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Thursday, September 25, 2003

Second Version: CHINA'S ECONOMIC FUTURE III: THE PIVOTAL CLASH BETWEEN CP AUTHORITARIANISM AND THE LOGIC OF ECONOMIC REFORM

In the three articles published the last four days on China's economic future --- including an exchange with a visitor posted yesterday --- essentially four conclusions were reached.

PART I: THE BUILT-IN CLASH BETWEEN COMMUNIST POLITICAL AUTHORITIANISM AND STATISM AND THE LOGIC OF MARKET DECENTRALIZATION AND FLEXIBILITY

This clash, already under way, is bound to intensify in the future. The underlying causes result from a series of converging trends and influences, pushed by the epochal economic upheavals in Chinese life since 1978, with all the political fallout and implications that follow . . . including, as we've seen, benefits to about half the population, with the remaining half either not helped by the far-reaching changes or clearly hurt. Remember, among other things, actual unemployment is probably close to 20% of the work force; income and wealth inequalities have skyrocketed; there are huge regional disparities; the environment has worsened, so too has public health for large parts of the 1.3 billion Chinese; and social tensions, outright protests, strikes, and demonstration, and political alienation have been documented even by the Chinese authorities.

Hence our main theme here: what, we ask, is forcing the question of major reforms --- economic, social, and political --- to move to the very center of the government's and CP's political agenda, and what will happen to it?

Introductory Comments

As we'll see, even though numerous, far-reaching social, economic, and political reforms may be necessary to stave off economic stagnation in the next decade or two, that doesn't mean they'll be carried out easily . . . if at all. In key quarters around the country, there exists tenacious, dug-in resistance to any vigorous reform strategy that threatens the current status quo: first within the divided CP itself --- about 60 million throughout the country, with perhaps a few hundred key CP leaders the ones to scrutinize; also the within the government and the mammouth bureaucratic machine, where millions of unproductive jobs are at stake; and not least within a divided Chinese people . . . only half of whom, remember, have benefitted from the changes since 1979, and with hundreds of millions threatened with lay-offs, shifts to other jobs, or outright unemployment during any transitional stage, driven by reforms, toward a more efficient, flexible, market-driven economy that can't implant itself without tens of thousands of state-enterprise enterprises and numerous uncompetitive private and communally owned firms going bankrupt.

(As a sidebar observation, think --- If it helps --- of the wrenching changes the American Mid-West and South went through in the 1980s and early 1990s as about 8 or 9 million jobs were lost when giant firms in steel, auto, chemical, textile, and coal industries found themselves uncompetitive and had to restructure, pare-down, and reorganize. Eventually, within a dozen years, the Mid-West and South emerged with new, more technologically up-to-date industries of a high-tech sort, to say nothing of far more competitive old-line ones. A dozen years of dislocation and flux and lay-offs and bankrupty galore, and then a spanking new economic basis. And all this, mind you, occurred in a highly flexible economy, where worker mobility is taken for granted and a social security safety net is in place, and political legitimacy is anchored solidly. Then multiply the dislocations and rippling changes that China will have to go through several-fold in the future, and you get a good working idea of what lies in store and why a systematic reform program is so divisive.





 

Note, as a final introductory comment, that the dilemmas pressing down on the CP leadership --- reform vigorously, dislocations and all, or face a future of incoherent and timid change that will lead in a decade or two to the existing economy's growth being buried under an avalanche of festering market inefficiencies and statist traps --- can't be finessed for too many years into the future. The longer difficult changes are delayed, the harder it will be to change the status quo. (Again, if it helps, think of Japan's economic problems here . . . in a country, remember, that is far richer, far more productive and technologically advance, and with a stable democratic system. For over a dozen years now, amid unstoppable stagnation and mountains of private and public debt --- caused by an over-regulated, over-protected, semi-cartelized economy dominated by way too much statist interference --- Japan's political leaders have balked at forcing through a big reform- and restructuring program in that country, the essential pre-requisite of a revived economic dynamism . . . and precisely out of fear for the social and political dislocations that would ensue.) To explain these dilemmas --- and the politically rippling clashes between the forces of the status quo and change --- shift attention now and consider the major conclusions that the first three articles published here this week about China's economic future arrived at.

