by Minxin Pei
National Post: 14 March 2006 - China's economic boom has dazzled investors and captivated the world. But beyond the new high-rises and churning factories lie rampant corruption, vast waste and an elite with little interest in making things better. Forget political reform. China's future will be decay, not democracy.
The only thing rising faster than China is the hype about China. In January, the People's Republic's gross domestic product (GDP) exceeded Britain's and France's, making China the world's fourth-largest economy. In December, it was announced that China replaced the United States as the world's largest exporter of technology goods. Many experts predict that the Chinese economy will be second only to the United States by 2020, and might surpass it by 2050.
Business people talk about China's being simultaneously the world's greatest manufacturer and its greatest market. Private equity firms are scouring the Middle Kingdom for acquisitions. Chinese Internetcompanies are fetching dot-com-era prices on the Nasdaq. Some of the world's leading financial institutions, including Bank of America,Citibank and HSBC, have bet billions on the country's future by
acquiring minority stakes in China's state-controlled banks, thoughmany of them are technically insolvent. Not to be left out, everyglobal automobile giant has built or is planning new facilities inChina, despite a flooded market and plunging profit margins.
But before we all start learning Chinese and marvelling at the accomplishments of the Chinese Communist Party, we might pause amoment. Upon examination, China's record loses some of its lustre:While Western investors hail China's strong economic fundamentals -- a high savings rate, a huge labour pool and powerful work ethic -- they gloss over its imperfections.
China's economic performance since 1979, for example, is less impressive than those of its East Asian neighbours, such as Japan,South Korea and Taiwan, during comparable periods. Its banking system is saddled with non-performing loans and is probably the most fragile in Asia.
A comparison with India is especially striking. In six major industrial sectors (ranging from autos to telecom), from 1999 to 2003, Indian companies delivered rates of return on investment that were 80% to 200% higher than their Chinese counterparts.
Behind the glowing headlines are fundamental frailties rooted in theChinese "neo-Leninist" state. The Maoist state preached egalitarianism, but the neo-Leninist state practises elitism, draws its support from technocrats, the military and the police, and co-opts new social elites (professionals and private entrepreneurs) and foreign capital -- all vilified under Maoism. Neo-Leninism has rendered the ruling party more resilient, but has generated self-destructive forces. In particular, it is spawning a dangerous mix of crony capitalism, corruption and widening inequality.
After a quarter-century of gradual reform, has China transformed its command economy into a genuine market economy? Not nearly as well as most people would guess. Though China was one of the earliest socialist economies to begin serious reform, recent data on the country's regulation, international trade, fiscal policy and legal structure place it in the bottom third of 127 countries surveyed for economic freedom -- below most Eastern European countries, India and Mexico, and all China's East Asian neighbours, save Burma and Vietnam.
The Chinese state remains deeply entrenched in the economy. According to official data for 2003, the state directly accounted for 38% of the country's GDP and employed 85 million people, or about one-third of the urban workforce. For its part, the formal private sector in urban areas employed only 67-million people. (In most Asian countries, state-owned enterprises contribute about 5% of GDP. In India, traditionally considered a socialist economy, state-owned firms generate less than 7% of GDP.)
Beijing continues to own the bulk of capital. In 2003, the state controlled $1.2-trillion worth of capital stock, or 56% of fixed industrial assets. And the state remains securely in control of the economy's "commanding heights." It is either a monopolist or a dominant player in the most important sectors, including financial services, banking, telecommunications, energy, steel, automobiles, natural resources and transportation. It protects its monopoly profits in these sectors by blocking private domestic firms and foreign companies from entering the market (though in a few sectors, such as steel, telecom and automobiles, there is competition among state firms). Moreover, the government maintains tight control over most investment projects through the power to issue long-term bank credit and grant land-use rights.
To many observers, Beijing's tight grip on the economy means only that its reform process is incomplete. It is wiedely imagined that unleashed market forces will eventually produce civil liberties and political pluralism -- as well as further economic liberalization
These hopeful visions ignore the regime's desperate need for unfettered access to China's economic spoils. Few authoritarian regimes can maintain power through coercion alone. Most mix coercion with patronage to secure support from key constituencies, such as the bureaucracy, the military and business interests. In other words, an authoritarian regime imperils its capacity for political control if it embraces full economic liberalization. Most authoritarian regimes know that, and none better than Beijing.
