Beijing's economic carve-up dooms vital reform to failure
In March next year Beijing will adopt its next five-year plan. The new directive will aim to construct a more sustainable model of economic development by promoting private consumption as the main driver of China's growth, instead of exports and investment.
It's a commendable objective, but a confidential US embassy cable posted on the WikiLeaks website this month gives a telling insight into why it will be almost impossible to achieve.
Sent in July 2009, the cable describes how senior Communist Party bigshots have 'carved up China's economic pie' between them.
Quoting 'embassy contacts with access to leadership circles', the US cable says it is 'well known' how former premier Li Peng and his family exert control over the electricity generation sector, while former security chief Zhou Yongkang and his allies dominate the country's oil industry.
Similarly the cable describes how the family of late revolutionary leader Chen Yun control substantial interests in the banking sector, while Chinese People's Political Consultative Conference chairman Jia Qinglin is said to command an extensive power base among Beijing's real estate developers. Other senior leaders boast close ties to developers elsewhere and to the heads of major corporations in other key economic sectors.
The result of this carve-up is an 'ossified system' in which vested interests drive decision-making and impede reform as leaders constantly manoeuvre to ensure that their personal fiefdoms are not threatened.
The self-interested political imperatives of the senior leadership are replicated further down the power structure. The cable describes how most local leaders have 'bought' their positions and so demand an immediate financial return on their investments. As a result they always favour fast-growth policies over controlling inflation or providing welfare for the poor, and oppose any reform efforts that might harm their interests.
This alignment of political and business interests has caused huge distortions in China's economy over recent years.
Although growth has been rapid, it has been wildly unbalanced as policy-makers have kept lending rates at rock-bottom levels to ensure their favoured business sectors can get easy access to cheap bank loans.
At the same time policy-makers have sought to support bank earnings by maintaining an artificially wide spread between the rates banks earn on their lending and the interest rates they have to pay China's vast legions of ordinary savers on their deposit accounts.
That's been fantastic for politically connected businesses, which have enjoyed near-limitless supplies of cheap capital to fund extravagant investment projects. And it's been great for the country's banks, which have earned massive profits on the back of interest rate spreads their overseas counterparts can only look at with envy.
But it's been brutally punishing for China's ordinary consumers and savers. The government's determination to keep interest rates down means that deposit rates have typically been held below China's rate of inflation. As a result, over the last five years the average return on one-year household deposit accounts has been negative in real terms, which means China's people have effectively been losing money by keeping their savings in the country's banks (see the first chart).
In effect, Beijing's interest rate policy enforces a massive subsidy paid by the country's ordinary people to fund the expansion of the senior leadership's pet business sectors.
Not surprisingly given such a huge transfer of wealth from individuals to the corporate sector, private consumption has suffered, falling from almost 50 per cent of gross domestic product in 1990 to just 35 per cent last year. Meanwhile, investment has soared, climbing from 25 per cent of GDP to 45 per cent (see the second chart).
The trouble is that such profligate investment is largely wasted. According to Diana Choyleva at Lombard Street Research, over-investment pushed China's return on assets down to a feeble 1.2 per cent last year.
Many in the senior leadership recognise that such an unbalanced growth model is unsustainable, hence the new five-year plan's aim of boosting private consumption. Yet it is doubtful whether Beijing can succeed in encouraging consumption without dismantling an interest rate regime under which ordinary consumers subsidise politically favoured business interests.
And given the picture painted by the US embassy cable of a leadership which spends much of its time protecting those interests, it looks very much as if the new five year plan is doomed to failure before it has even been adopted.