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China's Stumbling Future

John Lee

When Nobel prize-winning economist Kenneth Arrow was asked recently which country had the best-managed economy, he nominated China, Taiwan and South Korea. This viewpoint is consistent with the widely held belief that China is the latest and largest successful installment of the East Asian model of authoritarian development. But despite some similarities, looks can be deceiving.

The nature, purpose and extent of the role of the state in the Chinese economy and society sets it apart from its successful East Asian neighbors. In fact, the differences are significant enough to call into question whether China will taste the fruits of successful modernization enjoyed by other Asian economies, including Japan, South Korea and Taiwan.

The key to success in these countries was the development of conditions needed for competition and private enterprise to eventually take off. Even though it was within a context of state-guided capitalism and mistakes were made, the governments ultimately offered a helping hand to lay the foundation for future private enterprise and capitalist activity—in particular, widespread and open access to economic opportunity, rule of law, property rights and social and political stability.

Isn’t China doing similar things to achieve growth? Most Western commentators focus on the spectacular success of the emergence of China as the world’s factory. But the greater contributor to Chinese growth is actually domestically funded fixed investment, which constituted over 50% of GDP in 2008 and over 40% of growth in that year. China is way off the charts in this regard. Taiwan, for example, which had an unparalleled growth rate of 8% each year over 50 years, never had capital investment spending of more than 30% of GDP.

But it’s not just the high reliance on fixed investment that is striking. It is where the capital goes that is all-important. China is unusual in that bank loans, drawn from the deposits of its citizens and funneled into state-controlled banks, constitute around 80% of all investment activity in the country.

Even though state-controlled enterprises produce between one-fourth and one-third of all output in the country, they receive more than 75% of the country’s capital, and that figure is rising. The Chinese state sector owns almost two-thirds of all fixed assets in the country. This is the reverse of what occurred in South Korea (as well as Japan and Taiwan), where the private sector received over three-quarters of all capital during the 1960s and 1970s.

Another case in point is proved by a close examination of shares listed on the Shanghai Stock Exchange: Only around 50 of the approximately 1,300 companies are genuinely private. Between 1990 and 2003 less than 7% of the initial public offerings on the Shanghai and Shenzhen stock exchanges were from private-sector companies. The Chinese state owns about 50% of all the shares of listed companies. When state-controlled entities are included in the calculation, it is likely to be around 70% to 80% of all listed shares.

The massive bias toward the state sector would be acceptable if the 120,000 state-controlled enterprises could learn to innovate and adapt. Unfortunately, except for a handful of centrally managed state-controlled enterprises, this is not the case. World Bank findings indicate that about one-third of the state-controlled sector’s recent investments generated zero or negative returns.

The economic cost in terms of loans that go bad is well over $1 trillion (in U.S. dollars) and rising. But the social costs and impact on civil society are greater. Since the state dispenses the most valued business, career and professional opportunities, a relatively small group of well-placed and well-connected insiders benefit while opportunities to prosper are denied to the vast majority.

Despite impressive GDP growth, about 400 million people have seen their net incomes stagnate or decline over the past decade. The income of the poorest 10% has been declining by 2.4% each year since the beginning of this century. Since 2000 absolute poverty has actually increased, as has illiteracy.

China is not becoming Japan, Taiwan or South Korea writ large. A large, stumbling giant like Russia or Brazil might be a more accurate example of its future.

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