get chosen or delayed. JF-17 has long been talked about as a project that may provide the lo-end of China's fighter force and I've long advocated PLAAF purchase a variant of it. However, if PLAAF is in a cash crunch and deems JF-17 to be too expensive, it may continue to purchase J-8IIs or cut some of the regiments and restart J-10A production to lower the logistical cost of having another type of fighter jet in service. In the area of advanced jet trainer, PLAAF may completely give up on purchasing the more expensive L-15 project and only purchase the less advanced JJ-9 project. Future variants of JH-7 will probably be left on the drawing board while JH-7A replaces all remaining Q-5 regiments as the workhorse attacking aircraft of PLAAF. Future bomber projects will get pushed back even more while XAC continues to churn out newer variants of the 50s era H-6 bombers. The Y-9 project will probably get enough funding by then to already be in service, but the speculated jet engine powered version of medium transport will probably be abandoned.

In the navy, most of the programs are amazingly efficient due to China's very competitive civilian shipbuilding industry and advancing electronics industry. Off the top my head, I really cannot think of any ship class currently under production that's really badly managed and deserve to get cut. In the beginning part of PLAN's modernization, it was forced to make large leaps in technology and had numerous classes with limited production to eventually get modern warships. You can see that from 052 to 051B to 052B to 052C. In cases where it did make huge leap like from 052/051B to 052B/C, PLAN waited 7 years before the problems are all sorted out and it can start mass production at much lower cost. At this point, it is no longer forced to make as large leaps in technology, so I think cost escalations have not been major issues with PLAN. As seen in recently in new surface ships, PLAN chooses to either create a new ship class with the same hull but new weapon system or the same weapon systems but the same hull. You can see this in the transition from 053H3 (Jiangwei II) class transition to 054 and then from 054 to 054A. If PLAN had jumped directly from 053H3 to 054A, that would have carried a lot of risks in terms of having a entirely new hull and propulsion system on top of a wholly new air defense system. We've also seen this with 052C to 052D to the speculated 055 class. The new major item weapon systems eventually intended for 055 class will get tested out on 052D. So when 055 program starts, the risk of the project lies only with the new hull and propulsion system and not with the weapon system. The air defense suite, VLS, new naval LACM, main gun, and CIWS would already have been tested on 052D. So after complimenting PLAN for this long, what can they do to lower cost. I think one answer would be to reduce the production level of each ship class that's been mass produced. For example, 022 class could've stopped at 64 instead of whatever the total is now. 054A production run could've stopped at 12 instead of the 16 that's been planned. Yuan class submarine could've been stopped at 8 instead of 12 or 16 that's been planned. I would also advocate for the earlier retirement of some ships that have run out of use like most of the Luda class "destroyers" and Jianghu class "frigates". Recently, we've seen many new warships coming into service, but PLAN has shown an utter reluctance to decommission older ships. PLAN needs to retire some of the older ships or else it will have too many personnel to maintain. Above all, I think if PLAN is really facing a cash crunch, it could always delay the production of a carrier and planned escorts to cut costs. Naval air projects could also be delayed to cut down cost. If the choice for funding of blue water navy was between nuclear submarine or a carrier force, I think it's more important for PLAN to continue to fully fund its nuclear submarine research and development rather than aircraft carriers. There is nothing wrong with spending more time training and learning to operate on one domestic aircraft carrier (+ Liaoning, formerly known as Varyag) before speeding up aircraft production.

I think when it comes to training, large scale exercises and oversea missions, PLA should not cut back its funding in these areas at all. China is finally learning to devote more resources into more advanced training method and improving the quality of its sailors and pilots. Both PLAAF and PLAN have received a lot of new toys recently and I have always wondered whether improvement in software can keep up with improvements in hardware. So even if the procurement budget goes down, the training budget should continue at current pace to bridge the back between China and better trained military forces around the world. Finally, I think personnel cost is not going to be an issue. A large part of the recent climb in PLA budget has been to accommodate the increased quality of life around China. Food and fuel cost in additional to cost of goods have all been going up due to the economic boom. At the same time, better living quarters using more expensive construction material and increased wages have to be allotted to recruit more intelligent young people around the country to have a career in the increasingly less attractive profession of serving in the military. In the bust portion of the economic cycle, these costs will all be turned upside down with inflation likely to completely disappear and worker wage increases falling to flat.

