The China Development Model

Between the State and the Market

Dominique de Rambures

• Publisher: Palgrave Macmillan
• Year: 2014
• Print ISBN:
  9781349499557
  9781137465481
• eBook ISBN:
  9781137465498
• Topic: Politics & International Relations
• Subtopic: Finance
• Index: Politics & International Relations

Over the last thirty years, China has been reforming its economy at breakneck speed. However a surge in nationalism is threatening China's relations with its neighbours and its rise to regional leadership. This book addresses a wide range of factors influencing the development of China's model and its influence on the rest of the world.

1

What is the Socialist Market Economy?

The truth is not pleasant. Pleasant words are not the truth.

(Lao seu)

For any sensible mind, the term ‘socialist market economy’ is an oxymoron the two adjectives conflict. This definition appeared relatively late – in 1992, during the 14th National Congress of the Communist Party of China – as the policy of reform and opening that began in 1978. Up to this point, one spoke of a ‘commodity economy’ to avoid using the words ‘market economy’, which were taboo. The ‘market economy’ was discovered before the word was used. The policy of ‘reform and opening’ was meant to be a transition, but a transition to what? Towards socialism, or towards capitalism? It took Poland three years to complete what China has not yet achieved in thirty. The word ‘transition’ is the only stable part of the policy of reform – a sort of new ‘perpetual permanent revolution’, to paraphrase Lenin. However, the idea that something goes from A to B is not consistent with the traditional Chinese way of thinking. Everything is ephemeral; all events are part of a continuum without a beginning or an end. Everything forms part of the flow of the eternal stream of all things. Nothing is fixed, not even the truth – which is contingent by definition.

According to a former prime minister of the People’s Republic of China, Wen Jiabao (2002–12): ‘the complete wording of our economic policy is to let the market play its role within the allocation process of resources under macroeconomic policy and government regulations’. Any other country may comply with such a vague definition; there is no such thing as an economy that is market-driven on the one hand and command-driven on the other. There are, however, countries which are either market-driven or government-driven to varying degrees. If we were to draw a line where countries’ economies are ranked according to whether they are market-driven or government-driven and include the United States of America (USA) and the United Kingdom (UK) on the one hand, and Cuba and North Korea on the other, where does China stand and in which direction is she moving?

Theoretically, a market economy should lead to capitalism and democracy (as proposed by Schumpeter). A market economy needs to be backed not only by private property, free prices, an absence of government interference and an absence of monopolies, but also by free enterprise, freedom of speech and freedom of innovation. Citizens vote with their ballot; consumers vote with their money. In a market economy, the leading forces work in a bottom-up scenario through the choices of decentralized consumers and entrepreneurs.

Given that words do not have the same meaning within the Great Wall as outside it, what is the status of a company both legally and actually? Every form of legal status is authorized: privately-owned companies, public companies, state-owned companies, individual companies; cooperatives; mixed companies, where private investors are owners together with the government itself; government agencies or local communities. But neither a monopoly situation nor public services are useful criteria in this matter since, ultimately, the government maintains a firm grip on any company, be it directly or indirectly. When the 1984 Company Law was passed, it was understood that the goal was to ‘keep the large companies within government control and let the small ones go to the private sector’. But some ‘small’ companies have grown into ‘large’ ones, especially in the field of hi-tech or internet business: Alibaba, Baidu, Sina, Taobao. These developments take place while industrial sectors remain under direct government control, even though they have with public service or state monopoly. The legal statute does not provide any information as to the make-up of shareholders. A number of ‘private’ companies are actually owned by government entities. The government can interfere in many different ways and through many different intermediaries. In every case, the managers are appointed by the Party. In any company, there is a Party cell and a Trade Union cell, both reporting to the Party. There is a single Chinese Trade Union (the All-China Federation of Trade Unions – ACFTU) affiliated to the Party. Trade unions do not exist to support workers’ interests but, rather, to prevent labour conflicts. A public company is not a company whose ownership has shifted from government to private investors, but a company which is run in accordance with the capitalist management model: autonomous management, competition, market-driven pricing, management targets expressed in terms of profits, market share, accountability, and so on. All major decisions, from the appointment of top managers to strategic planning, from investment programming to mergers and acquisitions, must be approved by the Party’s Human Resources department or the Party National Development and Reform Commission (NRDC) – the powerful government agency which took the place of the former Planning Administration.