Four stand out in particular:



1) A Recent Slowdown in Economic Growth.

For both theoretical and practical reasons, China's fast-paced economic development over the last 25 years --- since 1978, the year the post-Maoist reforms began --- has slowed down from its torrid pace in the 1980s and very early 1990s, somewhere probably between 6.8 8.0% annually (the latter figure based on dubious official Chinese statistics, the former utilizing a more realistic deflator of high levels of inflation), to settle down to an average the last 11 years somewhere around . . . well, take a guess: probably in the range of a 4.0% annually to maybe as high as 7.0%.



Again, the latter figure is what inflated Chinese national statistics claim. Somewhere between it and 4.0% is likely to be more realistic, and some specialists like Thomas Rawski --- after a close examination of official Chinese national income acounts, interviews with Chinese statisticians and economists, and a study of the various energy and other inputs into GDP growth since 1997, the year of the Asian meltdown --- go further: they note the widespread complaints about cooked stats and fraudulence in the reports sent to Beijing by tens of thousands of local CP and government officials from around that vast country --- voiced publicly at one point by the then Prime Minister, Zhu Rongji in the late 1990 --- take into account the more realistic levels of unemployment (close probably to 20%), and doubt, by way of conclusion, that there has been any sustained growth to speak of over the last six years.

 

2) Further Economic Slowdown Inevitable.

Whatever the actual pace of development has been since 1992, it is almost certain to slow even further in the next decade or two. The chief reason?

Simply said, unless China's CP leadership can find ways to carry out all the difficult, politically charged reforms that stand in the way of a flexible, efficient, productivity-driven economy of a more market-oriented sort, its existing economy --- dependent largely (not entirely) on huge levels of capital spending and labor growth --- will suffer increasingly from diminishing returns as its cumulative capital stock swells in size. Only a switch to a far more qualitative market economy of this sort --- which advances mainly by technological progress and a steady and constant reallocation of crucial capital investment and skilled labor (including managers and scientists and engineers and technicians) along lines of comparative advantage, open to more and more international competition --- will manage the transition, turbulent as it will likely be, to a new long-term growth path that can overcome all the drawbacks that we know plague the largely statist, over-protected economy that has evolved since 1978, the start of the post-Mao reforms.

Inefficiencies Galore

Right now, to put it tersely, the resulting national economy is an incoherent mishmash:

1) On one side, there's a largely statist-dominated and statist-owned economy, with a swollen parasitic state-enterprise system despite recent paring and state-owned banks --- both essentially bankrupt, a huge waste of the Chinese people's vast savings;

2) On the other side, there are rapidly growing sectors of private and town-and-village communal-owned firms that continue, save in limited industries and regions, to be trammeled by a swarm of bureaucratic regulations, rigidities, and red-tape. One result: two and a half decades into the reform era, the national market remains badly fragmented across regions, a chopped-up economy that, among other things, discourages nation-wide firms from emerging. Another: over-investment has piled up for decades in highly protected industries --- even some with a big multinational corporate presence --- which will doubtfully be fully competitive in the global economy. Nor is that all. Even in the private sectors, subsidies, protection, over-regulation, and bureaucratic inefficiencies --- not least, which fragment the national economy across regions --- abound, with little progress on reversing these swelling inefficiencies that continue to multiply in every direction.

