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CHINA'S
MAKEOVER
Part 2:
Trimming the fat
By Francesco Sisci
Part 1: Political
reform on tap
BEIJING - Laying off
millions of people and ridding the state of burdensome
services has made production more efficient in China and
reduced the price of goods, resulting in deflation.
Officially, China is experiencing a deflation of about 1
percent a year.
Government statistics aside, the
actual cost of living is going up as the cost of
services gets higher almost by the day. This further
depresses consumption and drives prices even lower: not
only schools and hospitals are now expensive, but as
they have become costly by the day, people expect they
will be even more expensive by the time they need them.
When people become old or their children are old enough
to attend university, hospitals and schools might be
horribly expensive, thus people must save even more and
spend less. This explains the higher saving rate in
banks, and shows a vacuum: the lack of an efficient
insurance and saving system that guarantees the
interests of the depositor in the long term while
reinvesting the capital in production. Insurance
services are not purchased, money is not efficiently
invested and, as a result, capital is squandered. People
save, but they get an unfair dividend for their
sacrifices.
This inefficiency on the financial
side is a kind of spinoff of the greater efficiency on
the production side. State owned enterprises (SOEs) have
fewer workers and provide fewer services. They produce
cheaper goods, therefore they are more efficient, proof
that they are less burdened by bad loans. The heavy
servicing of bad loans would manifest itself in an
inability to lower the prices of commodities.
Banks therefore have fewer bad debts. In fact,
outstanding deposits are about one-third higher than the
total of outstanding loans. Even if all non-performing
loans were to become bad loans, the banks would have
more than enough deposits to back the claims. In a way
this shows that the problem is not that banks are too
reckless with their money, they are too cautious, they
do not spend their money effectively. In essence, the
real issue is bank management.
Banks are now
geared for SOEs and should switch to servicing small and
medium enterprises (SMEs), which are often private. At
the moment the state sector takes up some 70 percent of
the total of outstanding loans while producing some 30
percent of gross domestic product (GDP). The non-state
sector produces some 70 percent of the GDP with 30
percent of the outstanding loans. In these two rough
figures there is the potential for growth of the banking
sector, with low inflation and huge inefficiency.
However, it is not just a problem of poor
capacities of the managers, it is a systemic issue. SMEs
and private entrepreneurs have little or no collateral
to offer the banks. Even if they have properties and
cash, if they present these to the banks they might find
the tax bureau asking them how they got these assets. In
theory the Communist Party has accepted the idea that
this is a time of relative disorder in economic matters,
a time of "primitive accumulation", but anyone is
subject to the whims of the law catching up with them
over their ill-gotten funds. The issue of corruption
often revolves around this problem: it is often unclear
what a factory boss should or should not do with his
factory's money.
In essence, property rights and
responsibilities are not understood by anybody in China.
This creates opportunities for personal enrichment but
complicates the use of personal riches for the expansion
of a private business, ie, there is private money but it
is difficult to transform it into private capital to
create more wealth. Thus it is difficult to present this
private money and property to the bank. But from the
banking point of view, this kind of capital is healthier
than that of SOEs, but as it is impossible for the bank
to find solutions for this private capital, it can't
lend to SMEs (often private) and will lend to SOEs.
Hence the banking portfolio will always be unhealthy, as
SOEs have little desire or pressure to return money to
the lenders.
In a way, capital formation in
China takes place outside the banking system and the bad
or non-performing debts reflect a reality completely
different from other parts of the world. They are a form
of state financing of some companies, and are best
regarded as state deficit. The real danger is this: the
state is throwing a lot of money into low-return
investment and shouldering larger quantities of public
debt, which could impose a great burden upon its
financial system.
These investments take place
to sustain overall growth but do not have a return in
higher incomes from tax revenues. The losses suffered by
investors in the stock exchange could be viewed as a
form of indirect taxation: the private people providing
funds to sustain the state investment. But the system is
not transparent and is highly inefficient. The state
should not assume the responsibility of directly driving
growth itself; investment must have higher
returns.
To clear the ground and really introduce
the concept of capital formation to the banking system,
a clear idea of property rights and their protection
must be established. Here the proposed civil code would
be a milestone of paramount importance. But the code
alone will not be enough. The next step after the civil
code will be the sale of state property. It will start
with the land of the peasants, which will no longer be
collectively owned. This must serve as a mere starting
point for further reforms. Amnesty should be granted for
past misappropriations and wrongdoings. This will
encourage people to bring their wealth into the open and
make their assets bankable. This raises the issue of
trust: how can citizens be sure that if they bring out
their wealth they won't be persecuted at a later stage?