So in the face of increasingly gloomy economic situation in China, PLA will be forced to make some choices in cutting back some of its projected increases. I think that both procurement and personnel cost will see reduction from projected levels. I'm sure the conversation within PLA will be no different than some of the conversations going on in the Pentagon right now

12 comments:

David Zhang said...

On the contrary, I believe the military will get increase budget if not at least stay the same.

Just as you said China is trying to move away from a export economy to a domestic consumption economy, that means more spending inside the country, and what would be a better way to help the economy if not by investing into more into military, especially into military R&D, because when you want to develop something, the projects trickle down to many civilian companies and universities.

Peter said...

Wen said China is aiming for growth of 7.5%. China's economy is deliberately being slowed down to meet that target.

All the talk in media of hard landing, soft landing stuff is very exaggerated and biased since they just want to bash China. None of those "news" items mentions the 7.5% growth target.

Feng said...

China has slowed down because of laws of economics, not because of leadership intentions. Do you think any government out there can control laws of economics? The problem is that all of the world's economies are crashing. China will suffer simply because it's an export oriented economy. It takes time to re-orient the economy to a more consumption based economy.

You can give the same money you give for military R&D to just normal civilian research. Countries that continue to expand military at the same rate when the rest of the country starts to see slow down is just not responsible.

G said...

Feng,

I like your blog, particularly those related the PLA Air Force and Navy weapon system developments.

Your recent wades into the political economy topics, however, are of questionable judgement. This post is an example.

It's not appropriate to compare China's economy slowdown with the West's recession; it's even weird to liken your projected up-coming Chinese defense spending cut to those in the 80's, two completely different eras and circumstances.

In my opinion, China's defense spending will not be affected all that much by the current economy slowdown or any likely trajectory of the economy in the next few years. A couple of reasons:

1. China does not currently spend excessively on defense (about 2% GDP), relative to its economy and fiscal condition. Even if the economy slows quite bit and the fiscal revenue growth decelerates. China still has ample room to maintain a healthy defense spending.

2. The major weapon systems developments are well underway; they're strategic and they're critical to the overall national strategy. Navy's aircraft carrier program, submarines are all strategic weapon systems that take long-term funding commitments are unlikely to face funding cuts. The Air Force R&D programs such as stealth fighters, the carrier-based aircraft, the large transporter and its various derivatives are strategic programs and should have no problems to be supported. I agree with you, though, that some of the J-11 and J-10 derivatives might not have a higher enough priority and may be more vulnerable if there is a slower defense spending growth.

3. In the face of economy slowdown, the defense spending is unlikely to be the area to be negatively affected even from an investment and domestic economic development standpoint. China today suffers like a lack of good investment projects, not lack of funding. Defense industry investments increase domestic spending, improve China's R&D capability, at a time when China badly need to climb the value-add industry ladder.

I'm seeing some your recent writings start to align more closely to the mainstream western thinking. Not sure if this has to do with the fact you're trying to target mainstream western audience more and more (Information Dissemination, BBC quotes etc. come to mind), or you're simply out of touch with what's really happening in China. Minxin Pei is not a good example to follow, IMO.

G said...
This comment has been removed by the author.
Feng said...

Actually, I'm more pessimistic toward China's economy conditions than most Western media pieces. And whether you like it or not, if there is a real decline in economic conditions, I believe you will also see a reduction in projected increase in military expenditure. That's what happens. If you have more money, you can spend more. If you have less money, you can spend less. So knowing that, I have to at least look at areas that China can scale back on. China has done this in the past and it can certainly do it again. Or it will just end up controlled by the military industrial complex like the US government.

