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

China's Opening to the World

The role of the bureaucracy is also critical when it comes to foreign
trade. Opening China to the outside is, according to the optimists, a
key dynamic in China's eventual marketization and eventual political
liberalization. But it hasn't worked out that way so far. China's
official foreign trade, which has grown from $30 billion in the late
1970s to $290 billion in 1996, at an average annual rate of 16-17
percent, has surpassed all expectations. Few predicted that such a
large country could become so trade dependent, with some estimates
suggesting that over 40 percent of GNP is now derived from
international trade. Indeed, the level of foreign direct
investment--by 1997 totaling $250 billion--which allows foreigners to
be directly involved in managing Chinese enterprises, suggests that
China's economy in recent years has been more open than those of
Japan and South Korea, which have relied more heavily on,
respectively, foreign purchases in equity markets and foreign loans.

China's comparative advantage in foreign trade has created thousands
of relatively small, labor-intensive, export-oriented firms in the
countryside that want to expand their export opportunities. Both they
and SOES want to import resources duty free and circumvent state-run
foreign trade companies so they can deal directly with foreign
markets. The result is a "joint venture fever" that undermines state
controls over China's boundaries. That seems good, if greater
economic integration between China and the rest of the world is the
end to be sought.

But rent-seeking of a different sort propels the search for joint
venture partners, and it is not of a sort likely to advance
marketization. In protected sectors, where high tariffs prevent
imports of competitively priced foreign goods, joint ventures help
Chinese partners create products that are highly competitive within
the domestic market. Even if their prices are a little high and their
quality a little low, Chinese firms and their joint venture allies
can nevertheless earn large profits since their goods face no serious
competition. Therefore, those apparent advocates of increased
internationalization have strong interests in limiting that process
as well. The profits are rent in that they flow from a
non-competitive market arrangement. Real competition would make such
ventures less attractive, not more.

Indeed, due to its highly regulated nature, the foreign trade sector
remains rife with opportunities for corruption. China's bureaucrats
know that excessive restrictions and fewer foreign transactions mean
fewer rents, so they favor more trade and investment--but only under
their administrative purview. For them the choice is clear: no flow,
no dough! The result, however, is de facto, not de jure, trade
liberalization, for much trade ensues through smuggling and
corruption. According to the World Bank, goods smuggled from Hong
Kong to China equal 15 percent of all legal trade between the two
economies. According to the South China Morning Post, the scale of
smuggling actually forced China's television manufacturers to cut
domestic prices by 10 percent.

Other data broaden the picture. While the World Bank reported that
China's nominal tariff rate in 1995 averaged 32 percent, the
effective rate that was collected was only 6 percent. While half of
that seepage was due to special policy privileges given to foreign
invested enterprises, the other half was the result of bureaucrats
who waived regulations in return for payoffs. Today, for
infrastructure projects in Hong Kong, for example, large foreign
companies reportedly must give large equity shares to mainland
brokers who provide no value-added except to certify that the project
can go forward. One American firm working in east China froze its
power project because it refused to donate an equity share to a
company run by a top leader's son.

Such high-placed Chinese intermediaries have no interest in a
transparent trade system. Thus while China has carried out the easy
part of trade liberalization, or what the World Bank calls "shallow
integration"--reforming its import regime and limiting controls on
foreign exchange transactions--China has balked at "deep
integration", including greater market access, regulatory
transparency, non-tariff barriers and wage policies. China's trade
liberalization essentially plateaued in 1994 and has not moved
forward since.

At the bottom of such problems is the plain fact that China has never
wanted an open trade regime. Since 1978 it has erected a
transnational sector--Special Economic Zones, Export Processing
Zones, joint ventures, swap markets for foreign currency
conversion--to cordon off the domestic economy from external
influences. These special deregulated spaces and organizations
receive what the Chinese call "preferable policies" that exempt them
from tax, trade and investment rules governing non-open territories.
This has created a dual economic system of open, favored localities,
and more closed, highly regulated regions. According to Chinese
economist Hu Angang, the inequalities generated by this system create
"all sorts of special and independent economic and political interest
cliques within the state apparatus", who "although they are
communists, regard it as their goals to maximize the interests of
their own cliques, and to seek monopolies and privileges through
their economic and political pursuits."