Today, Beijing oversees a vast patronage system that secures the loyalty of supporters and allocates privileges. The party appoints 81% of the chief executives of state-owned enterprises and 56% of all senior corporate executives. The corporate reforms implemented since the late 1990s haven't made a dent in patronage. In large and medium-sized state enterprises (ostensibly converted into shareholding companies, some of which are even traded on overseas stock markets), the Communist Party secretaries and the chairmen of the board were the same person about half the time. In 70% of the 6,275 large and medium-sized state enterprises classified as "corporatized" as of 2001, the members of the party committee were members of the board of directors. All told, 5.3 million party officials -- about 8% of its membership and 16% of its urban members -- held executive positions in state enterprises in 2003.
An incestuous relationship between the state and major industries can doom developing countries, and China is more susceptible than most. The combination of authoritarian rule and the state's economic dominance has bred a virulent crony capitalism, as the ruling elites convert their political power into economic wealth and privilege at the expense of equity and efficiency. The World Bank estimates that, between 1991 and 2000, almost a third of investment decisions in China were misguided. The Chinese central bank's research shows that politically directed lending was responsible for 60% of bad bank loans in 2001-02.
The problem persists. Chinese economic planners revealed in early 2006 that 11 major capital-intensive manufacturing industries were overproducing.
State enterprises are also miserably unprofitable. In 2003, a boom year, their median rate of return on assets was a measly 1.5%. More than 35% of state enterprises lose money and one in six has more debts than assets. China is the only country ever to have simultaneously achieved record economic growth and a record number of non-performing bank loans.
Various indicators suggest endemic graft. The number of "large-sum cases" (involving monetary amounts above US$6,000) nearly doubled between 1992 and 2002. The rot appears to be spreading up the ranks, as more and more senior officials have been ensnared. The number of officials at the county level and above prosecuted by the government rose from 1,386 in 1992 to 2,925 in 2002.
An optimist might believe that these figures reveal stronger law enforcement rather than metastasizing corruption, but the evidence suggests otherwise. Dishonest officials face little risk of serious punishment. On average, 140,000 party officials and members were caught in corruption scandals each year in the 1990s, and 5.6% of these were criminally prosecuted. In 2004, 170,850 party officials and members were implicated, but only 4,915 (or 2.9%) were criminally prosecuted. Official impunity is thriving.
In their confessions, corrupt officials often blame their misdeeds on a loss of faith in communism. There is anecdotal evidence that senior party officials have taken to consulting fortune-tellers about their careers. The ruling elite is drifting and insecure. Fearful about the future, some officials do not want to wait even a few years to turn their power into wealth. In 2002, almost 20% of the officials prosecuted for bribery and nearly 30% of those punished for abuse of power were younger than 35.
Rapid economic growth has not yet produced political pluralism.Perhaps, some observers speculate, China is still too poor to afford democracy. But with a per capita income of nearly US$1,500 (US$4,500 if you consider people's purchasing power), China is richer than many poor democracies.
In part, democracy has been a victim of the country's economic expansion. Rapid growth has bolstered Beijing's legitimacy. (Democratic transitions in developing countries are often triggered by economic crises blamed on the incompetence and mismanagement of the ancien regime.) Meanwhile, the riches available to the ruling class tend to drown any movement for democratic reform from within the elite. Power has become more valuable because it can be converted into wealth and privilege unimaginable in the past.
Lavish government spending on law and order helps to ensure that power-sharing won't be necessary in the near future. Since the Tiananmen Square massacre, the party has invested billions in beefing up the paramilitary police force (the People's Armed Police) that has been deployed in suppressing unrest. To counter the threat posed by the information revolution, and especially the Internet, the Chinese government has blended technological savvy with regulatory might.
The Chinese "Internet police," officially known as the Ministry of Public Security's Internet and Security Supervision Bureau, is reportedly more than 30,000 strong. The party's refined strategy of "selective repression" targets those who openly challenge its authority, while leaving the general public alone. China is one of the
few authoritarian states where homosexuality and cross-dressing are permitted, but dissent is not. Domestic opposition groups and individuals who might challenge the party's authority are isolated and powerless.
China has already paid a heavy price for the flaws of its political system and the corruption it has spawned. Its new leaders, though aware of the depth of the decay, are taking only modest steps to correct it. For the moment, China's strong economic fundamentals and the boundless energy of its people have concealed and offset its poor governance, but they will carry China only so far. Someday soon, we will know whether this system can pass a stress test: a severe economic shock, political upheaval, a public health crisis or an ecological catastrophe.
China may be rising, but no one really knows whether it can fly.
Minxin Pei is senior associate and director of the China Program at the Carnegie Endowment for International Peace. He is the author of China's Trapped Transition: The Limits of Developmental Autocracy (Cambridge:Harvard University Press, 2006).; Whither the Dragon?: Can China sustain its current economic boom? You tell us.