* As for the bankrupt state banks and the parasitic state-owned enterprises, close to 100,000 in number still despite a steady paring the last six years from 200,000 in 1997 (mainly small- and medium-size enterprises, not the giants), they still employ 80 - 90 million workers; and even though they accounted for only 40% of China's industrial output in early 2002, they still gobbled up 80% of all the nation's scarce resources. Put differently, the private and community-owned firms produced 60% of all industrial output while using only 20% of total resources. For a good analysis and the stats, see Allan Zhang, 2002

*It gets worse. Despite the big reduction in total numbers of the state-owned enterprises, the remaining ones are essentially bankrupt and subsist because of huge influxes of subsidies funneled their way by the shaky, debt-ridden state-banks that waste, in the process, most of the Chinese people's vast savings, around a third of personal income in the country. At the same time, though more cut-backs are scheduled --- the government hoping eventually to sell-off or shut down about 90% of the number of state-owned enterprises, leaving about 10,000 giant ones over the next 17 years --- these bankrupt firms are the only ones that offer any social security safety net, including a pension scheme, for the 800 million Chinese work force: not only will the remaining 80 - 90 million workers in the state sector fight further reductions therefore, intensifying the pace of strikes, protests, and demonstrations, a common daily affair in Chinese cities --- those who remain in the state sector can only wonder how their pensions and other benefits will be paid. For that matter, despite lots of hullabaloo that includes a new agency to act as a shareholder for the state in these firms, no clear restructuring plan for slimming the number of enterprises exists, any more than for making the remaining giant enterprises profitable and competitive as China, now in the WTO, moves to open its economy to foreign competition in line with WTO rules.


 

Another Problem: Agriculture

Nor, come to that, are these the only two sides of the structural mishmash.

Add in a large, nominally private agrarian sector --- about 15-16% of total GDP, but with about 40% of the work force employed in it still --- that has been badly neglected since the early 1980s' initial reforms. In particular, investment in it has languished badly: by the mid-1990s, believe it or not, total agricultural investment was still 32% below the spending-level that it enjoyed in 1978, the start of the reform era! As a percentage of overall national investment, this means that agriculture --- which once attracted about 20% in 1980 --- was absorbing only 2.4% of the total by the mid-1990s. There's been little improvement since. (For the stats, see a good 2002 study: )

There are other problems too.

Chinese farmers have shown, after three decades of nightmarish Maoist collectives, that they are entrepreneurial, hard-working, and eager to improve their incomes in free markets. For all the problems that have afflicted agriculture, they have increased food output impressively. But note. As with collective-owned manufacturing firms, millions of them, the ownership rights of Chinese farmers to the land they work have not been consolidated in legal changes that protect private property from government seizure or other abuses in the future. What follows? Until these rights are clearly guaranteed and protected by the legal system, Chinese farmers will face uncertainty as they struggle, individually, to try finding loans and risking their livelihood by undertaking necessary but precarious investments in better technologies and cultivating strategies (such as genetically modified plant seeds) . . . to say nothing of a desperate need, which only government can satisfy, of better help for dealing with the dangers of floods, droughts, and insufficient irrigation. For that matter, a far better system of transporting and marketing food to teeming cities, near or far, is desperately needed too.

 

The Result?

It emerges with clarity. China's GDP growth, already slowed compared to the 1980s and early 1990s, will very likely slow down even more in the next few years. Faced with this prospect, the CP elites' hopes and ambitions to transform the country into an advanced, knowledge-based economy of high levels of per capita income, productivity, and technological dynamism by 2040 or 2050 --- a giant to compete with the US and the EU --- are perilously at stake. The outcome here hinges delicately on the party's ability to overcome massive resistance from within and from without and unite on a strategy of vigorous systematic reforms --- social and economic and political. These reforms, moreover, have to be implemented in a timely and effective manner, all aimed at one overrriding goal: to reorient the economy and place it on a new qualitative-driven developmental path before economic growth grinds to a halt, overwhelmed by sheer inefficiencies and diminishing returns.

Note that there's no magical alternative here; no clever short-circuiting these problems. Under such mountains of piled-up market inefficiencies and sheer incoherence, a mishmash of mammoth proportions, no economy can emerge out of early developmental progress and sustain steady growth to levels of productivity and per capita income that rival those of the EU and the US and Japan.

For that matter, as we noted earlier --- the comparison can't be overdone --- Japan's recent fate should be an object lesson here. Despite that country's far higher levels of per capita income, productivity, and technological prowess compared to China's --- to say nothing of its highly institutionalized democratic political system (with one-party dominance) --- its dismal economic record the last dozen years shows what can happen to even a former world-class economy, once touted as the global pace-setter, if swarms of market inefficiencies, over-regulation, political pork-barrel, shaky finances, and fears of change are allowed to multiply and fester without steady, vigorous doses of difficult reforms and an ability to absorb wrenching and painful structural change, dislocations and all.

