China: Less, Not More, Capitalistic?

Reader Michael passed along the Economist review of a new book, Capitalism with Chinese Characteristics: Entrepreneurship and the State by Yasheng Huang, which turns conventional wisdom about China on its head. It contends that, post-Tiananmen Square, new Chinese leadership shifted its approach to economic development to one that had more state direction than before, and also focused more on urban areas. Huang argues that the state’s record has not been good, and the change has lead to slower growth and higher social tension.

From the Economist:

Most people, particularly those living outside China, assume that the country’s phenomenal growth and increasing global heft are based on a steady, if not always smooth, transition to capitalism…

This gradualist view is wrong, according to an important new book by Yasheng Huang, a professor at Massachusetts Institute of Technology. Original research on China is rare, largely because statistics, though plentiful, are notoriously unreliable. Mr Huang has gone far beyond the superficial data on gross domestic product (GDP) and foreign direct investment that satisfy most researchers. Instead, he has unearthed thousands of long-forgotten pages of memoranda and policy documents issued by bank chairmen, businessmen and state officials. In the process he has discovered two Chinas: one, from not so long ago, vibrant, entrepreneurial and rural; the other, today’s China, urban and controlled by the state.

In the 1980s rural China was in the ascendancy. Peasants, far from being tied to the land, as has been assumed, were free to set up manufacturing, distribution and service businesses and these were allowed to retain profits, pay dividends, issue share capital and even a form of stock option. State banks rushed to provide the finance. Nian Guangjiu, a farmer from impoverished Anhui province, built up a business selling sunflower seeds (a popular snack), employed over 100 people and made a million yuan (nearly $300,000) in profit in 1986—just a decade after Mao’s death. Because most of this activity was set up under the misleading label of “Township and Village Enterprises”, Western academics largely failed to spot that these ostensibly collective businesses were, in fact, private.

But then, in 1989, came the Tiananmen Square protests. A generation of policymakers who had grown up in the countryside, led by Zhao Ziyang, were swept away by city boys, notably the president, Jiang Zemin, and Zhu Rongji, his premier. Both men hailed from Shanghai and it was the “Shanghai model” that dominated the 1990s: rapid urban development that favoured massive state-owned enterprises and big foreign multinational companies. The countryside suffered. Indigenous entrepreneurs were starved of funds and strangled with red tape. Like many small, private businessmen, Mr Nian was arrested and his firm shut down.

True, China’s cities sprouted gleaming skyscrapers, foreign investment exploded and GDP continued to grow. But it was at a huge cost. As the state reversed course, taxing the countryside to finance urban development, growth in average household income and poverty eradication slowed while income differences and social tensions widened. Rural schools and hospitals were closed, with the result that between 2000 and 2005 the number of illiterate adults increased by 30m. According to Mr Huang, the worst weaknesses of China’s state-led capitalism—a reliance on creaking state companies rather than more efficient private ones, a weak financial sector, pollution and rampant corruption—are increasingly distorting the economy.

But what about the growing cohort of Chinese companies starting to strut the world stage? Surely that is evidence of a healthy and expanding private economy. Mr Huang’s evidence shows that, on closer inspection, these firms are either not really Chinese or not really private. Lenovo, a computer group, has succeeded because it was controlled, financed and run not from mainland China but from Hong Kong (a happy legacy of the founder’s family connections there—not something enjoyed by most Chinese businessmen). The subsidiaries of Haier, a white-goods maker, were also put out of reach of mainland bureaucrats early on. Wahaha, a food producer, Galanz, a maker of microwave ovens, and many others all depended on foreign protection and capital to grow and escape state strictures.

Indeed one of the main, and underappreciated, functions of foreign investment in China has been to play venture capitalist to domestic entrepreneurs. As for Huawei, a telecoms group and one of China’s much vaunted “global” companies, its structure and links to the state are so convoluted that the most diligent China-watchers have little idea if it is a private or state firm. They do, however, agree that Huawei’s opacity is a microcosm of China’s distorted economy.

Could China genuinely embrace entrepreneurial capitalism again, as it did in the 1980s? Its current leaders under President Hu Jintao, who cut his teeth in Guizhou and Tibet, two of the poorest and most rural provinces, talk about supporting the countryside and reducing social inequality. But nothing much has been done. China’s deep problems demand institutional and political reform. Sadly, as Beijing’s heavy-handed control of the Olympics suggests, there is scant hope of that.

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  1. Steve Diamond

    I wrote a paper on the IPOs that China engaged in a few years ago that made a similar argument (“The PetroChina Syndrome”).

    The argument of constructive engagement – that western investment will lead to democratic capitalism there – is myth.

    Of course, statism is clearly on the rise here, too! Eamonn Fingleton’s Jaws of the Dragon is an excellent introduction to a similar analysis

  2. Anonymous

    On the first read, I thought China had been given the "Euro treatment" by the Economist. The Anglo-American press has long predicted the demise of the European social market (I remember the front cover of US News & World Report stating such…in 1986), and commentary on European society is so biased, so mocking, so confident of its eventual doom…

    …I thought "What a switch! For 15 years now China has been the crown jewel of neoliberalism, but as soon as Wall Street and the City start feeling vulnerable, China is all of the sudden a Red Menace, a Trojan Horse filled with state planners…the enemy amongst us!"

    But I will admit this article certainly makes a compelling case. I have consistently underestimated China over the last decade, simply because market economies do not develop that fast. It's taken Eastern Europe 20 years to begin to converge with the West…the underlying foundations of a market economy-clear and enforceable business law, a functioning banking system, and at least a patina of SMEs-simply take time to establish in a society that has been command & control for generations.

