China's system of authoritarian capitalism under stress
James McGregor says China's unique system of state-driven capitalism is grating so badly with global trade and business governance that, without reform, a collapse is likely
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, unco-ordinated 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 secrets to China's state-owned enterprises with whom they are forced to be partners.
The Communist Party has two objectives: make China rich and powerful, and guarantee the party's political monopoly. Some top party leaders are pushing far-reaching reforms that expand the private sector and empower entrepreneurs, 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 endeavours in tumultuous times. "Policy formulators in China often have a sense of venturing out alone," Liu He, deputy director of the State Council's Development Research Centre, 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 invested their earnings in local enterprises. By 1996, these enterprises accounted for 36 per cent of industrial output and 135 million jobs. Meanwhile, state-owned enterprises 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 Organisation Department that appoints all key leaders of centrally controlled state-owned enterprises. Most of these positions carry ministerial or vice-ministerial rank in the party, so they outrank their government overseers. As a result, these enterprises are more beholden to the party than the government.
A 2006 directive designated two categories of industries for state involvement: "strategic" industries - armaments, power generation, oil, telecoms, 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.
Also in 2006, China launched the infamous "indigenous innovation" campaign with the goal of transforming China into a technology powerhouse. The plans directed state-owned enterprises 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 Organisation 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 per cent of new jobs, 65 per cent of patented inventions and 80 per cent of technological innovation. Meanwhile, Chinese consumption is 35 per cent of gross domestic product versus 63 per cent in Brazil and 54 per cent in India. China is also facing what economists call "the middle-income trap", a stage when low-cost labour and easy technology adoption max out as competitive advantages. Without domestic consumers to offset an export decline and drive growth, the emerging economy will languish.
China's WTO membership and simultaneous return to favouring state-owned enterprises has been lucrative for these enterprises. A 2011 study by the Unirule Institute of Economics, an independent Chinese research centre, estimated that state-owned enterprises accumulated some 5.8 trillion yuan (HK$7.1 trillion) in profits from 2001 to 2009. But if the discounted land, cheap utilities, low interest rates and other subsidies unveiled by Unirule are deducted from their profits, the real average return on equity is in the negative. In 2010, only 2.2 per cent of their 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 US$90 billion.
A window into the use of state-owned enterprises to harvest wealth and underpin party power has been cracked open in the Bo Xilai scandal.
The most challenging reforms will be fixing the hukou, or household registration, system. 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.
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 economic planner Liu He.
The party mouthpiece People's Daily was bellicose after President Barack Obama criticised China last year for "gaming the system" of international trade. The paper responded that the US should realise that "smart people move with the times, conceited people are eliminated by history".
That's solid advice for China.
James McGregor is author of the new book No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism. Reprinted with permission from YaleGlobal Online. http://yaleglobal.yale.edu