The Weekly Standard, February 20, 2012, Vol. 17, No. 22
–Article by Ying Ma
“We have no plan” and “we are unable to act” have become common refrains among influential Americans who grumble about the decline of U.S. power in the 21st century. On both fronts, they lament, China is doing better. From President Barack Obama to New York Times columnist Thomas Friedman to trade union leader Andy Stern, prominent figures who favor a bigger government in America not only envy China’s state-directed grand plans and its one-party system’s ability to make quick decisions, they also accuse small-government adherents of blindly worshipping the free market, contributing to political polarization, and rejecting the reforms necessary to meet the grave challenges that America faces.
But many U.S. observers in the grip of Chinese authoritarian chic forget that China’s vast economic expansion resulted from the introduction of more economic freedom, not less. They also fail to understand that even after decades of reform, endemic state intervention continues to impose massive inefficiencies on the Chinese economy and prevent the realization of the market’s full potential. In short, China’s experience, both past and present, does not provide support for those who clamor for a more expansive government in the United States.
More than 30 years ago, when China began to dismantle its command economy, liberalization introduced market prices, allowed a return to household farming from collectivization, created Special Economic Zones in coastal areas that attracted foreign investment and promoted exports, exposed state-owned factory production to profit incentives, and opened up the market to private firms and entities.
Throughout the 1980s, Chinese citizens began to engage in the most basic economic activities, long prohibited. For the first time, many could buy food on the open market rather than using government-rationed food stamps; set up enterprises rather than stay permanently confined to the dreariness of government-assigned employment; and bask in the new goods, knowledge, and influences flowing in from the outside world rather than stare glumly at empty shelves in department stores.
These changes took place not because the Chinese leadership decreed them, but because reformers within the government fought for them, and because even when Beijing repeatedly sought to reimpose state control, a freer marketplace asserted its logic and delivered better results.
As economist Barry Naughton wrote in Growing Out of the Plan: Chinese Economic Reform, 1978-1993, the overall pattern of Chinese economic reform in the early years “emerged from the interaction between government policy and the often unforeseen consequences of economic change.”
Through periods of reform and retrenchment, China fitfully opened up its economy domestically and to the world. In the 1990s, the country abolished or further liberalized price controls for a wide range of products, embarked on the privatization of state-owned enterprises (SOEs), and implemented banking reform. In December 2001, after 15 years of painful negotiations and solemn commitments to further liberalization, China acceded to the World Trade Organization. For that effort, the Economist recounted 10 years later, China “had to relax over 7,000 tariffs, quotas, and other trade barriers.”
The results of China’s epic march toward a freer market have been sweeping. Over the past 30-plus years, China’s economy has grown at an annual average of nearly 10 percent. More than 500 million Chinese citizens have been lifted out of poverty. In 2010, the country surpassed Japan as the second-largest economy in the world, and it is expected by the International Monetary Fund to overtake the U.S. economy as the world’s largest in 2016.
China’s groupies in the West like to attribute this astounding economic success to the Chinese leadership and frequently describe Beijing’s economic guidance as “astute.” Often, they marvel—and gripe in the same breath—that Beijing is planning for long-term national greatness while Washington bickers over temporary fixes. In truth, though Chinese rulers deserve credit for overseeing their country’s economic miracle, the heavy hand of the state that they wield remains a serious hindrance to continued reform.
After three decades of economic reform, the state sector in China has shrunk but continues to maintain a major presence in the marketplace. The U.S.-China Economic and Security Review Commission (USCC), a congressional commission, noted in its 2011 annual report that SOEs and entities directly or indirectly controlled by the state still accounted for approximately 50 percent of China’s GDP.
The prominence of the state reflects Chinese leaders’ keen interest in pursuing economic growth without relinquishing the levers of economic control. In particular, although Beijing allowed most of the country’s small and medium SOEs to privatize or close, it has retained the large companies, especially in industries it considers vital. These include the “strategic” industries that the state seeks to own or wholly control, such as national defense, electric power generation and grids, petroleum and petrochemicals, telecommunications, coal, civil aviation, and shipping; “pillar” industries in which the state must maintain a strong position, such as equipment manufacturing, autos, information technology, construction, iron and steel, nonferrous metals, chemicals, and surveying and design; and other industries such as banking and insurance.
As a result of the consolidation process, China is now home to mammoth state firms that exert breathtaking market power and boast staggering wealth. In 2011, 57 Chinese mainland companies made the Fortune Global 500 list, and of those, only 6 were less than 50 percent state-owned. As of June 2011, state-owned firms made up 80 percent of China’s domestic stock market capitalization. To date, the state-owned Agricultural Bank of China holds the world title for the largest initial public offering in history with its $22.1 billion dual listing in Hong Kong and Shanghai in 2010. The Industrial & Commercial Bank of China, another state bank, comes in a close second with a $21.9 billion IPO in 2006.