    This article might explain it: China did not go through a transition like the CEECs; it simply opened the floodgates to well-heeled Western opportunists, and plowed massive amounts of money into the most ambitious infrastructure program since the pyramids. And the Great Neo-Liberal Success was not a success at all: it was merely greedy Western firms offshoring their operations nearly wholesale, turning China into one giant Caymans or Bermuda. And I suppose China is not really corporate capitalist (i.e. government using its power and taxing base to spend massive funds on multi-nationals…top-down economic development), its just a murky web of companies that are indirectly state controlled, sitting alongside Western-run companies whose owners are back in New York living the high life, praising globalization, and lecturing Main Street on its need to compete in the "new world".

    What a farce! What a lie! All this time, neoliberalism (The End of History, remember?) was nothing but hot air…

    What do the tea leaves say now?

    The reporting I see from China, and the commentary on the web, is so self-contradicting that I don't know what to make of it. We hear that the purchase of raw materials from Indian suppliers has evaporated overnight, that tension is building in China's outer regions, and that American economic problems will mangle export-driven China. Yet their growth rate is still over 10%, their banks are plush with deposits (I heard one estimate of $17 trillion), the government is running a surplus…

    and then we hear the rumor that Paulson moved on Freddie & Fannie after a meeting with the Chinese. If that's true, then whatever was communicated must have been in forceful enough terms to make a free-market conservative and former head of Goldman-Sachs immediately turn around and nationalize most of the mortgage market.

    I don't know what to make of it: is China struggling to keep its economy from imploding; or is it preparing to make the switch to a domestically-driven economy, and the earthquake that would ential for international political economy?

  3. bg

    My day starts early with business conference calls to europe and ends late with business conference calls to China and India. In my 10+ years of working with the Chinese things have changed a lot. Of course constructive engagement is changing the culture. But the government always lags behind the real culture in every society. Given the movement along fault lines we have seen in the last two weeks in the US government, I am more hopeful than most that even government inflexibility has its limits.

    It is important to realize with the Chinese (really all cultures actually) that they are deeply proud and deeply insecure. There is a fusion of ideas from the west and east that has happened in the urban centers.

    This is a deeply capitalistic culture with a long history of meritocracy. That doesn’t mean that they have swallowed the Anglo-saxon social structure whole.

    A lot of my friends feel I am too pro-China. But I have found it is much easier to do business in China than in India or Europe.

    One exception to this observation is at the top of the talent pool. Europe has a deep reservoir of highly talented people at the top ranks in management, finance, engineering. China’s pyramid is small at the top. Time will fix that too. When it does, there will be more talent to seed government as well.

  4. Anonymous

    How is this for a scenario:

    That an economic collapse of a significant degree in the US negates the Chinese government’s concerns about an appreciating yuan’s impact on exports. Obviously, if exports take a large dive, then the damage to that sector of the economy would already be done. You might ask “If exports sink, why would the yuan appreciate?” And that brings me to my point: is it realistically forseeable that large investors would see the yuan as an undervalued asset in one of the world’s largest economies, with a high domestic savings rate, massive aggregate deposits, and a budget surplus by a government that is extremely stable.

    i.e., is there a scenario where large investors would forsake the dollar for the yuan, out of a flight to safety?

    Domestic consumption would be the engine of the economy, China’s purchasing power would skyrocket, and that combination of purchasing power and size would produce a tsunami of foreign investment…by the Chinese, scooping up undervalued assets across the globe. It would be something akin to America in the years immediately after WWII, when the rest of the world’s economies were devastated by war, and the dollar became the reserve currency.

    OK, I’ve stuck my chin out, please educate me on why that scenario can’t happen…

  5. Kady

    @anonymous 7:29

    I’m Chinese-American, spent 7 years in Asia, and my sister has spent the last 6 years in China in private equity.

    I think the answer to your question is in this exact summary: the problem is that anyone who has spent some time in China knows that the Chinese government’s stability is on some level superficial. If the Chinese officials don’t find some way of reconciling the growing income disparity between those living in urban areas and those in rural areas, there is going to be the kind of civil unrest too large for them to crush, even with their strong military.

    Furthermore, I have to believe that among the first to suffer from the global economic downturn are going to be the factories: the intermediaries between the ownership class in the cities and the peasant class in the country. The factories tend to be a first stop for those seeking to leave the rural areas of China (though they are theoretically restricted from such moves). If these stop being an outlet for those seeking a better life, China is going to have a serious problem on its hands.

  6. Anonymous

    Thanks Kady,

    I also posted that comment on Michael Pettis’ blog, and he responded overnight, pointing out that the financial system in China is still nascent, and it would be doubtful that they could handle such an inflow…in the unlikely event that investors felt so inclined.

    Thanks for the education, all around…

  7. Anonymous

    Always a good idea to keep the lightning rod grounded.

    Obviously Red China told Paulson that principle and interest losses were not acceptable, that was all the prodding he needed to guarantee GSE paper or face a dumping of US currency onto the markets causing the ruination of his strong dollar speak.

    Somehow Chinese and US commoners are alike in that neither has any control over political/military goals…..could it be both are colored Red.

  8. macndub

    Is there anything in the book about the role of Li Ka-shing?

    One man is too small to have a huge effect in China, but he’s so freakin’ rich. It would be interesting to follow his rise along with the rise of the corporatist state.

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