Read an Excerpt
Looking Backward and Forward
Policy Issues in the Twenty-First Century
By Charles Wolf Jr.
Hoover Institution PressCopyright © 2008 Board of Trustees of the Leland Stanford Junior University
All rights reserved.
Capitalism, Chinese Style
A slightly edited version was published in The International Economy in winter 2002 under the title "Capitalism, Chinese Style."
ALTHOUGH THE PARTY FAITHFUL still refer to China's economic system as a "social market economy with Chinese characteristics," a more apt description is a "mixed state and private economy with European characteristics." These characteristics include a pervasive, interventionist government role as producer, regulator, and corporate owner; a growing and innovative private business sector (currently producing more than one-third of China's nonagricultural output); and a variety of joint ventures between government, domestic, and foreign business. (Two of these characteristics also bring to mind the formerly stagnating economy of Japan.)
What Britain's prime minister, Tony Blair, has referred to as the "Third Way" — supposedly something between central planning and American-style capitalism — and Germany's chancellor, Gerhard Schroeder, described no less elliptically as the Neue Mitte ("New Middle"), both embody those mixed attributes that increasingly apply to the Chinese economy.
Two recent developments, in addition to China's admission to the World Trade Organization, indicate the direction in which China's economy is evolving: first, efforts by the China Securities Regulatory Commission (CSRC) to reform China's dysfunctional stock markets; second, the recent welcome extended to private businesspeople to become members of China's ruling Communist Party.
Bringing the Shanghai and Shenzhen stock markets up to speed is a requisite for sustaining, in the future, China's past high economic growth rate. China has the world's highest savings rate — more than 35 percent of annual GDP, compared to less than half that rate in most major economies. Effective securities markets help guide savings into efficient and profitable investments, but this vital function has not been performed effectively in China. Instead, so-called policy loans to state-owned enterprises (SOEs) have been provided by the state-owned banks, in the process siphoning capital that could otherwise be available to non-state enterprises were securities markets more ample and more effective. In fact, China's securities markets have been thin and their trading volume low. One indicator is the small proportion of GDP represented by the market capitalization of stocks listed on China's markets (by comparison, in the United States the market capitalization of listed stocks is more than twice U.S. GDP).
To expand and improve the operation of securities markets, the CSRC (China's counterpart of the Securities and Exchange Commission in the United States) confronts two major problems: (1) continued government holdings of two-thirds of the voting shares of the "privatized" former SOEs among the 1,100 companies listed on China's exchanges and (2) the failure of corporate governance of the listed companies to contribute to improving the functioning of equity markets.
To remedy these deficiencies, the CSRC has made several important market-oriented reforms. First, government holdings are being gradually reduced, although the pace has been constrained by a fear that the markets would be destabilized if the pace were accelerated. This dilemma — rapidly reducing government holdings, without unduly destabilizing the markets — is perhaps more tractable than has been assumed. For example, a portion of the government shares might be converted to nonvoting preferred stock and transferred to the state banks, thereby offsetting some of the nonperforming loans on their fragile balance sheets, while extruding the government from intervention in corporate management.
Second, the CSRC has encouraged the listing of new nonstate companies, adding about a hundred new listings annually — a rate that should accelerate if and as new companies meet the financial and other standards set by CSRC for initial public offerings (IPOs).
Third, the CSRC has been making serious efforts to educate corporate management, as well as both government and retail shareholders, about the importance of improving corporate governance to enable securities markets to function more effectively.
Improved corporate governance is essential to make management accountable to prospective shareholders and thereby motivate savers and investors to acquire securities, thus widening and deepening the markets. This requires increased transparency in corporate management, frequent and regular financial reporting in accord with rigorous accounting standards, and the appointment of independent (nonaffiliated) members to corporate boards, audit committees, nominating committees, and compensation committees, practices far removed from the familiar practices of business management in China. Where ownership remains predominantly in the hands of the Ministry of Finance and other government ministries that hold majority shares in listed companies, management remains beholden to those entities and the interests of retail shareholders are largely ignored. Maximizing shareholder value is typically not high among the objectives of government owners.
Another indicator of China's circuitous path toward a more market-oriented system is Jiang Zemin's decision on July 1, 2001, to open the way for new entrepreneurs to become party members. (Before that, several thousand businesspeople were already among the party's 65 million members, but most of them became members when they were employed by the state — for example, by SOEs, by state ministries, or by the military.) The July 1 decision anoints "new" capitalists as potentially acceptable party members, thereby overriding the deeply ingrained ideological stance against the profit-oriented business class, which was previously viewed as something to be resisted rather than embraced.
