When the Nobel prize-winning economist Kenneth Arrow was asked which country had the best managed economy recently, he nominated China, Taiwan and South Korea. This viewpoint is consistent with the widely shared belief that China is the latest and largest successful installment of the ?East Asian model? of authoritarian development. But despite some similarities, looks can be deceiving. The nature, purpose and extent of the role of the state in Chinese economy and society set China apart from its successful East Asian neighbors. In fact, the differences are significant enough to call into question whether China will taste the fruits of successful modernization that Asian economies such as Japan, South Korea and Taiwan enjoy.
The key to success in these countries was the creation of conditions needed for vibrant organizations, competition and private enterprise to take off. Even though it was within a context of state-guided capitalism and mistakes were made, their governments ultimately offered a ?helping hand? to lay the foundations for future private enterprise and capitalist activity?in particular, widespread and open access to economic opportunity, rule of law, property rights, and social and political stability.
Isn?t China doing similar things to achieve growth? Most Western commentators focus on the spectacular success of China?s export sector and the emergence of China as the world?s factory. But the greater contributor to Chinese growth is actually domestically funded fixed-investment, which constituted over 50 percent of gross domestic product (GDP) and over 40 percent of growth in 2008. China is way off the charts in this regard. Taiwan, for example, which had an unparalleled growth rate of 8 percent each year over 50 years, never had capital investment spending of more than 30 percent of GDP.
But it is not just the high reliance on fixed-investment that is striking. It is where the capital goes that is all important. China is unusual in that bank loans?drawn from the deposits of its citizens funneled into state-controlled banks?constitute around 80 percent of all investment activity in the country. Even though state-controlled enterprises produce between one quarter and one-third of all output in the country, they receive over 75 percent of the country?s capital, and the figure is rising. The Chinese state sector owns almost two-thirds of all fixed assets in the country. This is the reverse of what occurred in South Korea (as well as in Japan and Taiwan) where the private sector received over three quarters of all capital during the 1960s and 1970s.
Another case in point: a close examination of the shares on the Shanghai Stock Exchange shows that only around 50 of the approximately 1,300 companies are genuinely private. Between 1990 and 2003, less than 7 percent of the initial public offerings on the Shanghai and Shenzhen stock exchanges were from private-sector companies. The Chinese state owns about 50 percent of all the shares of listed companies. When state-controlled entities are included in the calculation, it is likely to be around 70-80 percent of all listed shares.
The massive bias toward the state sector would be acceptable if the 120,000 state-controlled enterprises could learn to innovate and adapt. Unfortunately, except for a handful of centrally managed state-controlled enterprises, this is not the case.
To put the situation in perspective, China?s overall use of capital is twice as inefficient as India?s. World Bank findings indicated that about one-third of recent investments made by the state-controlled sector generated zero or negative returns. This might increase the chances that the Chinese Communist Party can remain in power but it is at enormous cost to the country.
The economic cost in terms of loans going bad is great?well over $1 trillion and rising. But the social costs, and impact on civil society, are greater.
An economic system that leads to the concentration of economic opportunity and wealth in the hands of a few creates an unsound and unstable political economy. Since the state dispenses the most valued business, career and professional opportunities, only a relatively small group of well-placed and well-connected insiders benefit; the vast majority are denied the opportunity to prosper. Despite China?s impressive GDP growth, about 400 million of its people have seen their net incomes stagnate or decline over the past decade. The income of the poorest 10 percent has been declining by 2.4 percent each year since the beginning of this century. Since 2000, absolute poverty has actually increased as has illiteracy.
Not surprisingly then that China?s Gini coefficient, a measurement of income inequality, rose from around 0.25 in the 1980s to around 0.38 in the 1990s. It is now around 0.5, the highest in Asia. In contrast, the Gini coefficients of South Korea and Taiwan from the 1960s to the 1990s hovered around 0.34 and 0.29 even as the economies of these countries were growing rapidly.
The Chinese Communist Party has cleverly tightened its grip on economic and, therefore, political power. But this has meant that the building of institutions such as ?rule of law? and enforceable property rights has been stagnant for almost two decades. Beijing?s model of ?authoritarian transition? is failing and its longer term prospects are uncertain.
China is not becoming Japan, Taiwan or South Korea writ large. A large, stumbling giant like Russia or Brazil might be a more accurate indication of its future.
(Dr. John Lee is the foreign policy fellow at the Centre for Independent Studies in Sydney and a visiting scholar at the Hudson Institute in Washington. He is the author of the book ?Will China Fail??)
