True faith missing from China's growth boost

2012-06-06Asia Times

BEIJING - The stimulus package that China launched last week to boost the economy is about China, of course, but it is also about Europe. Beijing does not want to be unprepared as the European dangers deepen, creating uncertainties all over the world since many economists believe that Greece's potential exit from the euro could trigger a global financial meltdown.

Weak foreign demand for its exports, a cooling real-estate market, and diminished bank lending have all slowed Chinese economic expansion to a pace not seen since the aftermath of the 2008 financial crisis. Moreover the global outlook is dire, as the Greek crisis has spread to Spanish banks, Europe seems unable to find a common strategy to tackle the issues at hand, and many do not rule out a second dip in the financial crisis in the coming weeks or months, triggered by a crunch in the euro area.

Then, as with the 2009 stimulus package, the goal is to try to relatively insulate China from the foreign turbulence and boost domestic demand and growth at a time when foreign trade and exports are collapsing and internal consumption from the rising middle class is slowing.

Yet unlike in 2009, when Beijing spent some 9 trillion yuan (about US$1.4 trillion) in all, today's China is being more careful. The government wants to minimize inflation and avert the skyrocketing public debt and asset bubbles that came from the hasty move in 2009 and that still bedevil the national economy.

The package is thus designed to address this issue: stimulate consumption where it is weakest (in the countryside) by boosting sales of cars, press ahead some with infrastructure projects (such as new airports), provide subsidies for energy-efficient household appliances, and invite the private sector to invest in state-dominated industries such as railways.

The People’s Bank of China, the central bank, could also reduce the amount of capital that lending institutions must hold in reserve and lower benchmark interest rates to spur growth.

The government intends that there will be no blank checks to state-owned enterprises (SOEs) or localities to build more unwanted high-rises or projects that are useful only to the careers of local officials - but still one can reasonably expect that a lot of money will go awry in the haste.

This time, as the package is coming before possibly the biggest crisis, it could be an occasion to address the lopsided parts of the Chinese economy, which is being re-dominated by state-owned enterprises. Their virtual monopolies in large sectors of the economy are stifling competition and thus future growth. However, SOEs have immense clout over the economy, and it is unlikely that their reform will be comprehensively handled before the 18th Party Congress this autumn.

One crucial issue in the meantime is how to prop up private enterprises, which have been the engine of China’s development in the past 30 years. Some reform-minded commentators in China, such as Hu Shuli, suggest cutting taxes for private companies.

This is reasonable as a direct measure to help them in a very difficult time and also to solve at least partially their problems of access to finance. Private businesses, as they need to survive in a difficult environment, already try to avoid paying taxes and often have different sets of account books for different purposes.

Their murky situation makes it more difficult for them to ask for money from the banks. Moreover, banks have no real system of incentives to lend to private businesses and conversely have many enticements to cater to SOEs and shun difficult private lending. If a transaction to a private company goes bad, the official in charge will routinely be investigated to ascertain if he received a kickback from the private business. If a transaction with an SOE goes bad, this will be simply considered a form of support for another state company.

Furthermore, private companies mistrust state banks - considered close to and transparent to tax offices - and try to get finances through all sorts of non-official channels. There are loans from SOEs (who can easily and cheaply borrow from banks and loan to private companies at a juicy profit), from associations of private lenders, and from small or large "pawn shops".

Here interest rates are well over 20% and are guaranteed with collateral (houses, land) that is often undervalued so as to guarantee an extra profit to the lender in the case of default. These numbers prove the extreme vitality of these private entrepreneurs who can churn out over 30% growth a year (the minimal amount to pay off the debt and have some profit). But they also prove the extreme inefficiency of the system because private entrepreneurs are scared of the state and its officials, who may threaten to clamp down on them with any excuse.

A basic way to bring back efficiency to the system must start with providing guarantees to private businesses against the power of local officials and authorities. This could be provided as a form of "amnesty" for past financial crimes (tax evasion, for instance).