 

3) The Diifficult Reforms Needed To Stave Off Slowdown and Stagnation

Given all this, what follows. Essentially, a duet of related questions.

*Can the Chinese economy be reoriented, switched away from a quantitative developmental path ending in a morass of stagnation and irretrievable incoherence and put on a new qualitative growth-path that is far more promising --- with rises in GDP based on steady improvements in productivity, technological progress, and institutional and structural flexibility?

*Will a reform strategy, to put this more tangibly, emerge that is sufficiently timely and effective and be implemented with resolute decisiveness despite tenacious, wide-flung resistance?

These, of course, are the $64,000 questions, the crux uncertainties hanging over China's economic and political destiny. Right now, the outcome isn't at all clear. In particular, as the first buggy article in this mini-series on China showed --- The Future of Pacific Asia and China --- the CP since 1978 has followed essentially an easy-to-hard reform sequence, with the most difficult reforms still lying ahead. But what exactly, in concrete language, are the tricky, politically controversial reforms that are needed?

They're numerous, needless to say; and fall into a few clear categories; and are fraught with conflict-laden challenges to existing CP rule . . . with the political status quo itself, not just the economic, at stake. That political status quo, recall, brings enormous benefits to the existing CP members, those around the country and even more those in top leadership positions: some 60 million in all. Especially in the leadership ranks, they retain enormous power, enjoy prestige and influence galore, and are enriching themselves (or their families) at a galloping pace . . . in effect, an entrenched and aggrandizing elite, even as authorized Chinese studies and survey data show that the party has, over time, more and more alienated itself from the masses of Chinese people. The result? Understandably, from an alienated people buffeted by change and upheaval --- prosperity and job security confined to a few regions and among certain classes --- the masses see the party as predominantly an engine of self-anointed, self-serving ends, little else . . . and are increasingly disgusted with the rampant corruption and nepotism that flourish in the country these days. (We'll return to these studies and surveys, which were mentioned in the first article in this mini-series on China, for a closer view later on here).

So what, concretely speaking, are the demanding reforms --- economic, financial, administrative, legal, and political --- that have to be implemented for China's economic growth to be reoriented to a more efficient, sustained developmental path with far greater benefits for all the population? We'll set these out in a moment or two. For the time being, jog your mind forward and ponder the last conclusion that emerged out of the previous buggy articles.

 

4) The Outcome: A Core, Politically Charged Conflict Pervades and Menaces The Pressing Reform Agenda

The best way to grasp the politically charged challenges and conflicts that hem in and jeopardize sweeping reforms --- all of these, remember, pre-requisites of a successful transition from a statist-dominated economy, largely quantitative in nature and lopsided in its benefits, to an economy driven by ever higher levels of productivity and steady technological progress toward the technology frontier ---- is to see it as a head-on confrontation between two conflicting logics:

---1. the logic of political authoritarianism, rampant corruption and power-hogging on one side, with all the political alienation and social discontent it has bred . . . along with a top-heavy, stifling administrative control over Chinese life in almost all aspects except for some of the private parts of the economy,

---2. and the logic of markets, decentralized decision-making, economic flexibility, a rule of law, and the ability to unleash the obvious energies and talents of the Chinese people . . . all of which would require vast changes in the role of the state in Chinese life, the hold of the CP on it, and the political-administrative smothering of initiative, decision-making, and innovation in the economy and society.

There's no escaping this clash. Sooner or later, a showdown between the two logics is inevitable. Finessing it much longer will only make reforms more difficult and make economic stagnation more likely. China's prospects of ever becoming an advanced, post-industrial knowledge-based economy --- rich and technologically creative, with far more balance in its economic life --- hang in the balance of how its resolved.

