Is it a menace for China and the global economy?
China’s phenomenal rise has led
many to view the country as an indomitable juggernaut. Why then does Premier
Wen Jiabao describe the country’s economic model as “unstable, unbalanced,
uncoordinated and unsustainable?”
Because it is.
The much-vaunted China Model has
morphed in the past decade into a one-of-a-kind system of authoritarian
capitalism that is in danger of terminating itself – and taking the world down
with it. It is also proving incompatible with global trade and business
governance, and threatening multinationals that fear losing technology and
business secrets to China’s mammoth state-owned enterprises they are forced to
partner with.
The Chinese Communist Party has
two unwavering objectives: make China rich and powerful and to guarantee the
party’s political monopoly. Some top party leaders are pushing far-reaching
reforms that expand the private sector and empower entrepreneurs. They believe
that the party must cede its smothering hold on economic power to foster growth
and social stability. But such plans face determined opposition from others
enriched by the status quo.
Describing the dilemma, a senior
economic planner cited a line from a Tang Dynasty poem, “No ancient wisdom, no
followers,” referring to new endeavors during tumultuous times. “Policy
formulators in China often have a sense of venturing out alone,” Liu He, deputy
director of the Development Research Center of the State Council wrote in an
essay advocating reforms, “with no ancient wisdom to guide them and nobody
appearing to follow them.”
Deng Xiaoping started down this
path in the 1980s by allowing farmers to market a portion of their crops. Rural
entrepreneurs quickly invested their earnings in local enterprises. By 1996,
these enterprises accounted for 36 percent of industrial output and 135 million
jobs. Meanwhile, the country’s Soviet-designed SOEs stagnated.
As the private sector rocketed
ahead, the party concluded in the mid-2000s that a dominant state sector was
necessary. To avoid the rise of Russian-style oligarchs, China opted for a
party-led oligarchy. Control is exercised through the party’s Central
Organization Department, which appoints all key leaders of the huge,
monopolistic, centrally controlled SOEs. Most of these positions carry
ministerial or vice-ministerial rank in the party, so they outrank their
government overseers. As a result, the SOEs are more beholden to the party than
the government.
This system was cemented in place
with a 2006 directive designating two categories of industries for state
involvement: “Strategic” industries – armaments, power generation, oil,
telecommunications, aerospace and more – were to have sole state ownership or
absolute state control. “Pillar” industries – including automobiles, electronic
communications, architecture, steel, nonferrous metals, and chemicals – were to
stay largely in state hands, meaning majority state control or ownership.
Also in 2006, China launched the
infamous Indigenous Innovation campaign with the goal of transforming China
into a technology powerhouse. The plans directed SOEs to obtain technology from
multinational partners through “co-innovation and re-innovation based on the
assimilation of imported technologies.” Not surprisingly, multinationals and
their governments saw this as a blueprint for technology theft.
Neither the World Trade
Organization nor the array of bilateral trade dialogues and dispute resolution
bodies has ever dealt with anything like China’s authoritarian capitalism.
Given the country’s size and economic clout, it threatens to push existing
systems to a breaking point. But China is also the biggest beneficiary of
current configurations. Contradictions abound.
Statistics in support of reform
are compelling. Though blocked from many sectors, and largely unable to get
bank financing, Chinese private enterprise accounts for 90 percent of new jobs,
65 percent of patented inventions and 80 percent of technological innovation.
Meanwhile, Chinese consumption is 35 percent of GDP versus 63 percent in Brazil
and 54 percent in India. China is also facing what economists call “the
middle-income trap,” a stage when low-cost labor and easy technology adoption
max out as competitive advantages.
Without domestic consumers to offset
export decline and drive growth – typically through innovation – the emerging
economy will languish. The World Bank says that that in 1960 there were 101
middle-income economies. By 2008, only 13 of them had reached high-income
status. The reason is that those enriched during the developing state are often
entrenched and able to block change.
China’s first decade of WTO
membership and simultaneous return to favoring SOEs has been lucrative for the
SOEs. A June 2011 study by the Unirule Institute of Economics, an independent
Chinese policy research center, detailed how SOEs are eating the fruit of
reform. Unirule estimated that SOEs had accumulated some RMB 5.8 trillion in
profits from 2001 to 2009. But if the discounted land, cheap utilities, lowball
interest rates and other subsidies unveiled by Unirule are deducted from SOE
profits, the real average return on equity for the period is negative 6.29
percent. As of 2010, only 2.2 percent of SOE profits were turned over to the
state.
The past decade has been China’s
version of America’s Robber Baron Era and Gilded Age – compressed, compounded
and intensified. Previously, the party seemed to operate under an unspoken
“don’t ask, don’t tell” adage. The party aristocracy could use influence to
accumulate family assets, but they were supposed to keep it low-key. According
to a Bloomberg study, the wealthiest 70 members of the National People’s
Congress now have a combined worth of $90 billion.
A window into the use of SOEs to
harvest wealth and undergird party power was cracked open by the March
detention of Politburo member Bo Xilai for “serious discipline violations” and
the arrest and later conviction of his wife, Gu Kailai, for killing a British
businessman. After Bo’s detention, reporters dug up public records showing that
his brother under an assumed name was vice chairman and the holder of US$18
million in stock options of a Hong Kong-traded SOE. Bo’s sister-in-law was
found to be serving on the board of more than 20 companies.
Less than three months after Vice
Premier Zhang Dejiang was dispatched from Beijing to replace Bo as Chongqing
city party secretary, the government announced RMB 350 billion worth of
contracts involving several dozen central SOEs to boost the Chongqing economy
and revitalize support for the party – investments worth nearly $12,000 per
Chongqing resident.
The most challenging reforms will
be fixing the hukou, or housing registration, system enacted in the 1950s to
prevent peasants from flooding into the cities. The government estimates that
more than a quarter of urban residents in major cities lack an urban hukou.
This population includes some 160 million migrant workers who lose access to
health care, education and other social services once they leave their
countryside homes. Just over 50 percent of the Chinese population now lives in
cities. With 13 to 15 million migrating to the cities annually, this is
expected to reach two-thirds by 2030.
The good news is that hukou
reform could transform 10 million migrant workers annually into the next wave
of urban consumers, forming a “potential new global market of unprecedented
size” that would boost the world economy, according to DRC economic planner Liu
He.
The Party mouthpiece People’s
Daily was bellicose after President Barack Obama criticized China in November
2011 for “gaming the system” of international trade. The paper responded that
the US should realize that “Smart people move with the times, conceited people
are eliminated by history.”
That’s solid advice for China.
James McGregor, Yale Global
Business & Investment Opportunities
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