Not surprisingly, corporate wealth and state power are closely intertwined in this story. China’s largest SOEs benefit from a wide range of government preferences, including preferred access to bank capital, heavy tax subsidies, cash injections in times of financial trouble, and more favorable treatment by regulators than their nonstate competitors. Although many of China’s largest SOEs have been converted into corporations, can respond readily to market forces, and are publicly listed on domestic and foreign stock exchanges, they remain political entities subject to political control. In this context, SOEs are given political ranks reflecting their size and importance. For instance, the largest and most powerful central SOEs carry the rank of ministries and do not need to take orders from political entities of lesser rank, such as city governments. In addition, though top executives of state conglomerates jockey for power by demonstrating corporate success, they owe their appointments and promotions to the Communist party apparatus.
State backing, however, is not necessarily an indication of success. Over the past three decades, the private sector has emerged as the most vibrant part of China’s economy, and serves as the largest source of growth for the country’s export sector. The state sector is far less efficient. According to a report issued by the Congressional Research Service in December 2009, by some estimates, over half of China’s SOEs lose money and must be propped up by subsidies that flow mainly from state banks. Though various centrally owned SOE behemoths rake in impressive profits, in part because of the monopoly status and handouts granted to them by the state, thousands of smaller SOEs that are locally or provincially owned are plagued by poor performance, bad management, cronyism, and corruption enabled by unseemly ties to government officials in their respective regions.
When the global financial crisis hit in 2008, the state roared back into the Chinese economy. The government aggressively intervened in economic activities, favored state firms over private companies, and expanded into the private sector.
To battle the financial crisis, China pushed out a massive $586 billion stimulus package (12.5 percent of China’s 2008 GDP) that was heavily dedicated to infrastructure projects, and unleashed a torrent of $2.7 trillion in new loans through its state banks in 2009 and 2010. Many Westerners were impressed by how quickly China acted to confront a worldwide crisis. The noted economist Andy Xie has written, however, that the “growth in the past three years has packed too much fat, dependent as it was on a property bubble and excessively expensive government projects. Throwing money around to create GDP is just not sustainable.”
Additionally, the government’s stimulus funds and bank loans significantly benefited SOEs over the private sector. According to the Chinese state media, of the $1.4 trillion in bank loans issued in 2009 alone, 85 percent went to SOEs.
Meanwhile, SOEs, taking advantage of their size and government largesse, have made a dramatic push into the private sector. Notably, in 2009, state-owned China National Cereals Group invested in Mengniu Dairy, a private company, in the largest-ever deal in the Chinese food industry. An essay on the website of the government organ that oversees centrally owned SOEs has described the transaction as an example of “the big helping the small” and “free love” between the two companies involved. To critics fearful of the unfair advantages enjoyed by the state sector, the transaction appeared more like an example of “the big eating the small” and of the state advancing at the cost of the private sector.
Many Chinese citizens—from investigative journalists who care about clean government, to small and medium enterprises squeezed for credit, to liberal economists concerned about long-term growth—have loudly criticized the outsized role of the state and its encroachments on the economy. Technically, the expanding wealth of large state firms in China belongs to the people, but no Chinese citizen would mistake the high-flying valuations of these companies for their personal financial portfolio. As prominent Americans use the China example to call for higher U.S. government spending or more swift government action, Chinese citizens have offered a distinctly different view.
For instance, Caixin Media, a premier source of financial and business news, has repeatedly zeroed in on the inefficiencies, corruption, and injustice of the state’s power and interference in the economy. Most notably, Caixin has tirelessly covered the debacles that plague China’s high-speed rail system, once the very emblem of the authoritarian regime’s ability to plan long-term and act quickly. Yet even before two high-speed trains shattered that myth by colliding last July, killing 40 passengers and injuring 191, Caixin reporters were busy exposing the Railway Ministry’s cost overruns, astronomical debt, railcar quality issues, corruption among top officials, and opaque practices for contract bidding and tendering. Early last year, Caixin reported that government spending on high-speed rail grew from $33 billion in 2007 to more than $111 billion in just four years. Yet with all that money sloshing around, the Railway Ministry in 2010 oversaw the awarding of up to 80 percent of all high-speed rail projects to just two state-owned contractors.
Wang Shuo, managing editor of Caixin, remarked at a recent panel discussion that he was a bit baffled by Americans’ eagerness to trash their own model of market capitalism to admire a much more state-centric approach. After all, Wang later added, state capitalism is merely a step on the way to crony capitalism.
Wang might be right, but the Chinese state isn’t about to relinquish its control of the state sector. As a Shanghai-based economics professor explained, the levers of economic control are fundamentally tied to the Communist party’s political control. Even in the economic realm, which has become much more freewheeling than the political realm, the prominence of the state reflects the party’s excessive concentration of power and imposes severe costs, undermines public welfare, and prevents further liberalization.
By contrast, the free market has delivered breathtaking success to China’s economy, and the battle for its continued expansion rages on. China’s admirers in America can continue to envy—and panic about—China’s rise while complaining that the United States has no plan and cannot act quickly, but they should remember that the U.S. political process, playing out this year in Iowa, New Hampshire, South Carolina, Florida, and the rest, offers a ready solution of its own: Make Barack Obama a one-term president and replace him with a pro-growth, free-market believer in November 2012. Most likely, big-government types would rather rail against political gridlock than support this plan.