Any predictions? None is easy. It's a point we'll return too. What can be said unqualifiedly right now is that if China's leaders ever hope to transform the country into a modern, up-to-date country --- rich, with high levels of per capita income, technological dynamism, and productivity on the order of the US or the EU and Japan --- only a successful switch to a new, much more flexible, efficient, and open market-oriented economy will do the trick . . . whether in three or four decades or for that matter over the next millennium.

First, though, as just promised, a detailed look at the needed reforms --- economic, legal, administrative, and political --- is needed.

 

PART II. THE ESSENTIAL REFORMS, ALL DIFFICULT, AND PREDICTABLE OBSTACLES

Here the list of needed reforms --- if China's economy is ever to overcome the built-in danger of continued diminishing returns and hence continued slow-down in its pace of economic development --- is confined to the economy proper and related social policies. The even more pivotal political reforms will be dealt with in Parts III and IV.

Big Legal Changes

There are pressing needs for dealing with corruption and nepotism in the CP and government and holding them accountable, but in a more limited economic sense, two major sets of reforms are needed:

o privatization and a vast pruning the bankrupt state-owned enterprises . . .some of which, the remaining giant 1000 or so, to be no doubt corporatized in the South Korean fashion before 1997;

o protecting private property rights (including intellectual rights), which requires creating an almost entirely new judiciary and effective legal procedures . . . this in a country that for thousands of years has had no effective rule of law, only the law of "good rulers."

Big Financial Challengess

o sanitizing and probably privatizing the largely bankrupt state banking sector, the key to effective investment for industrial firms --- especially the surviving, revamped state enterprises --- as well as keeping government spending under control,

o developing or improving other market-oriented financial institutions (private banks, expanded stock and bond markets, insurance companies, brokerage firms),

Opening the Economy to Foreign Competition

o Vast barriers to manufactured imports from abroad --- by means of tariffs, quotas, governmental directives, bureaucratic red-tape, and state-controls of Yuan conversion by Chinese firms --- will have to be gradually removed . . . not just to help other countries whose trade imbalances with China are becoming politically dislocating like the USA (inundated by Chinese exports concentrated in a few industries at a time of job-stagnation, pushed by an undervalued currency), but to introduce more competition into the national economy and hence help to allocate Chinese and foreign investment in more economically efficient ways. Much of the investment, especially Chinese, is being wasted, directed into bankrupt state-enterprises and private firms that are heavily protected and may never be internationally competitive.

This point deserves to be amplified. Specifically, the best way for any country to be sure of efficient allocation of scarce capital is by more and more openness to foreign trade; the logic of comparative advantage will then come into play. China is no exception. Japan's stagnation for 12 years shows what can happen to a country that tried to seal off the domestic economy and financial system from vigorous international competition --- and Japan's economy, for all its problems, is a model of efficiency compared to China's right now, to say nothing of being far richer and more technologically advanced.

Joining the WTO this year is only the start of major reforms here --- "only the end of the beginning, " in the words of China's chief trade negotiatior . The party and the government have to follow up on their formal commitments here, and that means a slew of politically charged, controversial changes remain to be tackled . . . a long long list of them

Big Fiscal Challenges and New Policy Priorities, Including

o a revamped and effective tax system,

o privatizing socialist housing (a relic of the state owned enterprise system, with the vast urban workforce of 120 million in that state sector dependent mainly on such housing and other limited welfare benefits),

o a vast infrastructural program to improve the economy's efficiency as opposed to the pump priming of the last few years,

o vigorous environmental policies,

o a thoroughly revamped medical and health system, with the recent SARS epidemic a clear warning of future trouble if major reforms aren't made on this score. Right now, a large part of the population doesn't have access to reliable medical care.



Further Redistributive and Reallocative Challenges

o overcoming the huge gaps in per capita income across China's regions, especially between the booming coastal provinces and those in the hinterland and in the north of the country . . . and also the great gaps that exist almost everywhere between the urban centers and the countryside

o reviving agriculture, whose productivity has actually fallen the last decade or so, after the early 1980s big spurts once the reform era began.

o at least a good start on a series of social-welfare programs if only to create more flexible labor markets . . . and also to blunt the resistance of the 5 million or so workers in the state enterprises being sacked every year since 1997 or so, as well as to encourage retirement through a portable pension scheme.

