China’s Misreading Of The Global Economy

More stories come out every day about how China is favoring state-owned enterprises (SOEs) at the expense of China’s private sector. Every day there are stories about SOEs advancing and the private sector in retreat or 国进民退 as it is called in Chinese。Seemingly, the Chinese leadership has embraced the view that China was able to save its own economy in the fall of 2008 by rapidly injecting a stimulus package into the Chinese economy, which meant state-owned enterprises through its own state-owned banks. By doing this when the US government was not able to react so quickly, China was able to fire up its own economy and maintain production and employment when the rest of the world was left on life support.

It sounds good as a story, but is it really true? Certainly the Chinese government is doing some of the right things by getting foreign manufacturers to raise wages, but is the conclusion that SOEs are the right way to go for the Chinese economy the right one?

My argument is that it’s not; it’s actually a return to a corrupt version of Gosplan which the Soviet Union had in the 1980s, and led to economic stagnation.

But first, let’s talk about the Chinese government reaction to the Wall Street financial crisis of 2008. The conclusion which the leadership has drawn is that some companies should be “too big to fail” because they employ such huge numbers of people. Since the single overriding issue for the Chinese government is social harmony (low unemployment + less social incidents), then yes, SOEs do prevent this. But this comes at the price of business efficiency for the whole economy, since, for the most part, they are large inefficient behemoths. And because they receive money from the state-owned banks on a policy basis, as opposed to business criteria, they can continue to do so. The price China pays for this inefficient allocation of capital is high; it means that Chinese consumers have less money to spend on discretionary items, which means that consumer spending is kept artificially low. All because the government is subsidizing its own kind in the name of social harmony.

The greatest single misreading of the situation is that the Chinese government believes that they were able to act quickly and decisively, when in fact, it had more to do with the US’s decision to bail out the financial industry, and then presented the bill to not only today’s Americans, but future generations of Americans. Up until this crisis, the US had the reputation for practicing the most efficient form of capitalism, sometimes with harsh social results. More than Europe, the US has allowed new industries to replace older outdated industries. For the first time this time, the US stepped in to bail out the banking industry at the cost of the whole country. This time, the US government decided that the unadulterated version of capitalism was too much.

China didn’t come out better because of its stimulus package; it looked better because the US betrayed its own economic values and policies.

The right conclusion for the Chinese leadership to draw from the crisis would have been that the 2008 stimulus package was a necessary one-time fix to save China’s economy during a global crisis. But then expanding that to say state capitalism is the best form of capitalism for China’s situation is exactly the wrong conclusion.

Now Beijing has ended up with a bunch of state-owned enterprises at the trough talking about how brilliant the Chinese version of state capitalism is, while Chinese private-sector companies are starved of capital and cannot compete against larger SOEs. Not only that, but the Chinese leadership has bought the line, and is reselling it as some magic fix for turbulent economic times.

Pushed to its logical conclusion, China will end up with:

  • Large companies which are less efficient and less innovative, just when Chinese companies need to move up the value chain;
  • The most talented young Chinese will continue to emigrate because they know that China does not reward innovation and individual initiative;
  • Chinese entrepreneurs will stay in China only long enough to get experience and develop their ideas, then will emigrate because they want their child to enjoy a brighter future;
  • The rich/poor gap, already large, will worsen because of widespread power abuse;
  • The SOEs will get fatter and dumber because they enjoy a monopoly;
  • By showing that they have so much sway over government policy, they risk becoming a target for government and policy criticism, and the Chinese government will largely be seen as a shill for the SOEs;
  • Needed political reforms, such as those recently mentioned by Premier Wen Jiabao, may be pushed back even further into the future;

Judging from the debate going on in China, it looks like the supporters of state capitalism want this to become a stated policy goal. If this were to happen, it would be a betrayal of Deng Xiaoping’s economic policies, which were about putting pragmatism over ideology. Putting state capitalism on a pedestal as if it were the single answer to all of the world’s economic problems would not have been a policy which he would have approved of.

If this were to happen, it would be a tragedy for China, its people and its aspirations. And for the rest of the world.

5 Responses to “China’s Misreading Of The Global Economy”

  1. gregorylent says:

    don’t you think china can “turn on a dime, a mao” and reverse much of this? that entrepreneur and private industrialist culture is growing, the allure of wealth being, alluring?

    pragmatism seems to me to be a huge force in china, if something doesn’t work, change directions … far more so than “the west”


  2. admin says:

    Gregory: There are plenty of private small shopowners and restaurant owners; they will not be affected. However, there will be plenty of midcaps which are adversely affected by these decisions. Just read through some of the articles published in the past few days.

    There is a too much arrogance and swagger in the words and actions of Chinese govt officials and SOE heads to make me comfortable. Pride cometh before a fall.

    Yes, it is easy to make changes so far in China, but if the SOEs become an entrenched interest, it is much more difficult to make changes. That is my point.

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  5. I appreciate the insightful post. Thanks.