Victor Shih on the Chinese Economy

Your first choice is Yasheng Huang’s Capitalism with Chinese Characteristics. I believe this book successfully demolishes the idea that China is developing a new economic model called ‘market authoritarianism’.

I think Yasheng goes a little too far with some of his claims. But the broad outline is correct. There was a period of healthy organic growth in the 80s, driven by the de facto private sector. Many township and village enterprises were collectives or owned by the local government. But in reality they were private enterprises. This changed in the mid-90s, especially with the adoption of the ‘grasping the large and letting the small go’ policy that circumvented the special interests in the state sector. When Deng Xiaoping was alive, his executive vice premier, Zhu Rongji, wanted to bankrupt or merge many of the smaller state-owned enterprises into larger ones. It was a political tactic to further reform. And it worked.

The problem was that it created these giant, state-owned enterprises. Recent statistics reveal the state sector made a profit of 2 trillion renminbi last year, of which the 122 largest SOEs made 1.35 trillion. They have combined assets of over 10 trillion dollars and have become an enormously resourceful and powerful interest group. Their CEOs have numerous ties with top political leaders and sit on the party’s central committee. Most bank loans, issued bonds and stock-listing proceeds in the system go to these conglomerates. There’s still a private sector but it has been squeezed tremendously, especially in the last two years.

Yasheng does a great job of explaining the genealogy of this process. He shows us the evidence on a national basis and in terms of Shanghai. People think of Shanghai as this dynamic, market-oriented city that symbolises the future of China. But Yasheng points out – and I know this because I’ve done fieldwork in the city – that the largest enterprises in Shanghai are state-owned. From energy, steel and car manufacturing to taxi firms and newspaper stands, the state dominates.

Does this bode badly for the Chinese economy or can the state get away with it?

Yasheng says it’s a bad thing because the state doesn’t allocate capital efficiently. It’s not their money, after all. That’s what you see in China: a lot of wasted money. Travellers are impressed with the infrastructure – stadiums, airports, opera houses – but it’s not used very much. The Bird’s Nest – the Olympic stadium in Beijing – cost hundreds of millions of dollars but I don’t think anyone uses it. There are many other examples like that across China. But I do think Yasheng’s book is possibly a little harsh.

In what way?

The reason for such a concentration of financial resources is that the leadership became increasingly concerned about the possibility of a major economic shock. The policy stemmed from insecurity, especially after the death of Deng in 1997, which coincided with the Asian financial crisis. They wanted to ensure there was a large foreign-exchange reserve and plenty of centrally-controlled resources. They tried to suppress the amount of explicit government debt. Instead of using budgetary allocation to finance local infrastructure, the central government instructed local governments to form companies and borrow money from the banks, thus hiding the deficits. They got the results they wanted: relative financial stability and fast growth, fuelled by high investment rates and low government deficits. Since 1997, we’ve had a decade and a half of stability and growth. That’s quite something.

Still, I agree with Yasheng that this situation will become increasingly untenable in the future. There has been so much waste, a lot of it financed by debt in the financial system instead of government debt. This means that either these wasteful projects will have to generate cash flow to pay back the banks or the banks will become insolvent. The Chinese government is grappling with this major issue.

Since we’re discussing the problems facing China’s banks, shall we talk about Carl Walter and Fraser Howie’s Red Capitalism? You mentioned you think this is going to be a bestseller.

To the extent that a book on finance can be a bestseller, yes, I really hope so! People need to pay attention to it because it’s a very important book.