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FUTURECASTS JOURNAL

China's Economic Prospects

(with a review of "The Party: the Secret World of China's Communist Rulers," by Richard McGregor.)

February, 2011
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Leninist party rule:

  Is China destined to become the predominant world power? Is the U.S. in decline and destined to continue in decline? These themes have become increasingly popular.
 ?

Because of its shear size, China will achieve massive economic power under any kind of market capitalist system.

 

The projections as to the extent of China's growth, however, depend crucially on further economic liberalization that at present seems to have stalled and in some vital respects has recently been thrown into reverse.

  We have heard these themes several times before during the last century.

  1. During the 1930s, the democracies were viewed as decadent and it was the Axis powers that were the wave of the future.

  2. During the 1960s and 1970s, socialism was the wave of the future. The influence of the Soviet Union was displacing that of the decadent democracies and expanding remarkably throughout Africa and Latin America.

  3. In the 1980s, the economic systems of Japan and Germany directed by government industrial policy were widely expected to leave the U.S. economy in the dust.

  No matter how often their expectations are disappointed, those asserting the inevitable decline of the United States never tire of finding new reasons for their expectations.
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  China, however, will, indeed, continue to increase in economic power for some time to come as it continues to leave the constraints of socialism behind. Because of its shear size, it will achieve massive economic power under any kind of market capitalist system. The projections as to the extent of China's growth, however, depend crucially on further economic liberalization that at present seems to have stalled and in some vital respects has recently been thrown into reverse. China's rulers are not ten feet tall.
 ?
  China has an autocratic capitalist market economic system with a large and currently growing state capitalist segment.  Ruled by a Leninist political party, it is an extreme version of autocratic capitalism. It is far more extensively autocratic and less market oriented than Singapore, for example, but far more subject to competitive disciplines than many other examples of this economic genre.
 ?

"The Party: the Secret World of China's Communist Rulers," by Richard McGregor

 

While the Party has infiltrated all aspects of government and society, society, "with all its rapidly evolving aspirations, demands and cleavages, is now infiltrating the Party, and the Party is struggling to keep up."

 

Party cells control appointments to top business management positions and may even direct business policy when that is in the perceived interests of the Party.

  In "The Party: the Secret World of China's Communist Rulers,"  author Richard McGregor describes the Chinese Communist Party as a thoroughly Leninist party energetically extending its control into all major aspects of Chinese life. This is a must read book for anyone interested in China.
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  McGregor sets forth the considerable strengths and notable weaknesses of Party rule and the vast network of Party cells that have been inserted into every significant Chinese entity, whether political, military, religious, civic, intellectual or economic. Party officials at all levels generally strive to remain behind the scenes but retain the ultimate power over policy in all entities. All loyalty must be towards the Party first even before the nation or any particular entity.
 ?
  The interests of the Party are always the predominant interests. Its 75 million members dominate all aspects of Chinese life. McGregor provides an extensive yet admittedly less than complete account of internal Party practices and the important ways in which they are evolving over time. Members from the business, intellectual and professional communities are an increasing segment of the Chinese Communist Party. While the Party has infiltrated all aspects of government and society, society, "with all its rapidly evolving aspirations, demands and cleavages, is now infiltrating the Party, and the Party is struggling to keep up."
 ?
  Major Chinese companies are being listed on Western securities exchanges. However, investors must understand that the ultimate policy making authority in these companies resides in the Party cells rather than in the boards of directors. The Party cells control appointments to top management positions and may even direct business policy regardless of shareholder interests when that is in the perceived interests of the Party.
 ?
  The nation's chief justice is a Party appointee with no legal education. The Party is "locked in its ossified Leninist ways, is secretive, corrupt, hostile to the rule of law and vindictive in the pursuit of its enemies," McGregor points out.
 ?

Subordinate political entities have to raise their own revenues and thus have a major incentive to facilitate economic prosperity or at least the success of the politically favored businesses within their jurisdictions.

  The strength of the economic system has come from market competition. To a great but not invariable extent, Party policy submitted all economic entities and subordinate political entities to the often ruthless competitive pressures of the domestic Chinese markets. Managers and Party cell apparatchiks alike were under considerable pressure to manage their economic entities profitably. Vigorous profit incentives in ruthless competitive markets drove economic success.
 ?
  Subordinate political entities have to raise their own revenues and thus have a major incentive to facilitate economic prosperity or at least the success of the politically favored businesses within their jurisdictions. However, lately, this successful model has been increasingly undercut by industrial policy initiatives that support political favorites and surviving state owned enterprises.
 ?

Since salaries are often low, the primary incentive for service in executive and subordinate Party ranks is the opportunities for receiving corrupt payments and Party promotions and appointments into business executive and higher Party positions.