In the second half of the nineteenth century, China felt the urgent need to reform by importing Western technologies. Following the Taiping Rebellion which lasted 10 years (1854–1863), starting in Nanking, the Rebellion almost reached Beijing and almost toppled the Qing dynasty. The Imperial regime was seriously shaken and weakened, both internally and externally. The central government being too weak, the onus was on the local governors to break down the Taiping rebels by collecting taxes, raising money and armies, building up arsenals and shipyards, buying modern weaponry and recruiting foreign instructors. It was also the burden of the same generation of local Mandarins – such as Zeng Guofan (1811–71), Zuo Zongtang (1812–85) and Li Hongzhang (1823–1901) (who would go on to become Prime Minister) – to initiate the reform movement. After the disastrous Treaty of Shimonoseki (1894) which ended the Japanese war (1994), the local governors undertook the Industrial Revolution in their respective provinces, disregarded the central government’s neglect along with Chinese merchants and foreign experts or mercenaries. ‘Oversight by Mandarins, management by merchants’; ‘Western technology, Chinese wisdom’. In 1918, thanks to World War I, Shanghai’s shipyards were the largest in the world.

Under the rule of Chiang Kai-shek (Jiang Je-shi) (1927–49), the largest Western banks were, de facto, nationalized. They were under the control of the wealthy Generalissimo’s brothers-in-law, T.S. Koong (the brother of Chiang’s wife) and H.H. Kung (the husband of Chiang’s wife’s sister), alternatively and successively Minister of Finance and President of the Central Bank. Initially, Koong was Minister of Finance and Kung, a former banker was head of the central bank. Subsequently, Koong and Kung exchanged posts. War bonds were included in the bank reserve requirements. As the interest rates of the government bonds were higher than the interest rates charged to the customers, and because Chinese banks were required to subscribe to the government bonds, Chinese firms were starved of credit finance.

The ‘policy of reform and opening’ undertaken by Deng Xiaoping and his fellow reformists was mostly inspired by neighbouring countries such as Japan and the ‘Asian Tigers’ (South Korea, Taiwan and Singapore). Reform was to support the concentration of big firms, one or two in each industrial sector behind the Great Wall of custom barriers such as the Japanese zaibatsu and the Korean chaebols. The plan was then to expose the most successful to the foreign markets and to international competition once they had achieved sufficient turnover and productivity levels.

Once state-owned companies are listed on the stock exchange, the aim is not to change ownership from that of government to private investors but, rather, to mop up the high level of saving by government target industries and to impose market discipline on management while keeping overall control of the companies. Whatever the company’s legal status, it remains under government control. Only between 5 per cent and 10 per cent of the shares are floated. Of these, only one third of the shares are tradable. The volume of shares available to ‘private’ investors is quite limited and is sufficient to supply a fully-fledged, well-fed stock market. The stock shares owned by foreigners in Chinese companies cannot exceed 20 per cent, and such shareholders have no say regarding the company management. The newly issued bank shares are frozen by means of a three- to five-year lock-up provision. In joint ventures, foreign shareholders are always granted minority participations. Given the unofficial backing of the government and the quasi state guarantee, there is no major difference between stocks and bonds. In most cases, the new shareholders are government institutions. The public auction for new infrastructures (subsequent to the rescue package) is normally reserved to government-owned companies. In a 2013 directive, the government instructed state-owned companies to pay a minimum 5 per cent profit to the shareholders (including state and government entities).

The China Merchant Bank, a 100 per cent government-owned bank, was ‘privatized’ in 2003 through an initial public offering (IPO) on the Shanghai Stock Exchange and further, in 2009, on the Hong Kong Stock Exchange. No more than 15 per cent of the stock was sold and it was mostly subscribed to by policy banks such as the China Development Bank, state-owned banks such as the Bank of Communications (BOCOM), China Construction Bank (CCB) and Bank of China (BOC) or government entities such as the State Agency of Foreign Exchange (SAFE), the State-owned Assets Supervision and Administration Commission (SASAC), the China Investment Corporation (CIC), Huijin (which is part of CIC), and various large foreign banks subscribed to early IPOs through private placements priced below market value. These banks comprised, among others, Goldman Sachs in the Industrial and Commercial Bank of China (ICBC), the Bank of America and the Royal Bank of Scotland in CCB, the Hong Kong and Shanghai Banking Corporation (HSBC) in BOCOM, Crédit Agricole in the Agricultural Bank of China (ABC), J.P.Morgan in the China International Trust and Investment Corporation (CITIC). They soon realized that the price of shares was too expensive when compared with the expected benefits: their investment did not provide them any influence on bank strategy and did not open the Chinese market to foreign shareholders. More often than not, the companies with the most important shareholders did not hesitate to form affiliated companies with their competitors. Most of them tried to resell their shares once the lock-out period had come to an end.