David Zhang said...

I stand by what I have said, the military spending certainly will not decrease, at worse it will increase by a single digit only.

As someone have pointed out, China's military spending is less than 2% of the GDP, which means there is plenty of room to go before it will have negative effect on the economy, if anything, more spending on military will actually help the economy to grow. Who do you think are doing all the R&D works? Who do you think are producing the hardware? They are normal people like you and me that earns the wages to feed their family.

Now compare that of more than 4% in the United States. If anything, US desperately need to cut back on spending, because it is crowing out the civil sector, and they are leveraging to their eye ball to do it. However just like you have pointed out that China is trying to transform their economy from a export focus into domestic spending focused, so you contradict yourself to think if they were to cut back military, which is a huge part of domestic spending.

You are also basing on the logic that economy slow down = less money = less budget for military.

This would be true, if the year were 1500, if money is base on gold or silver, but in the 21st century, we are living in the keynesian economy + fiat currency. That means money itself is no long finite, all currency have no value of it is own anymore, the value of every world's currency derives it base on the value of other currencies, and as of right now, RMB is by far, one of the world's strongest. That means as long as all other currency is in the shitters, aka dollar, Euro, the RMB will remain strong, that means unfortunately the government can afford to print it if they need more, of course this will be very bad for the people, but it also means the money will never run out.

And lastly, judging by the recent few years of world's event, it is even more unlikely China will cut back on military spending.

Increasing spending at the time when economy slows is not irresponsible, in fact, it is necessary to keep up with the nation's strength. China's economic influence around the world will only increase in the coming years, not decrease, in fact it is already the #1 manufacturer and exporter in the world. That means they need to have a strong navy to protect it, I mean sure right now US is doing all the work, they are keep the peace and China is reaping the benefit, but don't think this arrangement will last forever. You should only look at all the stupid political rhetoric that come out of Obama and Romney about China to see how messed the situation is.

Feng said...

I didn't say military spending will decrease, but rather that it will not increase as much. If instead of seeing 11% increase, you see a 6% increase. Then, PLA would still have to cut something back that they planned.

William said...

I agree with Feng that growth of China economy has slowed significantly not because of government's deliberate cooling measures, but due to both weakness of global economy and China's structure imbalance. The country's future economic condition does look gloomy. However, pace of increase in military budget will also depend on one other variable; that is influence of military apparatus within the central government. Even though no military personnel currently occupied any seat in the political bureau standing committee (and not likely in the future), military still yield significant power and plays a big role in setting defense spending. All past administration (including the current one) has to cater to special interests of the PLA or risk losing its support, which will be detrimental. If next generation of leaders decide to cut back on the defense spending in face of deteriorating economic condition, will the military have enough sway to stop that from happening? It remains to be seen.

Jiang said...

China's future looks bright. Because it is still far better than every other country !

Meng-yuan said...

PLAAF will never buy JF17 because RD93 costs almost as much as AL31 and actually more to maintain. This also implies that J-31 is just using RD93 for testing. The production model has to switch to WS-13.

As for overall military spending, I expect it to go up at a faster pace than in recent years. The island disputes and the US pivot have proved beyond any doubts of the importance of modern air force and navy. China has wasted a lot of money on internal security, culminating in a budget there bigger than military spending. That department is being demoted soon, as the head of security will be excluded from the politburo standing committee. I expect more resources to become available to the military.

Inquiring Mind said...

China will use drilling oil and natural gas in east china sea as China's next growth engine.
China already had drilled several oil field in east china.
With the new UNCLOS declarations, China will step up the oil and natural gas drilling in east china sea.
China is planning to build 3 to 5 aircraft carrier battle groups before 2020.
So China can protect it's oil and natural gas interests in east china sea and south china which is another growth engine for China.