  The predominant weakness in the system - typical of autocratic systems - is corruption that is pervasive among executive and Party ranks alike. Since salaries are often low, the primary incentive for service in executive and subordinate Party ranks is the opportunities for receiving corrupt payments. Party promotions and appointments into business executive and Party positions are frequently for sale. Party connections are a vital determinant of political and economic success. Bribes in the hundreds of thousands of dollars have been extended for Party appointments, so the opportunities for corrupt payments must be vast.
 ?
  Indeed, corruption has become an important factor in Party management, McGregor explains. Corrupt opportunities attract new recruits and bind Party cliques together, and exposure provides a convenient method of getting rid of the losers during Party infighting. Except in extraordinary circumstances, the investigation of corruption and sharp practices is kept completely within the discretion of higher level Party officials so such investigations have become a method of resolving conflicts within the Party.
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  In essence, corrupt practices place the head of every Party functionary on the chopping block if he is on the wrong side of some power struggle. When extraordinary circumstances like the SARS epidemic cover-up get beyond Party control, scapegoats from outside the Party can be thrown to the wolves to limit the damage to Party members.
 ?

The visible hand of the Party must guide the invisible hand of the markets - and all other significant aspects of society.

 

The immediate personal interests of subordinate cadre are local interests which frequently are in conflict with national interests and even with the interests of higher level cadre.

  There are many other strengths and weaknesses in the system. Term limits for top Party officials protect the system from the senescence at the top that is otherwise such a debilitating feature of autocratic governance. There is a strong sense of nationalism that permeates the system from top to bottom and gives it a unifying purpose. The Chinese people take immense pride in their economic accomplishments, and the Party, determined to increase Chinese power and influence broadly, has until recently been impressively persistent in pushing the economic reforms needed for further economic growth.
 ?
  The Chinese people today enjoy a degree of economic and personal freedom unimaginable under Mao albeit still sharply limited by the unchallengeable "leadership" role of the Party. The visible hand of the Party must guide the invisible hand of the markets - and all other significant aspects of society. As a result of the recent Credit Crunch recession, there is increasing confidence within the Party in the superiority of China's autocratic capitalist system.
 ?
  However, China still has mountains to climb with respect to economic reform, and there have recently been signs of a weakening of the reforming resolve. The Party is not monolithic and China is vast, making it difficult for the central authorities to exercise control throughout the nation.
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  Indeed, since the immediate personal interests of subordinate cadre are local interests which frequently are in conflict with national interests and even with the interests of higher level cadre, it can take considerable effort and persistence - often amounting to a Party campaign - to initiate and maintain top Party policy nationwide. Subordinate Party units have considerable autonomy and are so opaque that they can routinely keep their business secret within the Party as well as from those outside the Party. Except for widespread acknowledgement of the Party's core political interests, the Party has inevitably become awash in conflicting objectives and interests, McGregor explains.

  "It is true that many local leaders will ignore Beijing's edicts if they can get away with it. In many cases, they may be right to do so, because in a country as large as China, the center cannot intelligently prescribe policies that fit the widely divergent conditions on the ground. The local locks of power allowed by the Party's decentralized structure can make for dynamism as well as defiance."

Party influence inevitably intrudes into market competition and winners and losers are increasingly determined by Party influence.

 

Larger private businesses, including those listed on Western stock exchanges, may have such intimate government ties that the dividing line between state owned and private enterprise becomes indistinct.

  The Party is determined to maintain control over the commanding heights of the economy. The state owned enterprise system has been subjected to the rigors of market competition and profit incentives. Those that were reformed sufficiently to survive are now a growing presence in the economy. They still dominate banking and major economic industries.  Major private economic entities are subjected to Party influence by the insertion of Party cells and Party acquisition of considerable ownership interests.
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  Privatization has thus stalled and even been reversed. Party influence inevitably intrudes into market competition and winners and losers are increasingly determined by Party influence, McGregor explains. Banks are controlled by the government and provide ample financial support to state owned and major private economic entities leaving small and even medium sized business without such support.
 ?
  In many other ways, the competitive playing field is being tilted in favor of political favorites. At the highest levels of economic policy, mercantilist policies support exports and hinder imports, industrial policy picks winners and losers, and state owned enterprises receive considerable support. Private enterprise still produces considerably less than 50% of GDP. Larger private businesses, including those listed on Western stock exchanges, may have such intimate government ties that the dividing line between  state owned and private enterprise becomes indistinct.
 ?
  Incredibly, there are many Western liberals who view such mercantilist and industrial policy factors as economic strengths, but they are all serious system weaknesses. They are all designed to direct the flow of economic benefits to the Party and the politically influential at the expense of the people and the economy as a whole. They all provide massive opportunities for corruption, favoritism and nepotism at all levels of government and the economy.
 ?

The Chinese economic system is subjected to serious and growing distortions that will cause considerable trouble in the future.

  China's growth has been extraordinary, but the investment levels required for that growth have been huge - amounting to almost half of GDP. Clearly there is enormous waste and divergence of these investment funds. The Chinese economic system is thus subjected to serious and growing distortions that will cause considerable trouble in the future. We have seen this game played out before, most dramatically in Japan.
 ?
  Like Japan, however, China maintains a healthy balance of payments surplus that provides it with the resources to respond to any emergencies that may arise. It will not crumble like the Soviet Union as long as its payments surplus is maintained. For most purposes, it has more dollars available from its massive reserves than the U.S. Federal Reserve. During the Credit Crunch, it was able to expend massive sums so that China recovered from the recession at a considerably faster rate than the U.S. or most of the advanced nations. At the same time, China was able to employ dollar diplomacy, providing substantial loans to assist Venezuela and other client states.
 ?