In the short run, Jiang's decision is no less significant as a symbol than as a significant reflection of accelerated market-oriented reform. Probably the number of capitalists admitted to party membership in the next year or two will be relatively limited to forestall opposition by leftists in the party to this "anointment" of capitalists. In the middle to longer run, however, the pace will quicken, and capitalist membership in the party will swell along with the burgeoning of private business in the Chinese economy. Hence, the policy influence of the business sector is likely to increase significantly in the future. One consequence will be greater pressure to strengthen the rule of law as a precondition for economic performance and for the growth of the business sector. Another consequence is likely to be enhanced pluralism within party councils, reflecting the diversity of business interests across a wide range of economic and regulatory policies and practices.
The vector of near-term and longer-term changes under way in China's economy suggests something more like the mixed system of Europe's "New Middle" economies, rather than a prototypical American system. To be sure, the economic performance of the European economies has been something less than lustrous, and it is at least debatable as to whether the expanding reach of the European Union's bureaucracy is more likely to improve than to impair it. But in China the prospect that a mixed system involving both government intervention and private capitalism will enhance economic performance may be brighter. Unlike Europe, China's economic system is moving away from the heavy hand of centralized state planning toward a system marked by greater openness, competitiveness, and flexibility.
With few exceptions, the main points are as valid now as when the article was published in 2002. Some exceptions are that the growth of the market-oriented private sector has been even more rapid than the essay anticipated (the private sector accounted for 60 percent of China's GDP in 2006) and that improvement in corporate governance has probably been somewhat less than envisaged.CHAPTER 2
Foreign Investment Leverages China's Growth
Published in the Asian Wall Street Journal on June 24, 2004, under the title "Uncertain Times for Foreign Investment in China."
AMONG THE FEW PROPOSITIONS on which all China experts — those in China as well as outside — agree is that foreign direct investment (FDI) has been one of the two or three most important contributors to China's rapid economic growth during the past fifteen years. Initial calculations suggest that each $10 billion of FDI is associated with between 0.9 percent and 1.6 percent of annual economic growth in China. If annual FDI fell by $30 billion, China's annual growth might decline by nearly half its current rate.
FDI is defined as the creation and/or acquisition, by foreign capital owners, of tangible assets situated in the recipient country.
There is less agreement concerning the explanation for FDI's impact. According to one view, the effect of FDI lies in its packaging of technology, management, and marketing (especially export marketing), together with capital, with each component enhancing the effectiveness of the others.
A second explanation contends that FDI's effectiveness results from the preferential treatment it is accorded, enabling FDI to take advantage of opportunities within China inaccessible to domestic capital due to barriers to capital mobility that exist among China's thirty-one provinces.
In any event, China is the second-largest recipient of FDI in the world economy (the largest is the United States). The $43 billion of FDI in China in 2001 is larger than the corresponding amounts received by all other Asian economies, excluding Hong Kong, which functions as an entrepôt for FDI in China as well as other Asian countries. FDI in China has risen to this level from a figure of $2 billion in 1986, increasing at a compound annual rate of more than 18 percent, and steadily rising from 1986 through 1997, with a slight decline since 1997 in constant 1995 US dollars.
The consensus among China experts is that FDI will continue to rise in the coming decade. According to a survey I conducted a few months ago, 88 percent of the respondents expressed this view. But experts are typically more reliable in interpreting and explaining the past — for example, in their consensus that FDI has been crucial in contributing to China's economic growth during the past fifteen years — than in forecasting the future. In forecasting what will happen, rather than explaining what has happened, their testimony has frequently been wrong. Consider, for example, the failure to forecast Japan's stagnation in the 1990s against its background of remarkable growth in the 1970s and 1980s; the failure to predict the plunge in the economies of Korea, Indonesia, and Thailand in 1997–1998; or the protracted slow growth of Germany in the 1990s.
So, although FDI may remain at high levels or increase in the coming decade, it may also fall substantially, with serious consequences for China's economic growth. This uncertainty is due to the many factors — both within China and outside — that can affect FDI in an upward or downward direction.
Internal factors prominently include such political developments as the harmony or friction that accompanies the impending transition from China's third-generation to its fourth-generation leadership and the prevalence of political and social stability in China or, conversely, the spread of civil unrest from rural areas to urban areas.