Local communities were often shareholders of industrial or banking institutions. In some cases, the venture was initiated by local authorities to meet local needs. In the early 1980s, following agricultural reform (household contract or household responsibility), farmers were free to leave the collective communes and production teams. Most local communities had to form local companies known as ‘Township and Village Enterprises’ (TVEs) to meet the needs of the newly independent peasants. In the 1980s, the TVE sowed the first seeds of private capitalism ‘with Chinese characteristics’. In a second stage, as a result of the ‘period of political freeze’ which followed the 1989 Tien An Men events, most of the TVEs were merged and ‘privatized’ (i.e. transferred to their managers). Some cities formed investment companies or private equity companies with a view to participating in local companies or external companies willing to invest in their territory – thus producing new jobs, new opportunities and new taxes. In 2011, the city of Beijing formed a private-equity company together with the American investment company Carlyle (the world’s second largest investment company) to extend ad hoc financing to industrial investment in Beijing’s Special Economic Area (SEA). Most of the local banks are partially or wholly owned by local communities; for example, the Bank of Nanjing is partially owned by the City of Nanjing and 20 per cent owned by the French Bank of Nanjing.

In any case, it is almost impossible to open a new venture in a local community without the active support and involvement of the local authorities. In case of trouble, there is no recourse before the Party or the courts unless the private investor is relying on a strong network of ‘friends’ (guanxi). In the countryside, the business community is also a mix of private initiative and local official involvement. The land is state-owned, as has been the case for centuries. The farmers are granted a piece of land by the local authorities in accordance with the needs of the household, the fertility of the soil and the distance of the plot from the village. Long-term renting allows farmers to invest in farming equipment and improving the fertility of their plot, with the expectation that they can harvest the profits of their efforts in due course. They can buy and sell, lease and rent the usufruct of their lots in order to widen the scale of the cultivated land for the buyer, and to collect savings to facilitate their migration to the next town or the seller.

Market mechanisms

The market has a dual function: it is both a price mechanism and a supplier of information – the latter being no more important than the former, as Hayek used to say. On one hand, it is the place where demand and supply meet to build up a common price; on the other, it is a source of information and data – a crucial ingredient to all market participants: consumer choice, producer investment, marketing strategy and government macroeconomic decisions are market-driven through the price process. Under one condition, the price mechanism should be free of any interference – that is, no market participant, especially the government, is strong enough to manipulate the price mechanism to take advantage on their own behalf. All market participants must have access to the same market data and information. In China, both the large state-owned enterprises (SOEs) and state-owned banks (SOBs) have a quasi monopolistic market share, with the government continuing to interfere with the price process.

Under certain conditions, government supervisors can prohibit, delay, or authorize new entrants to the market, such as foreign investors. Companies are kept under tight control through any of a wide range of legal constraints, existing regulations and informal guidance. The government supervizing agencies can use intrusive, detailed frameworks of regulation – often overlapping, or even contradictory – on behalf of some market participants at the expense of the others. Regulation – whether it relates to financial, banking, labour, legal, ecological, or safety matters – is arbitrarily used to support or eliminate a competitor. Whenever necessary, companies in a targeted sector, especially the banking sector, are summoned to join ad hoc meetings convened to convey government instructions. As a follow-up to the massive 2008 stimulus plan (Rmb 4000 billion, or US$650 billion), the banking sector (i.e. the four big state-owned banks) was instructed to undertake a dramatic increase in bank lending in support of the government’s plan. Within one year, the volume of bank loans had more than doubled. Later, it appeared that most of the new loans that were granted to finance pointless local authority infrastructures were not going to be repaid. One year later, the banking sector was again recalled – this time it was instructed to refrain from granting fresh loans and being financially wasteful with regard to local authorities. Backed up by a gigantic domestic market (though not necessarily marketable), China’s government imposed its own standards and criteria at the expense of international partners. Once authorization was granted, the investor – whether Chinese or foreign – had to apply to the local authority for a fresh round of groundless, duplicated enquiries. It is well-known that Chinese mining pits are poorly equipped, even dangerous. A number of manufacturing companies, including foreign companies, recruited youth and/or migrant workers without the required work permits. Migrant workers were unprotected: they had no binding contract, no social security, no access to schools, no health system, no pension scheme. As a matter of policy, the central government actively supported a consolidation process among the major manufacturing companies. Through merger, acquisition, regrouping and restructuring, under government or Party inducement ‘national champions’ emerged which had a monopolistic or quasi monopolistic market share. This was in order to compete ‘evenly’, or to benefit from ‘fair’ competition on the domestic and international markets. From then on, the new ‘champions’ will be in a position to dictate their wishes to business partners: suppliers, sub-contractors, bank institutions, distribution networks and/or local authorities.