U.S. decline:

 There is no question that the U.S. is in decline. Relative decline is not surprising since rapid economic growth is the normal result with respect to nations that throw off socialist shackles in favor of some form of competitive capitalism.
 ?

As in the 1970s, the U.S. is digging a deep financial hole for itself, but there is nothing inevitable about U.S. decline.

  The U.S. is currently also in observable decline financially and thus also economically, militarily and diplomatically. Since the reasons are readily understandable and reversible, however, expectations of inevitability should once again be disappointed.

  1. The U.S. as in the 1970s is a Keynesian policy state, and Keynesian policy states are inevitably declining states.

  2. The U.S. as in the 1970s is aggressively employing monetary inflation as a method of managing its economy, and states that rely on aggressive rates of monetary inflation are inevitably declining states.

  3. The U.S. is increasingly an entitlement welfare state, and entitlement welfare states are inevitably declining states.

  4. The U.S. during this last decade has been governed first by unprincipled political hacks in the Republican party predominantly interested in looting the public treasury, and then by a liberal extreme in the Democratic party that is in intentional denial of economic reality, so financial insolvency and national decline is inevitable as long as this continues.

  This is, with some important differences, very similar to what occurred in the 1970s. As in the 1970s, the U.S. is digging a deep financial hole for itself, but there is nothing inevitable about U.S. decline.
 ?

The markets are inexorable and remorseless and deal ruthlessly with those in intentional denial of reality. The markets will increasingly punish the U.S. for any continued refusal to accept reality, and thus persistently push the U.S. to adopt rational economic policies.

  As in the 1980s, the American electorate will not accept national decline as inevitable. The question, thus, is whether they will find and support leaders like Reagan and Volcker who can take the hard decisions needed to support renewed growth and increased prosperity? Will they find and support leaders who will kick the Keynesians out of Washington, restore responsible budgeting and monetary policies, impose robust spending caps on entitlements, and generally return to the "Golden Straightjacket" policies of the 1980s and 1990s that enabled recovery from the Keynesian inflationary morass of the 1970s and then provided two decades of renewed economic prosperity and superiority.
 ?
  This will not be easy since it will initially throw the nation into a very deep recession similar to that of 1980 to 1982. But the markets are inexorable and remorseless and deal ruthlessly with those in intentional denial of reality. The markets will increasingly punish the U.S. for any continued refusal to accept reality, and thus persistently push the U.S. to adopt rational economic policies.
 ?

It is impossible for price inflation that is chronic to exist in the absence of monetary inflation.

  Reality has struck the welfare states of Europe, forcing them kicking and screaming to reverse decades of intentional denial. Reality has also struck the most liberal states in the U.S., forcing massive retreats from liberal governance policies. Liberal governance has repeatedly proven capable of causing financial ruin in the most wealthy states and cities of the nation like New York State and New York City, California and Los  Angeles, and Illinois. Market realities, and only market realities, can punish these states and force them to retreat sufficiently from liberal policies to save themselves.
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  As FUTURECASTS has repeatedly explained, government policies were responsible for the Great Depression and the failure to recover from the Great Depression, and government policies are responsible for the financial distortions and instability of today. See, Blatt, "Understanding the Great Depression and the Modern Business Cycle." Bernanke is busy directing blame at world markets and at China and other emerging economies for the price inflation levels that are rising world wide and causing instability in many third world nations, but the dollar is the world's primary reserve currency and Bernanke's aggressive monetary inflation policies are the primary cause of price inflation worldwide. See, Bernanke's Bubbles. It is impossible for price inflation that is chronic to exist in the absence of monetary inflation.
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The economic limits of mercantilist systems:

  If China's economic transformation has indeed reached its limits, then China, like Japan, will eventually be blocked by the natural limits of its mercantilist policies, its corruption and distortions from its government industrial policy.
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China's influence is displacing Western influence widely and is increasing within international organizations. Its military reach is extending further into the Western Pacific and even into the Indian Ocean. Its vast markets have already transformed international commerce.

  The Japanese people are certainly not suffering from such limits, and the Chinese people should similarly reach levels of prosperity significantly above current low and poorly distributed levels. However, the growth projections currently favored by many credulous economists will prove no better than most of the economics establishment's long term economic projections, and the pervasive corruption in China will inevitably limit the prospects of the Chinese people for widespread prosperity.
 ?
  However, China is ten times the size of Japan, so even if its economic limits become manifest at lower economic levels, the economic resources available to its government will be massive. Already, its economic and diplomatic influence is displacing Western influence widely among developing and undeveloped nations and is increasing within international organizations. Its military reach is extending further into the Western Pacific and even into the Indian Ocean. Its vast markets have already transformed international commerce. See, Halper, " The Beijing Consensus," and Bremmer, "The End of the Free Market."

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