China: China’s hybrid economy

No longer a planned economy, but not yet a fully capitalist economy

China’s hybrid economy

DESPITE THE RAPID growth of the private capitalist sector and the strengthening of centrifugal market forces, the state still exercises considerable economic power. China is no longer a planned economy, but it is not yet a fully capitalist economy. The state still wields power through the allocation of massive state resources and effective control of large-scale SOEs (state-owned enterprises), which continue to dominate key sectors of the economy. Despite formally being transformed into joint-stock companies (selling shares to private investors), the major banks are still effectively controlled by the state. Currently, state-owned and state holding enterprises account for roughly half of all (non-property) urban investment in fixed assets.

At the same time, the party-state, a powerful apparatus with massive financial resources, continues to exercise general political direction over the economy. Sweeping measures taken by the regime to facilitate the recent Olympic games demonstrated the power of the state to mobilise resources and sweep away obstacles to its policy objectives. There was phenomenal public expenditure on the games, the government ruthlessly cleared residents from large areas of Beijing, and heavy industries were shut down in a desperate attempt to reduce air pollution for the duration of the games.

How much of the economy remains under the direct control of the state? While the class character of the state is not determined mechanically by the percentage of state ownership, the changing balance of ownership is an important indicator of the direction of change. But it is not easy to determine the state/private balance of ownership. Different studies give different figures. Will Hutton wrote in his book, Writing On the Wall: “China’s approach to private ownership means that attempting to assess how much of China is public and how much private is a fool’s errand because it cannot capture how the party is trying to develop Leninist [in reality, ruling party] corporatism”. (Hutton, p147) Like many other commentators, Hutton shows how, in practice, the state has effectively retained control of former SOEs that have become joint-stock companies. With many apparently privatised companies, “the shareholder and accounting structure is such that at any time the party can regain control if it is necessary”. (Hutton, p148; see Peter Taaffe’s review, China’s Future? Socialism Today No.108, April 2007)

Recent figures are presented by Barry Naughton in his comprehensive survey, The Chinese Economy: Transition and Growth (2007). The economy is dominated by so-called ‘above scale’ firms (with an annual output value above five million renminbi or $600,000). Although there are literally millions of small businesses, only 23% of industrial sales come from the small-scale sector.

SOEs and corporations controlled by the state (including joint-stock companies) accounted for 49.6% of industrial output in 1998. In 2004, this had declined to 38%. Central government (as opposed to provincial and local government) accounted for 23.7% of the workforce of all state-controlled firms, but 48% of their assets.

“… the decline in the state share of output has been much more gradual than the decline in state employment. As state ownership has become increasingly concentrated in large, capital-intensive firms – and as demand for energy and raw materials has pushed prices up for those firms – state-controlled companies have sustained only a small decline in their share of total output… In 2004, state-controlled firms accounted for roughly 29% of industrial sales, since they accounted for 38% of above-scale output, which according to the Economic Census was about 77% of total industrial sales”. (Naughton, p304)

Agencies of state control

IN 2003, THE government established the SASAC (State-owned Assets Supervision and Administration Commission) to exercise ownership rights of state SOEs on behalf of the government. Subsequently, local SASACs were set up to exercise ownership of state firms in every province. There are undoubtedly many tensions between the SASACs and the bosses of the powerful SOE corporations under their oversight. Nevertheless, the SASACs are powerful agencies of state control.

The central government SASAC has authority over 196 key firms. “Many of the 196 ‘enterprises’ governed by central SASAC [writes Naughton] are in fact large holding corporations that evolved from the former government ministries. These corporations have hundreds of subordinate firms, control large sums of money, and exercise strategic control over decision-making. Moreover, these corporations typically retain their own revenues and remit only taxes (not profits) to the government. For example, SASAC exercises nominal ownership rights over the five large electricity conglomerates that produce virtually all of China’s electricity, as well as the two primary electricity grid operators. These conglomerates in turn control hundreds of firms, including at least ten listed corporations. These conglomerates are highly opaque, and in practice officials with political ties and little accountability exercise government ownership rights within the organisation. There are numerous similar cases in the sprawling industrial empire overseen by SASAC. Thus SASAC has a long way to go before it can serve as a government holding company, exercising ownership rights in an unambiguous fashion, governed by law”. (p317)

In theory, the SASAC should be operating at an arms-length distance from the party-state, overseeing state-run firms on the basis of a clear legal and regulatory framework. However, “the demarcation of SASAC’s authority is plagued with a number of difficulties. By far the most important is the inherent conflict with the Communist Party over appointment power. Arguably the most fundamental characteristic of the Chinese political system is that the Communist Party retains its traditional nomenklatura role, in which party committees make all the key personnel appointments in the state sector”. (Naughton, p317)

There is no question of the Communist Party pursuing ‘socialist’ aims (even in the Maoist sense of defending a state-planned economy and the social gains of 1949). However, nor do Communist Party appointees act on the basis of purely capitalist, profit-maximisation aims. The maximisation of investment and growth, the undertaking of prestige development projects, and the augmentation of the personal wealth and privileges of the nomenklatura are equally important motives.

