Undemocratic Capitalism

Undemocratic Capitalism

Mini Teaser: Will  the market democratize China? The logic of economic determinism may not be so inexorable after all.

by Author(s): David Zweig

Nor is it the intention of the present reformist government to build
such an ethic. While Jiang Zemin has called for increasing the
diversity of investors in SOES in order to separate "administrative
functions from enterprise management and change the way enterprises
operate", he has also called for continued state management of
China's core enterprises. That means insuring that bureaucrats will
continue to dominate the commanding heights of the economy. That, in
turn, means that managers of the 500-1,000 key state enterprises will
remain beholden to state bureaucrats for cheap capital and technology
inputs. Jiang also echoed pre-Congress commands to managers to rely
on their factory's Party committees before deciding on layoffs,
prices and production levels when he said that enterprises must "give
play to the role of the Party organizations" in the plants "as
political nuclei."

China's top leaders still reject genuine privatization even in
principle, preferring that shares be sold to workers or to other
companies. One key reason, at least according to researchers at the
Chinese Academy of Social Science in Beijing, is precisely their deep
fear of the emergence of a real, autonomous middle class. As a
result, the stripping of state assets and the sale of land and
equipment to other companies need not, and probably will not, create
a large private ownership class. Bureaucrats will retain a
significant hand in making key decisions; a distorted market will
persist; and close relations between captains of industry and the
state will continue.

This means, too, that despite a shift of decision-making authority
from the center to the localities, many key economic decisions remain
under the purview of local governments. What is emerging is a form of
local economic corporatism, replete with regional monopolies,
rent-seeking opportunities and "relational contracting"--a
characteristic of early capitalism (as well as socialist transitional
economies) where firms carry out business transactions based on
long-term, personalized trading relations and trust, not on
maximizing profits and market efficiency.

This system of local protectionism is a phenomenon already a decade
in the making. In the mid-1980s China reformed its fiscal code,
creating a tax farming system under which all levels of government
were given tax quotas to pass up to the next level of government.
Some or all enterprise profits and taxes above the quota were
retained by local governments. Further, as the state withdrew tax
subsidies, many local governments suddenly had to swim on their own.
These conditions gave local governments powerful incentives to
maximize local output, sales, profits and taxes. It also provided
incentive to establish barriers to trans-regional trade in order to
keep products from other regions out. Thus, for example, taxi
companies in Shanghai can buy only Santana vehicles produced by the
city's joint venture with Volkswagen. The prospect of discontented
unemployed workers laid off by bankrupt SOES under Jiang's new reform
initiative could increase pressures on cities to protect their
remaining SOES from regional competitors.

Most businessmen avoid inter-regional trade for other reasons as
well. Shortages of quality goods, weak market signals and
information, and widespread corruption create great uncertainty for
enterprises in China's emerging semi-market economy. There is little
sense of the sanctity of contracts, and the legal system favors local
firms. When money alone cannot insure supply, firms resort to
relational contracting. Thus in the 1980s Wuhan's department stores
bought most of their stock from factories with whom they had
long-term relationships. Similarly, officials in the First Machinery
Factory in a large urban center used close government ties to secure
loans at rates significantly below those available to their
competitors. The result is a far less than perfect market,
significant waste, limited inter-regional competition and high
transaction costs as firms invest excessive time and money maximizing
business-bureaucracy relationships as the major mechanism for making

Finally, Chinese firms, awash in a sea of rent-seeking, accept
payoffs to bureaucrats as part of doing business. Many of these
companies resulted from "downsizing with Chinese characteristics", a
process in which governments lay off bureaucrats from their official
payrolls only to help them establish new semi-public firms. Situated
strategically between the government and genuine enterprises, these
firms earn income by charging a handling fee for transferring goods
and resources. Like barnacles on ships, they draw their sustenance
from their parastatal relationships with the ministries from which
they were spun off.

Labor Unrest as a Liberalization Brake

Jiang and Zhu's plans for restructuring the SOES suggest their
commitment to greater liberalization of China's transnational
economic relations and their understanding that there is a close link
between international competition and domestic reform. As China
continues to lower its barriers to the outside world and takes steps
to accede to U.S. demands for World Trade Organization accession,
most of its SOES will face economic extinction. In the face of such
threats, China's leaders know, too, that they can no longer afford to
throw good money at bad firms. Unprofitable SOES will fend for
themselves, while the state will choose and help "winners."