Nolr is that all. There will almost certainly emerge here acute allocative problems as between investment, infra-structure, social programs, environmental protection, and military capabilities will likely make the choices here even more difficult and problematic.,

 

POLITICAL DIVISIONS WITHIN THE CP AND FIERCE RESISTANCE TO EFFECTIVELY IMPLEMENTING THIS REFORM STRATEGY IS ALMOST INEVITABLE N

(i) Since these reforms, if carried out, amount to a declaration of war on the remnants of the Maoist socialist economy that still accounts for about 40% of China's GDP and still employs 80 million urban workers who have repeatedly protested changes in their status --- to say nothing of the dangers of increased social tensions and the eruption of outright political conflict of the sort that shook the status quo in the late 1980s and led to Tinanamen Square in 1989 --- the efforts by doubters and dissidents within the CCP and also inside the huge, bloated state bureaucracies (at all levels), resistance is likely to grow the more serious the reforms . . . especially if social tensions and disorder emerge. All the more so, for that matter, because it isn't just the social and economic status quo that is at stake. So too is the hold on power and prestige and wealth-making enjoyed by the Communist Party at all levels.

To explain briefly, consider that

o An upsurge of such tensions, even conflicts involving widespread strikes and demonstrations, can't be ruled out --- in fact seems like --- especially since no one less than Zhu Rongji, the former Prime Minister in charge of the reform movement, himself said at the National People's Congress in March 2001 that intensifying the pace of reforms, as required among other things by WTO membership, would invariably entail more pain, not less, for the state sectors of the economy.

o And as we'll see, the party rank-and-file and much of the higher ups fear above all else the prospects of major social strife, not least at a time when, as we've seen, the party itself admitted in June 2001 that the vast bulk of the Chinese population was alienated from the CCP and saw it essentially as an engine of corruption and self-serving.

(ii.) Among other things, then, as part of the reform movement, the party will have to tackled head-on the rife corruption and nepotism and outright orgies of wealth-making at all levels of the party, the military officer corps, and much of the state bureaucracies. That this will take place easily without tenacious resistance, at all levels of these institutionalized groups, seems highly unlikely.



(iii.) Finally, at a time of leadership succession, the various factions in the party that have supported economic reforms the last few years could conceivably split apart on Jiang's successor, with the losers fearful of gung-ho reforms seeking to recoup their losses by hemming in his room of maneuver.

o Not least, the likely reason is that the factions in the party that have agreed on the desirability of reform --- aside from some diehard Maoist remnants largely isolated to date --- are a motley lot, driven into co-existence since the early and mid-1990 for diverse, often discordant reasons: ardent reformers; nationalists with little enthusiasm for reform per se, but who recognize that a modern economy is a pre-requisite to China's becoming a major power in the world; other half-hearted reformers who understand that the party's future in overcoming the alienation or hostility of the Chinese people depends largely --- maybe entirely --- on stepping up the pace of economic growth, especially with the steady decline in annual GDP rates since 1992; and a group of pragmatists and careerists who are mainly concerned with staying in the graces of whoever is at the top of the party and in control of the other factions.

o As a result of this party diversity, too much economic pain and hence too widespread the resulting social strife could easily open up internecine battles about the nature and pace of reforms . . . or even their desirability if they threaten the monopoly hold on power that an



TO BE CONTINUED (Santa Barbara time, Thursday, 3:30 PM)

Replies: 1 Comment

Dr. Gordon,

It's true that the Chinese government will face a potential political upheaval because economic reforms will be painful. How effective will the memory of Tiananmen Square be in reducing mass dissent? People tend to suffer in silence if they know that protesting brings death; hence we don't see any protests in North Korea, for example.

THE BUGGY RESPONSE

Michael: Please see the next article: it's an extensive commentary in reply to your query.

Posted by Michael Jabbra @ 09/27/2003 12:51 AM PST