The firms could pay a lump sum to cover past misdeeds, and in return pledge they will not misbehave. Moreover, central tribunals, with a large degree of autonomy, could be established to sort out controversies arising between localities and enterprises. This will not eliminate the possibility of overbearing local officials, but it could limit their power.

Forms of tax reductions could be devised if profits of private companies are reinvested in the companies themselves, in the fashion used in the 1980s to encourage foreign companies to invest in China.

All these measures would help the emergence of a vast portion of the underground economy, which has developed with little or no support from the local government. It would cut the cost of access to finance and thus boost healthier growth in China - without the mega-investments that cause bubbles.

In a nutshell, the strategy would be to export and improve the growth model of Wenzhou, an area dominated by private businesses, to the whole country. In return, these businesses should clear their decks. They can get tax cuts, protection from the central government, forgiveness for past sins, and better access to low-interest finance; but they should from then on be clear in their accounting. They should no longer keep messy and different sets of account books, but provide clear papers. Put your papers in order, invest what you earn, start a virtuous cycle, become known to your banks, and prepare for growth of your business and your country.

The main obstacles in this virtuous cycle, however, are not the many technicalities that such a move would entail - after all, some of these were measures China used to draw foreign investment in the early phase of reforms. The real hurdle is the faith private companies may not have in the overall reliability of the central government.

In the 1980s, foreigners did not trust Beijing, but they had political encouragement from America, and they could hedge the risk by investing little by little; this could be done and could pay off handsomely as China's economy was small and investments then were quite cheap. If they lost it, this would not endanger the survival of the company.

Now for Chinese private companies, the risk of becoming entirely legal is huge, as Beijing could change policy in a few years, renege on past promises, or clamp down on private entrepreneurs. This happened with Chongqing for instance, where the pre-2007 party chief Wang Yang promoted private business, and his successor, the now disgraced Bo Xilai, branded it mafioso and seized some of it. Now, with Bo's political demise, political sentiment has changed again. Real political stability and continuity in policies is the fundamental issue to gain trust and substantive support of the entrepreneurial and middle classes of China.

Thus a plan for the direction of political reforms is the key also to trigger better-quality growth in China. Without trust in the long-term political environment, the model for businessmen will only be that of moving all or part of their assets abroad, and then reinvesting them more or less clearly as foreign capital.

That is, Chinese entrepreneurs feel safe in China only if they become to some official extent not "Chinese" and are under some form of tutelage of a foreign government. This murky business structure creates extra costs to the local economy because of the lack of transparency in the market, which further impacts the cost of finance for private businesses.

Moreover, despite official sentiments, Chinese businessmen trust Washington more than Beijing when it comes down to the safety of their own money. This should be a consideration of extreme importance China's thinking about its ties with America. A tight alliance with America is impossible to dismiss if, as Marxists believe, politics walks on economic feet.

This, perhaps, touches on the broad issues of growth and political changes that will have to be addressed at the 18th Party Congress this autumn to stave off the internal and international crises that are bound to weigh on China in the near future.

But this is also true in the longer run. If China wants to reach the US per capita GDP, it should keep growing at 8% for the next 30 years. A slowdown in the growth rate could extend this frame to 50 years or more. In either the faster or slower model of growth, lukewarm, opportunistic support of entrepreneurs by Chinese state institutions will not suffice.

For Beijing, at this crucial moment when innovation and creativity is necessary to project the country into the future, there must be real strong trust between Chinese institutions and business. Internationally, tight political cooperation with foreign countries will be also crucial.

Patriotism (no matter how strong) and a semi-religious faith in the destiny of China and its "emperors" (not much different from in imperial China) will not be enough to bind the bets and legitimate interests of businessmen and their country.

This de facto requires a new political pact between the state and its people - and given the present and future dimensions of the Chinese economy and its impact on the world, a pact with the people of the rest of the planet, too.  (2012-06-06 Asia Times)


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