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2009/06/23

WHEN the Nobel Prize-winning economist Kenneth Arrow was asked recently which countries 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 successful instalment of the "East Asian model" of authoritarian development.

That is certainly what Beijing would like to think but looks can be deceiving. The nature, purpose and extent of the role of the state in China's economy and society set it apart from successful East Asian neighbours. In fact, the differences are significant enough to call into question whether China will taste the fruits of successful modernisation enjoyed by such Asian economies as Taiwan.

The key to success in South Korea, Taiwan and Japan was the creation of the conditions conducive to vibrant organisations, competition and private enterprise. Even though it was within a context of state-guided capitalism and mistakes were made, these 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.

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 per cent of gross domestic product last year and more than 40 per cent of that year's growth.

China is off the charts in this regard. Taiwan, by contrast, with an unparalleled growth rate of eight per cent every year for 50 years, never had capital investment spending of more than 30 per cent of GDP.
But it is not just China's reliance on fixed investment that is striking. Where the capital goes is all-important. China is unusual in that bank loans -- drawn from citizens' deposits funnelled into state-controlled banks -- constitute around 80 per cent 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 more than 75 per cent of the country's capital, and the figure is rising.

China's 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 Japan and Taiwan), where the private sector received more than three-quarters of all capital during the 1960s and 1970s.

Another case in point is shares listed on the Shanghai stock exchange: only around 50 of the approximately 1,300 companies are genuinely private. Between 1990 and 2003, less than seven per cent of the initial public offerings on the Shanghai and Shenzhen stock exchanges were from private sector companies.

The Chinese state owns about 50 per cent of all the shares of listed companies. When state-controlled entities are included, it is likely to be around 70-80 per cent of all listed shares.

The massive bias towards 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 half as efficient as India's. World Bank findings indicate that about one-third of recent investments made by the state-controlled sector generated zero or negative returns. This might increase the chances of the Chinese Communist Party remaining in power, but at enormous cost to the country.

The economic cost of loans that go bad is great. But the social costs, and impact on civil society, are greater.

An economic system that concentrates economic opportunity and wealth in the hands of a few creates an unsound and unstable political economy. As the state dispenses the most valued business, career and professional opportunities, a relatively small group of well-placed and connected insiders benefit, while opportunities to prosper are denied to the vast majority.

Despite impressive GDP growth, about 400 million Chinese people have seen their net incomes stagnate or decline over the past decade. The income of the poorest 10 per cent has been declining by 2.4 per cent every year since the beginning of this century.

Absolute poverty has actually increased since 2000, as has illiteracy.

Not surprisingly, 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 have been stagnant for almost two decades. Beijing's model of "authoritarian transition" is failing, and its longer-term prospects are poor.

China is not becoming South Korea writ large. A large, stumbling giant like Russia or Brazil might be a more accurate indication of its future.

The writer is foreign policy fellow at the Centre for Independent Studies in Sydney and a visiting scholar at the Hudson Institute in Washington