China’s strength begins at home

YASHENG HUANG – The Financial Times

Bill Gates recently pronounced that China had created “a brand-new form of capitalism” with consumers at its centre. Unless he meant foreign consumers, it is a curious claim, given that China’s consumption/gross domestic product ratio has been steadily declining. It is a sign that China’s growth is increasingly driven by investments, which many economists and officials in China have warned is an unsustainable trend.
Mr Gates’ remark was also a reminder of how western observers typically gloss over the institutional shortcomings in China’s system, even while the Chinese themselves are increasingly voicing their complaints about the issues and obstacles to doing business in China.
Even China’s beleaguered banks have their fans in the west. In a new report, McKinsey, the management consultants, tout the superiority of China’s financial system over India’s. This is a remarkable judgment. Chinese analysts have long pronounced China’s banking system “technically insolvent” and, in implicit agreement, the Chinese government has injected more than Dollars 60bn (Pounds 33bn) to recapitalise the banking system. Every year for the past five years, India’s stock market has outperformed China’s, and China’s non-performing loan (NPL) ratio is sev eral multiples of India’s. India has also consistently outperformed China in corporate governance rankings.
I experienced this split perspective in a previous job, researching China’s institutions. In the equivalent of a performance review in the corporate world, a senior professor who had visited China only once and spoke no Chinese declared that I (Chinese born and raised) did not understand China.
Is there such a systematic difference in perspective between Chinese and westerners? Part of it is ignorance. China’s achievements are visible and telegenic – the easily available and compressed GDP data, the skyscrapers, impressive highways, ultra-modern airports and so on. But few ask how the building boom is financed. A huge portion of China’s urban boom has been financed by massive yet indirect taxation on peasantry including fees for education in rural areas; possible future reductions in pension payouts for China’s rapidly ageing population; curbing of bank credit to millions of small domestic private entrepreneurs. To truly understand this dynamic, one must either know the country beyond the impression of a casual tourist or experience the burdens of the system first hand.
Another reason for the rosy foreign perspective is that the Chinese government has historically favoured foreign business over domestic. Foreign companies operating in China often find it a better place to do business compared with their domestic private counterparts. In a recent world business environment survey administered by the World Bank, more domestic private companies said they saw China’s business environment as constraining than foreign companies did in seven out of 10 areas, ranging from labour laws to corruption.
Take the recent Fortune Global Forum in Beijing. While top Chinese leaders have attended each of its three Fortune forums held in China, I am not aware of a single occasion where the same leaders attended a similar gathering of domestic private entrepreneurs. While one can tout the benefits of foreign direct investment, the simple arithmetic is that economic contributions from the domestic private sector have dwarfed those of the foreign sector. In urban areas in 2003, the domestic private sector employed some 48m workers, compared with just 8.6m in the foreign sector. China’s vast countryside is virtually untouched by FDI and yet China’s rural entrepreneurs have created another 100m non-agricultural jobs.
The policy biases in favour of foreign investors are real and substantial. In 2002, the state-owned banking system lent Rmb172bn to foreign companies operating in China. In the same year, its loans to the domestic private sector amounted to just Rmb39.2bn. In any other country, it would be unimaginable for a government to treat its own entrepreneurs so shabbily.
But even some prominent western economists do not view institutional reforms as a priority for China. Their view is heavily influenced by their experiences elsewhere. Many have dealt with disaster economies in Latin America or Africa. Whatever its institutional imperfections, China’s performance, in comparison has been unambiguously stellar. China’s institutions are not good, they would acknowledge, but good enough. This is an understandable but flawed perspective. For one thing, a private entrepreneur in rural China does not get up every morning congratulating himself for not living in Africa. What matters is that his businesses are starved of financing and his commercial opportunities are being squandered by corruption and red tape. The costs of China’s institutional shortcomings are high precisely because its economic and social fundamentals are so good. Yes, China’s achievements are real, but careful analysis by academics such as Alwyn Young, a University of Chicago professor, shows its growth has been “respectable, but by no means extraordinary”.
Two remarkable facts need to be kept in mind. First, every single economy that has caught up with the west since the second world war is located in east Asia. Second, the only two east Asian economies not to have caught up are China and North Korea. Many courageous academics, journalists and entrepreneurs in China risk their careers to push for institutional reforms. The least we can do is not to undermine their efforts.
Copyright The Financial Times
The writer, associate professor MIT Sloan School of Management, is author of Selling China (Cambridge University Press)

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