China’s Trapped Transition

February 19th, 2009 at 11:21 pm David Frum | No Comments |

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I cannot remember when I read a public policy book that has made more of an impression on me than Minxin Pei’s China’s Trapped Transition: The Limits of Developmental Autocracy. Marshalling a masterful assemblage of evidence, Pei argues that almost all the current thinking about China’s development is wrong. China is not an overwhelming success story rapidly racing to economic parity with the United States. It is he argues a society on the verge of crisis.

In the 1980s, China’s leaders commenced a gradual transition from a command economy to a market economy. This transition has yielded dramatic results, as all the world knows. But Pei warns that the transition is faltering – victim of the regime’s determined refusal to share political power.

* The Chinese economy remains dominated by government monopolies. State-owned enterprises control all or virtually all the telecom and banking industries, as well as tobacco, grain distribution, power generation, among other industries. State-owned enterprises employ nearly half the industrial workforce.

* The Chinese state is growing rapidly. By the government’s own (and probably understated) numbers, government expenditure grew 318% per year between 1978 and 2002, unadjusted for inflation. Over the same period, government revenues grew 65% per year.

NB a query from reader Matthew Rieff sends me back to Pei’s text to double check this stat. And indeed I did misread it. The 318% PA increase refers to administrative expenses only. While Chinese state employment is rising rapidly, China’s revenues are actually declining relative to GDP. This is especially true of the central government – see the following point:

* The Chinese state may be disintegrating. The fastest growth of both expenditures and revenues is at the district and local level. Local cadres seem increasingly effective at diverting revenues to themselves to build up their own local patronage machines.

* The state is overwhelmed by corruption. Pei cites a range of estimates on the pervasiveness of corruption and ends by guessing that corruption consumes somewhere between 4% and 17% of China’s gross domestic product. Corruption is prosecuted rarely and ineffectively, a few spectacular exceptions notwithstanding.

* The Chinese Communist party’s grip on power is tightening, not loosening. While 60% of entrepreneurs who launched businesses in the 1980s were workers, peasants, or other ordinary people, by 2002, two-thirds of China’s business owners were former government officials, party cadres, or executives of state-owned enterprises. This is not a case of successful businessmen opportunistically joining the ruling party. Rather, it seems that the ruling party is oppportunistically seizing successful businesses.

* Social and class tensions are intensifying. China’s tax collections fall most heavily on peasants and the countryside. Pei documents mounting tax resistance – and survey data showing that even relatively privileged city dwellers express growing concerns about corruption.

Pei argues that these disturbing trends represent something more than growing pains. He argues that they inhere in the path the Chinese Communist Party chose for the country it rules.

The great problem facing any state is how to control the actions of its agents. In a democracy, we rely on a free press to alert us to abuses by the government and competitive elections to correct them. Mao Tse-Tung’s version of communism relied on capricious and all-enveloping terror. But when the Chinese reformers semi-opened their economy, while sedulously denying political freedom, they loosened their control of their agents – while creating lucrative new incentives for their agents to siphon wealth away for themselves.

A vicious cycle has been unleashed. The richer China grows, the more reluctant the ruling elite becomes to surrender power, because power has become so much more valuable. But the refusal to loosen the grip on power undermines China’s wealth, by creating unchecked incentives to the state’s agents to prey upon wealth creation.

Meanwhile, the central authorities and local bosses engage in an ever deadlier competition to control the society’s wealth: Last year, the CCP’s Shanghai boss, Chen Liangyu, was ousted from his post for corruption. Chen faces the death penalty. Is he China’s biggest crook? Very unlikely. But from the point of view of the Beijing rulers, his aggressive freelancing made him the most dangerous.

Growing pessimism about the future of the regime encourages party cadres to steal while stealing is possible. The society’s new financial openness frees the corrupt to hide their misappropriated wealth abroad. Meanwhile, investment in the future – in health, education, and environmental protection – is starved.

Pei suggests that China’s neoauthoritarian regime will soon exhaust its economic vitality. At that point, China will encounter three possible paths out of crisis:

1) It could try true political reform. But that of course risks triggering the collapse of the regime, as happened in the Soviet Union.

2) The regime might just collapse. Pei imagines “the political equivalent of a bank run – a panicked rush for the exit by the regime’s insiders who no longer have the will or incentive to defend the regime.” (211) Such a collapse could just as easily be followed by a more authoritarian rather than a more liberal successor regime.

3) Political power might devolve to the local level, where informal reforms might find more supporters and fewer opponents than would be the case at the national level. This is Pei’s most optimistic scenario – also his most unlikely.

None of these 3 outcomes should be expected anytime soon. The most likely near term solution is an extended “trapped transition”:

The international community should take another look at China and start preparing, at least intellectually, for the unpleasant prospect that China may not only fail to realize its potential, but also descend into long-term stagnation.

China’s Trapped Transition is carefully researched and closely reasoned. It is (I must acknowledge) a very demanding book. But it is absolutely indispensable for anyone interested in China policy – or for that matter, any investor considering placing money in China.

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