Although China is more prosperous than ever before, its unbalanced economic growth has led to significant issues that can no longer be ignored. In 2012, the country must deal with a slowing economy, fallout from the highest-profile political scandal in years, and a major leadership transition this fall, constituting the biggest challenge to Communist Party leadership since the end of the Cold War.

Background

China's meteoric growth since reforms of the 1980s has been heralded by some as an “economic miracle.” The 2008 financial crisis revealed serious shortcomings in the international monetary system, cast doubt on Washington's development model, and hastened the Middle Kingdom's rise to global economic power status. Assessments that the United States is heading for decline along with observations that emerging powers are increasingly challenging Western dominance have reinforced the notion among China's political elite that their development model is a viable alternative, and that the post-Cold War era of US preponderance is giving way to a new multipolar order with China as a key player.

Yet with the euro zone mired in debt and with anemic growth in the United States, China's economy—which depended heavily on low-wage labor and benefited from an undervalued currency, the Renminbi—is facing an inevitable slowdown in 2012. In January, the forecast by state-run Xinhua News Agency about decelerating GDP growth and uncertainty due to weaker exports and fixed-asset investment, did little to inspire confidence. Inflation is being felt more harshly on the ground than official numbers suggest. In addition to decreased short-term demand and a lagging domestic consumption rate, an unstable real estate market, central bank inefficiency, aging population, rising labor costs, and less room for infrastructure improvement are all threatening to constrain China's mid- and long-term growth potential.

Why is China's economy relevant?

The Chinese Communist Party's legitimacy is no longer based on ideology but rather on performance with respect to its goals of stability and economic development. Given the overall politico-economic situation, the Chinese government is facing one of its toughest challenges in decades. Though China's growth model has produced impressive results, it is far from perfect and in urgent need of reform. Many believe that 2012 will by characterized by both pitfalls and opportunities as the country prepares for this fall's leadership transition. The government's ability to address domestic issues of corruption, pervasive social inequality, and environmental destruction will ultimately be a function of how well the Party can reconcile its internal conflicts and restructure the Chinese economy.

The way in which China handles this year's economic situation will have far-reaching regional and global implications. Although the US will almost certainly remain the leading economic and military power for years to come, its relative position and influence have declined. Emerging markets and developing countries will play an increasingly significant role in global governance, and East Asia is rapidly gravitating towards China as the region's economic center. This presents an opportunity, as there is a certain logic of cooperation inherent to international economic development. However, the Asia-Pacific region still looks to the US for military protection, giving rise to an opposing logic of security competition. In an era of increasing economic interdependence, China has the potential to help secure a strong, sustainable global economic order; likewise, it could increasingly view the world in terms of a zero-sum game, intensifying competition and the possibility of conflict.