Growing disillusionment in China's government is more of a worry than the economics
Analysts are stating that the political stability in China is more concerning than its economics at present. &nbsp;"Black Monday", a decelerating economic growth, the recent Tianjin explosion etc, along with the Chinese government's reaction, or lack of, is beginning to cause disillusionment amongst its citizens, especially its middle class, say analysts. &nbsp;Furthermore, without sustainable economic growth, China's 300 million migrant workers will be left in the lurch, which translates into an enormous number of people living poorer lives than they could have otherwise, as well as a potentially serious political liability.
China's Shanghai Composite Index has fallen catastrophically — by 7.6 percent just on Tuesday. The decline follows a huge Monday collapse dubbed "Black Monday" and is part of a four-day slide; on the heels of another huge decline in July, this has erased the Chinese stock market's 2015 gains entirely. On Monday, stock markets around the world dropped as well following the Chinese losses.

So what does this mean for China? China's stock market is not a major part of the Chinese economy, so it's unlikely that this crash alone will trigger a broader economic crisis there. But the political consequences could be quite serious. There is a big debate going on right now within China's leadership over what to do about the economy, and this turmoil could push that debate in the wrong direction.

The crash could bolster political factions inside China that want to block critical economic reforms, and weaken factions that do want these reforms — which are, make no mistake, very important for the country's future. Without these reforms, China is much likelier to face far more severe economic problems.

How big of a deal is China's stock market decline for the country?

Over the past year or so, China's stock market has grown like crazy, mostly funded by people taking on debt to buy stocks. The Shanghai stock market hit highs that hadn't been seen in about eight years. Some decline was probably inevitable.

The stock market plays a fairly limited role China's economy. "Relatively little Chinese wealth is stored in shares. More is held in property, the market for which has stablised in recent months," the Economist writes in an excellent piece on the crash. "The knock-on effects from market turmoil should be limited, at least in the short run."

"The knock-on effects from market turmoil should be limited"

The stock market "matters, to a certain extent," Damien Ma, a China analyst at the Paulson Institute, told me. "But how much it's going to bleed over to the real economy is hard to say, other than certain investors having lost a lot of money."

Of course, economic crises are notoriously unpredictable, so it's possible that this problem could grow. But as of right now, there's little reason to believe that China's economy is headed for a crash just because of its stock market troubles.

How the crash could matter more: China's internal political battle

To understand the politics at play here, look at this graph of China's annual GDP growth, and look at it dropping into the single digits:

Seven percent GDP growth would be wonderful in the United States. But in China, that's slow.

What you're seeing is China's economic slowdown, which reflects a fundamental change in the Chinese economy. For years, China's economy has been driven by two things: cheap exports and government-driven investment in things like infrastructure. But if China wants to become a European-style upper-income country (and it does), this model isn't sustainable. Rich countries can't manufacture goods as cheaply as poorer ones, and there are only so many bridges and roads a government can build.

To fix this problem, China needs to switch to a consumption-driven growth model: It needs regular Chinese consumers to buy Chinese-made stuff and fuel the economy that way. That requires major structural reforms, such as freeing up private industry and raising wages. The reforms necessary to make that happen are critical to maintaining long-run growth, but according to Ma, the cost of getting there has been somewhat slower growth in the short term.

And China still needs to do a lot more to really shift (or "rebalance") over to a consumption-driven economy. That's why the stock market crash is really worrying: because it could make those reforms more politically difficult than they are already.

The Chinese political system is full of political and economic elites who have a vested interest in keeping the status quo and not changing the economy. For example, China's energy sector is dominated by three major oligopolies, which have used their political connections to block reforms designed to introduce competition (and thus fuel growth) in the field.

These elites are struggling against the pro-reform factions in the Communist Party leadership, tooth and nail, to try to block reforms. The nature of China's authoritarian political system, which depends heavily on rule by elite, gives those elites a lot of power. The elites could exploit the stock market crash by blaming the crash on the economic reforms China has made so far, Ma warned, and thus make further reform more politically difficult.

"The concern is whether [the crash] opens up room for people who are already not so pleased with the reform agenda to kind of push back on it. This is where the political issue gets more testy." Ma says. "You have seen several interesting op-eds in official Chinese papers, like People's Daily, that make the case that there is still a lot of internal resistance to the reform agenda."

And the timing isn't great: The Chinese Politburo is holding a plenum in October, which will focus on China's five-year economic plan and the future of the reform agenda. "That discussion is where a lot of the politics will play out [focus on] how much they will continue to reform," according to Ma.

What happens if rebalancing fails?

China's economic transition is not a minor problem. If it fails, we could be talking about a serious collapse in China's GDP growth, with potentially dire economic consequences.

"If by 2022 they're dragging their feet, and none of the major reforms seem to be really taking hold, they will be in pretty serious economic trouble," Ma told me in a July conversation. Specifically he thinks it'll "look a lot like Japan's 'lost decade'," the period starting in the 1990s in which Japan's productivity and growth fell substantially.

"Look at a lot of the structural trends — an aging population, labor market volatility, a lot of economic headwinds they can't control — and they're really being forced to change, whether they want to or not," he continued.

This will be more painful for some groups within China than others. Take China's migrant workers: Between 200 million and 300 million people who travel around the country for work. "They want what the urbanites have, but they can't really get it because of inequality in terms of residence permits, as well as access to social services and opportunity," Ma said.

Without sustainable economic growth, this enormous population — potentially a source of consumption and growth — will be left in the lurch. That translates to enormous numbers of people living poorer lives than they could have otherwise, as well as a serious political liability for China's leadership.

And that's to say nothing of the rest of the world, which has come to rely on continued Chinese growth as a key engine of the global economy. It's not clear precisely what the consequences of a Chinese slowdown would be, but it certainly wouldn't be good.

So it's in everyone's interests that China succeeds at transitioning its economy. Except, that is, for the Chinese elites who will likely try to take advantage of the stock market collapse to protect their own interests — consequences for others be damned.