Numerous other factors will make China's economic environment either congenial or adverse for FDI in the coming decade. These include, for example, whether China moves toward or away from a rule of law in which property rights are respected and predictable, equities markets are expanded, corporate governance becomes more responsive and transparent, and corruption recedes rather than advances. The outlook for FDI in China will also be materially affected by the pace and fidelity with which China complies with its WTO commitments, whether the Chinese yuan remains stable while moving toward full convertibility, and whether and how the huge volume of nonperforming loans on the balance sheets of China's four state banks continues to grow without triggering a financial crisis.
With increasing integration and competitiveness in global capital markets, FDI in China will depend not only on these internal factors but on how the environment for FDI evolves in other parts of the world in both capital-exporting countries (such as the United States and the European Union), as well as capital-importing emerging markets including Korea, Russia, Eastern Europe, Southeast Asia, Taiwan, South Asia, and Latin America. Hence, China's ability to attract FDI will depend on other countries' political stability; their development and protection of property rights, corporate governance, the rule of law; and their possible resource discoveries, in particular. It will also depend on China's ability to maintain reasonably harmonious relations with its neighbors, including the United States, Japan, the European Union, Taiwan, and Southeast Asia.
In the past, FDI in China has been sparked by the lure of its potentially huge market. In most instances, promise has exceeded performance. Thus far, few FDI undertakings have resulted in significant profits for foreign investors. As a consequence, some of the previous optimism has been replaced by increasingly hardheaded calculations of costs and prospective returns.
In sum, future FDI in China will depend to a much greater extent than in the past on China's risk-adjusted, after-tax return on investment, relative to opportunities elsewhere in a world of globally integrated capital markets.
The ensuing stakes for China are immense. If the combination of internal and external factors influencing FDI in China moves in an unfavorable direction, China's forgone economic growth would be seriously eroded. This prospect will and should, as Samuel Johnson observed, "concentrate the minds" of China's policymakers.
The importance ascribed to FDI was right on; the prognosis was way off! FDI in China has continued to grow but at a decreasing rate.CHAPTER 3
Fault Lines in China's Economic Terrain
A slightly edited version was published in the Los Angeles Times on June 1, 2003, under the title "Pitfalls on Path of Continued Growth," and in the South China Morning Post on August 7, 2003, entitled "Eight Threats to China's Economic Miracle."
BETWEEN 1980 AND 2002 China's annual economic growth was 8.6 percent. Despite some fuzzy statistics, as well as ups and downs along the way, this remarkable record overshadows Japan's economic "miracle" of the 1970s and 1980s by nearly 75 percent: Japan's average annual growth in the 1970s and 1980s was 5 percent.
If China is able to sustain its growth at a rate similar to this recent history (its current rate is reported as 8.1 percent), its gross domestic product by 2025 would be only modestly below that of the United States, although its per capita product would still be less than 15 percent of that of the United States.
This rosy scenario confronts an array of potential "fault lines" — obstacles that could seriously hinder or even reverse this trajectory. Eight potential fault lines are especially serious. They impend in a wide range of differing sectoral and institutional areas, constituting serious obstacles to China's future growth. These fault lines, together with rough estimates of how much they would reduce China's annual economic growth, can be briefly described as follows:
Unemployment, poverty, and social unrest Open and disguised unemployment in China amounts to more than 20 percent of the total labor force, or approximately 170 million people. Recent and prospective increases in unemployment are due to population increases in the 1980s, privatization and downsizing of inefficient state-owned enterprises, and the employment effects of China's efforts to comply with its WTO commitments. Rural poverty is accompanied by increased income inequality between rural and urban areas, by rural-to-urban migration, by rising urban unemployment, and social unrest. A possible worsening of these adversities could cause a reduction of between 0.3 and 0.8 percent in China's annual growth during the coming decade.
Corruption Pervasive and perhaps increased corruption in China could adversely affect China's economic growth by distorting resource allocations, though how large these distortions would be is difficult to estimate. In cross-country comparisons, increases in corruption are associated with lower rates of economic growth. Were corrupt practices in China to worsen, China's position would decline in the country indexes that link economic growth with a prevalence of corruption. Such an adverse shift could reduce China's expected annual growth rate by perhaps 0.5 percent.
Excerpted from Looking Backward and Forward by Charles Wolf Jr.. Copyright © 2008 Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of Hoover Institution Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.