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End The China-Envy: Democracies Have It Better

John Lee

Back in 2009, New York Times columnist Tom Friedman admitted to a large dose of China-envy in offering praise for an authoritarian system that could ignore democratic political chaos, identify problems and implement solutions with minimal fuss and opposition. In short, its authoritarian system was simply better, simpler and more effective.

Friedman’s China-envy was widely reported because it was widely held. But such envy was never founded on an accurate representation of how China actually works. With its economy now clearly in trouble, the same advocates of the authoritarian model are now placing their faith in the presumed ingenuity of the technocrats running the country. Except technocratic fixes will not solve China’s problems. Only transitioning away from an authoritarian model will be enough.

Let’s begin with how recent problems started: the emergence of a property bubble. The bubble had its roots in a government driven response to the global financial crisis from 2008 onward which devastated China’s advanced economy export markets.

From 2009 onward, Beijing responded with the largest fixed investment stimulus in history, forcing state-owned banks to lend predominantly to state-owned-enterprises (SOEs) to build more things for the sake of generating growth needed for political stability. The result: ghost cities and empty residential housing that can meet the urbanization needs for decades to come.

Flushed with cheap credit created out of the savings of its citizens in the coffers of state banks, SOEs then made a killing by on-lending money to the credit starved private sector at exorbitant rates, with private and SOE firms in turn using over-valued assets as collateral for more borrowing. From 2008-2014, new credit flooding the economy increased by over $20 trillion, exceeding the size of the entire American commercial banking sector by one and the half times.

Then consider the related drivers of the stock market turmoil in China. Capital controls designed to prevent capital flight and keep state-owned banks solvent mean that Chinese private firms and households cannot easily take their savings out of the country, and must instead deposit savings into state-owned banks. Households and private firms receive barely any return from these savings as ceilings are imposed on deposit rates. So with the property boom flat-lining and few other money making options, speculating on the stock market become one of the few ways to make a decent return.

The problem now is that technical fixes by an authoritarian government is only making things worse. For example, Beijing has delayed the repayment of trillions of dollars of maturing debt incurred by wasteful and incompetent local government SOEs since 2008. This is being achieved by through forcing lending institutions to roll over maturing loans, and forcing state-owned banks and other SOEs to buy local government corporate bonds. It is a unique solution available to authoritarian governments to prevent SOEs from defaulting on loans or running out of capital.

But to what better end? Bad companies deserve to fail as ‘creative destruction’ is mandatory in successful and innovative economies. That SOEs in China are rarely allowed to only exacerbate moral hazard: encouraging even more risk taking and inefficient investment, and worsening the debt burden. As it stands, one in every three new dollars borrowed by SOEs goes toward managing existing debt. As the majority of borrowing in China’s state-dominated economy is by SOEs, this is hardly a constructive use of national wealth.

It is undeniable that Europe, Japan and the U.S. have their own serious problems. So why pick on authoritarian China? There is one good reason. Isn’t the whole point of economics to improve the living standards of households and individuals, despite its reputation as the ‘dismal science’? Otherwise, what is the ultimately point of wealth creation?

Around 80% of the poverty alleviation since 1979 onward in the first two decades of reform. That was when the domestic private sector was encouraged to rise up and take the lead in wealth creation. The problem with China’s political-economy since this century, and the authoritarian fixes being applied to stabilise and perpetuate its model is that the current version is deliberately designed to enhance wealth and opportunity for the dominant state-sector at the expense of the private sector, households and individuals.

So unlike in democracies where the balance of power and opportunity between government on the one hand, and the private and household sectors on the other, is far more equal, the Chinese people on the whole have no chance to grow rich before they grow old. Achieving that would require a radical transfer of national wealth and opportunity away from SOEs to the rest of the economy. But doing so would imperil the authority and relevance of the Communist Party and propel China toward a path of economic and political liberalisation experienced by now rich East Asian countries such as Japan, South Korea and Taiwan.

Instead, we are left with authoritarian technical fixes that are being applied in increasingly panicked fashion, are looking more and more ineffective, and continue to disempower and remove opportunity for ordinary Chinese citizens by the day as the Party finds new ways to tighten its grip in the face of loss of control.

Being forced into messy compromises in liberal-democratic systems is frustrating. But maybe for the average citizen, that tends to work out better than the authoritarian alternative.

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