In light of these interests, one must marvel at the audacity of Zhu
Rongji's WTO offer, which, if accepted and fully implemented, will
severely limit bureaucratic rent-seeking and management of foreign
trade. But the deal is not completed, and China remains a
mercantilist state where the majority of leaders, bureaucrats,
industrial managers and regional officials support state involvement
in China's foreign trade. Their view is that China's trade should
grow but in directions set by official definitions of China's
interests, rather than by domestic or global market forces. Chinese
leaders still advocate an East Asian style "developmental state",
with an industrial policy geared at competitive export industries. As
was the case in South Korea and Japan, China wants to "create"
comparative advantage where it does not now exist. In particular,
Chinese industrial policy is meant to protect sunrise industries,
which bureaucrats see as the source of future trade competitiveness.
It has targeted the electronics, telecommunications, transportation,
pharmaceutical and other high-tech export industries as key sectors
that will drive its economy in the next century. Similarly, insurers
and banks that have yet to adapt to global competition would get
swamped should China open these sectors up. It is worth remembering
that China is hesitating to open to the WTO too quickly in order to
protect and develop its own future global Fortune 500 companies;
otherwise, these sunrise companies would get swallowed by the global
giants. Still, protection leaves these firms with little incentive to
become fully market-oriented.

The same applies to government ministries. China's bureaucrats
benefit far more from regulated trade than from anything approaching
real free trade. As China opened up in this constrained and selective
manner, ministries were empowered to establish monitoring agencies
that control threats to their own industries posed by trade
liberalization and global competition. The Ministry of Machine
Building established an Equipment Approval Division to monitor and
approve all imports of equipment, including equipment for joint
ventures. In 1995, as China opened the construction industry to
foreign direct investment, strict guidelines were introduced and new
foreign-funded enterprises needed approval from the Ministry of
Foreign Trade and Economic Cooperation as well as the Ministry of
Construction, which owns and operates its major competitors.
According to the U.S. Trade Representative, one of the strongest
advocates of continued protection is the vulnerable pharmaceutical
industry, whose State Pharmaceutical Administration issues quality
certificates for pharmaceutical products.

In sum, despite the conventional wisdom that increased global
transactions will liberalize China's trade regime, forcing it from
autarky into global interdependence, strong forces will limit China's
movement along such a trajectory. Also, the involvement of foreigners
in China's economy does not necessarily support the emergence of a
market-oriented middle strata. Foreign direct investment throughout
China is partnered with local governments or the PLA at all levels of
the system. Even Hong Kong's investment partners in wild and woolly
Guangdong Province are mostly local township officials, not private
entrepreneurs. Rather than undermine government authority, foreign
direct investment strengthens its legitimacy by increasing economic
growth and helping local governments meet social welfare obligations.
Opening China to the world, therefore, does not necessarily translate
into opening China within itself.

China as a Democracy?

It appears, then, that while there are social and economic trends in China pressing for greater marketization, strong counter-trends seem to limit it. There are some impulses toward greater political liberalization, but again strong counter-impulses that would stymie it as well. As for the picture as a whole, there is no evidence of a necessary or automatic lockstep relationship between economic development and market liberalization, broadly defined, and the political liberalization that many pundits and politicians have predicted.

The truth is, no one really knows what will happen in the political domain in China. On the one hand, the confluence of corruption, inflation and economic recession could again trigger massive protests. In 1989, 30 percent annual inflation dropped real incomes for Beijingers even as a nouveau riche or "princeling" class composed of the children of high-ranking cadres emerged. If a substantial sell-off of state enterprises in 1999 brings large profits to managers even as it puts millions of unemployed workers on the streets, new protests could bring the regime to its knees. On the other hand, without alternative political parties in readiness, such a collapse would be far more likely to lead to a military dictatorship than to a democratic regime.

Essay Types: Essay