The state-owned government trading companies no longer exist but the companies have kept some business practices inherited from the planning period. In order to guarantee access to the supply of raw materials, equipment and unfinished products at any given price, companies remained in touch with each other to bypass government constraints. During the credit crunch, corporations borrowed from and lent to each other, even though this is prohibited by law. For both lenders and borrowers, the spread was tightened (i.e. the interest rate paid by the borrower to the lender is higher than the bank savings rate and lower than the bank lending rate). It is estimated that business-to-business (B2B) transactions account in the region of 30 per cent of the overall amount of credit extended.

Thanks to monopolistic (a single seller) or monopsistic (a single buyer) market share, companies can increase or decrease prices over or under the otherwise free market price. In the Western world, such practice is prohibited by law as it bypasses the bank monopoly; in the Chinese market, it is a deliberate process undertaken by government on behalf of certain companies or industries at the expense of others. The rise of consumer prices is a way to transfer profits from the consumers to the producers, and vice versa.

Mao Yushi, an economist, tried to calculate the social cost of price distortion in China. According to him, estimated extra profits collected by government-owned telecommunication companies thanks to their monopolistic situation amounted to Rmb 31 billion (US$5 billion) per year from 2003 to 2010. This does not include the calls discouraged by the price level and estimated at a further Rmb 422 billion (US$ 60 billion). Depositor losses due to government regulation amounted to something in the range of Rmb 1,160 billion (US$184 billion) in 2011 (i.e. 2.5 per cent of the gross domestic product (GDP). Without free prices, companies cannot compare the respective costs of production factors, and prices do not reflect real costs; so are the economic actors: buyers and sellers, investors and savers, or lenders and borrowers. Companies are not provided with the data that they need to operate effectively.

In this respect, the price liberalization in banking in September 2012 was an historical event. Hitherto, the rate paid by banks to a customer’s deposit account, the rate paid to the central bank for necessary daily refinancing and the rate charged to the individual or corporate borrowers were fixed by the central bank on the instruction of the State Council. From this point on, banks competed with each other to attract savings and deposits through so-called ‘Wealth Management Products’ (WMPs). These are a sort of subprime deal based on a certain range of loans which produce a rate higher than the usual bank savings account. Thus far, the rate scale was flat as all commitments were rated at the same level of risk (whether Treasury bonds or loans to government-owned companies or banks, whether short- or long-term) and, thus, at the same price. As a result, the banks allocated their liabilities to buy Treasury bonds rather than lend to companies as well as small and medium-sized companies or individuals.

The great return of the state

In 2012, more than 90 per cent of the 2,400 companies listed on the stock exchange were granted government or local authority subsidies amounting to Rmb 85 billion (US$13.8 billion) (i.e. a 24 per cent annual increase). This is while the profits of listed companies registered only a 13 per cent annual increase. In 2011, government subsidies amounted to 4 per cent of total companies’ profits (3 per cent in 2010). Gove...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Tables, Figures and Boxes
• List of Abbreviations and Acronyms
• Introduction
• 1 What is the Socialist Market Economy?
• 2 The Transition Period
• 3 A Fast but Unbalanced Growth
• 4 An Uncompleted Banking and Financial Reform
• 5 Investment in Human Capital
• 6 The Knowledge Economy
• 7 Growing Inequalities
• 8 A Foreign Policy which Serves Growth (and Vice Versa)
• 9 In Search of Civil Society
• Conclusion
• Notes
• Bibliography
• Index