But the social stresses liable to be generated by the winnowing out
of China's SOE sector are staggering. China's approximately 350,000
SOES employ over 70 million workers, pay benefits to another 20
million retirees, and in total support about another 200 million
dependents. With as many as 45 percent of them in the red, China's
SOES have a combined debt of 620 billion Renminbi (RMB), or $75
billion. The past decade's policy of paying laid off SOE workers
their "basic" salary--usually comprising 40 percent of current wages
and excluding all subsidies and bonuses--worked much like
unemployment insurance schemes in the West. But that strategy has now
left China with a welfare problem of catastrophic proportions.

Even in a very imperfectly competitive market, ending subsidies will
expose many SOES to the pressures of competition. But if closing down
large numbers of SOES, without an effective unemployment insurance
scheme to cushion the impact, promises to put 10-12 million workers
on the streets, regional and local governments may strongly resist
such a policy. Recent eyewitness reports from Sichuan Province tell
that threats of worker violence have so frightened managers that they
hesitate to fire workers until they have been retrained and helped to
find a new job. In fact, these pressures forced the Politburo in
June 1998 to decide to stop laying off urban workers in order to
avoid an urban explosion. Instead, many unprofitable firms may be
merged with stronger firms that may be pressured to keep on more
workers. Already powerful conglomerates (jituan) are buying up the
assets of weaker firms. A more oligopolistic economy could emerge in
which a few large firms dominate different sectors. This would not
promote increased marketization in China any more than a roughly
similar situation has promoted broad marketization in Russia.

The reform of SOES also directly affects the liberalization of
China's financial system, which needs to become more market-oriented.
Chinese banks have loaned money according to national or local
policy, not at its real cost. In 1996 alone China's banks loaned out
over 4 trillion RMB, of which 75 percent went to support SOES. Many
of those loans are non-performing. Clearly it will take years to sort
out these problems. Even if widespread selling of bank shares occurs,
the banks will still be under enormous political pressures to make
loans based on personal and political, rather than market, factors,
until the day that the central and local banks really do become
independent of the political system. But that day is far off.

The politics of regional disparities will further limit genuine
economic reform. Under Deng, China deregulated the economies in
coastal provinces, granting them preferential treatment that helped
their economies boom. Inland areas remained apart from global
markets, even as the state suppressed the prices of the natural
resources that are the heart of their economies. Consequently, the
coast flourished while inland areas languished. Based on my own
calculations, while 60.8 percent of China's gross value of industrial
output (GVIO) was produced in coastal cities in 1984, a decade later
those same cities produced 70 percent. Although inland areas might
prefer an end to policy favoritism and an even playing field, they
are also home to some of the most inefficient SOES, whose closing
will only exacerbate their economic plight. Under the current regime
their interests lie in supporting central bureaucrats who believe
that the state--not the free market--must redistribute resources and
resolve regional inequalities.

It is likely, then, that looming instability will undermine any
impulse toward political liberalization. The current middle strata of
corporate directors and local government leaders--those locked into
the existing property rights regime of state or publicly owned
industries--will surely prefer corporatism and soft authoritarianism
to democratic change. If social unrest stemming from SOE reform
challenges their managerial rights and threatens them with
recrimination for their side payments to bureaucrats, they will even
support hard authoritarianism if it is necessary to protect "public
order." They are likely to interpret democracy under such
circumstances as tantamount to chaos.

In the countryside, too, where most private firms exist, there is
little support for democratization among the rural business elite. As
of 1992, only 0.5 percent of the millions of rural enterprises at or
below the county level had trade unions, and there is little reason
to believe that the number of union shops has increased since then.
And even as China's leaders let farmers elect villager committees in
order to stabilize the countryside, weaken oppressive cadres, and
persuade farmers to invest in public works projects, elections remain
restricted to the lowest levels of rural society. Top Party leaders
are likely to prevent these elections from sparking a nationwide
democracy movement. The key test will be whether similarly open
elections as those taking place in China's villages will take place
at the next level up in the rural bureaucracy--the township level. As
for the more economically advanced coastal areas, rural people there
seem too busy making money to care about political liberalization,
and so long as limited economic reform allows them to do so they are
unlikely to become a source of democratic advocacy.

Essay Types: Essay