Then there is the broader necessity for the efficiency
in the sale of state properties to private people or
corporations.
This would mean a further
withdrawal of the state. Private property will have to
have legal recognition, and violations of private
property rights by other private investors or the state
shall be prosecutable. The power of the state will have
to co-exist with that of private property. Although the
two powers might not have an equal status at the
beginning, the dynamics of private property could
eventually place the state in the service of companies,
as has happened in several countries already.
China is convinced that it needs large and small
companies to increase the global reach of Chinese
business, and private companies are more efficient than
public ones. From a strategic point of view, the power
of the country rests with those companies. Who is more
powerful in the world today, Switzerland, without a
nuclear program but with many companies trotting the
globe, or North Korea, with its nuclear program but
without such companies? For Beijing the answer is
Switzerland, and it wants to follow the Swiss example,
not the North Korean one. Unfortunately, the strategic
necessities of becoming an economic power will entail a
huge social cost that is hard to overestimate.
Legalizing wealth will clearly draw a line
between winners and losers of the 25 years of reforms,
between those who have become rich and those who just
get by. It could very well open a Pandora's box of
massive social discontent. Differences exist now, but
they are blurred, and many poor may hope that the rich
will be punished later for their "corruption".
Legitimizing wealth will eliminate any chance of
prosecuting the rich for their prior offenses and will
solidify the currently vague gap between the haves and
have-nots.
Consequently, China needs a new
social pact to enforce this legalization, the state has
to provide better guarantees to the common people for
their savings and services, thus ensuring that after the
legalization people will feel more inclined to try to
expand their wealth.
Meanwhile, the state must
clean up the stock market. Many of the listed companies
are junk bonds and the stock market is a way for the
state to extract cash from the investors and refinance
bankrupted companies. The people know it but live with
the stock exchange as a kind of national gambling house,
where they hope to strike it lucky, rather than conduct
prudent investment. The cleaning up of the market should
adhere to two principles: listing better companies and
granting more power to all stockholders. With these
changes the control board would be in a better position
to fulfill its role and even common people would want to
participate in China's capital formation, as well as
that of individual companies.
On the other hand,
the state wants to provide better social services,
replacing existing services with ones that will
eventually be provided on a national basis, so that
people can move around the country without losing the
right to social services. For now these services are
incomplete and very localized. Weaker categories will
have better representation and, even if national trade
unions competitive with the state are out of question,
local unions will gain a louder voice to channel social
protests and protect the interests of state workers.
This should make possible the plum of overall
change: access to credit for startup businesses,
opportunities for upward mobility. Now there are two
ways to obtain in China: the bureaucratic ladder or
business. Opportunities for social reform must increase
- the legalization of wealth will bring about a
revolution if it is done through means that only favor
the rich. This was the ancient imperial order, but it
can't be repeated if Beijing doesn't want a new
revolution: for the people at the bottom there must be
opportunities and protection.
In sum, the social
pact requires an agreement with the conservative left.
Legal wealth to some people ought to be guaranteed in
return for control on them and opportunities for others.
The controls can't be the old-fashioned controls by the
state of companies, which were bundled together before
the almighty state. Enterprises must check one another
through competition and operate under rules that
guarantee transparency of their books and products.
The left wing of the Communist Party, taking a
rightful interest in the poor, must participate in the
reshaping of this order, although the toll it may take
in the short term may be quite high, because of its
hardline views on dissent.
Legalization and
better opportunities for startups will increase the
likelihood of success in improving the efficiency of
banks. However, these reforms may take many years to be
completed and the first stage could take a decade to be
realized. In this period it will be necessary to
maintain political stability while granting greater
freedom of expression to objectively criticize
government measures. The aim should be to encourage new
political forces to spring from the healthy sectors of
society and avoid the possibility of the Communist Party
being replaced by mafias and sects, which are rife in
China now. This road toward reform is so full of traps
that it may prove to be a mere pipe dream in the end.
However, the determination shown by the Chinese
leadership in the past 25 years, especially the past 14
years, and the concrete measures taken in recent months
seem to indicate that China could make it to the other
side of massive political reform. But history does not
always follow a straight line, and nowhere has this been
more true than in modern China.
(©2003 Asia
Times Online Co, Ltd. All rights reserved. Please
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