“The Communist Party explicitly retained the direct appointment powers for the top jobs of 53 of the 196 enterprises managed by central government SASAC and has delegated appointment powers for the other top jobs to the Communist Party committees within SASAC. The Communist Party holds onto its appointment power and thereby continues to shape the career paths and incentives of enterprise managers. Politicians and bureaucrats struggle to refine these relationships in an economically rational way”. (Naughton, p317)

“… SASAC consistently argues for a large and ongoing role for government ownership at the central level. According to Li Rongrong, the head of SASAC, state ownership is appropriate in four sectors: national security, natural monopoly, important public goods or services, and important national resources. In addition, a few key enterprises in ‘pillar’ (priority) industries, and hi-tech sectors, should be maintained under state ownership. This rationale is consistent with the trends in the Chinese economy discussed earlier because central government ownership is in fact concentrated in these sectors. The articulation of an explicit rationale for government ownership suggests a continuing gradual state withdrawal from competitive sectors where there is no compelling argument for a direct government role, but it also implies the persistence of a large central government-run industrial sector for the foreseeable future”. (Naughton, p318)

“… While the scale of change has been enormous, there has also been continuity, most strikingly in the continued role of SOEs”. (Naughton, p298) Naughton, a specialist in the Chinese economy, is an advocate of the strengthening of the market in China, the transformation of China into a fully capitalist economy. But he recognises that currently the transition is far from complete.

“The persistence of the large-scale, heavily capitalised and concentrated, centrally controlled state sector provides a significant element of continuity in the Chinese industrial ownership structure”. (Naughton, p303)

“Ultimately, China’s diversity can be traced to two incomplete transitions. First, China is still completing its transition away from bureaucratic socialism [Maoism-Stalinism] and toward a market economy. Second, China is in the middle of the industrialisation process, the protracted transformation from a rural to an urban society. China is in the midst of ‘economic development’, the process that transforms every aspect of an economy, society, and culture. These two transitions are both far from complete, and so China today carries with it parts of the traditional, the socialist, the modern, and the market, all mixed up in a jumble of mind-boggling complexity”. (Naughton, p4)

Naughton’s analysis confirms the analysis of Hutton (referred to earlier), that China is a ‘mixed’ or ‘hybrid’ society, “neither a communist [in reality, Stalinist] nor a capitalist economy”: “The Chinese economy and the Chinese Communist Party are in an unstable halfway house – an economy that is neither socialist nor properly capitalist, run by a party that is neither revolutionary nor subject to the normal constitutional checks and balances of even China’s own Confucian past, let alone the Asian or western present”. (Hutton, p117)

No ‘big bang’

THE CONTINUED ROLE of the state sector reflects the character of the transition from Stalinism in China. In contrast to the former Soviet Union, there was no ‘big bang’ implosion of the centrally planned economy or shattering of the old state apparatus (which under Stalinism was intimately linked with the economic planning apparatus). The leadership of the Chinese party-state has done its utmost to avoid an economic meltdown, and this is reflected in the relatively limited extent of privatisation of state firms – as opposed to ‘corporatisation’, that is, running SOEs according to market criteria.

In the first phase of economic reform from 1978-93, privatisation, in fact, played almost no role. Changes in the rural sector, based on the ‘family responsibility’ system (in effect, small family businesses), produced a mushrooming of private firms, dominated in that period by the TVEs (township and village enterprises), which have since declined in importance. At the same time, the regime encouraged the development of foreign firms, especially in the special economic zones on the coast. In other words, the private capitalist sector developed alongside and around the state sector – it did not involve a destruction and replacement of the state-owned firms.

In the second phase of economic reform from 1996, there was a massive downsizing of the SOEs (with a 40% reduction of the workforce) and the corporatisation of SOEs (under which they were supposedly run according to purely profit-seeking market criteria).

There are literally millions of small businesses, employing over 59 million workers. But many of them are very small and poorly capitalised, and only account for about 23% of industrial sales. There is evidence now of a process of differentiation within the small-scale private sector, with the growth of the most successful, more technologically advanced firms, but the failure and disappearance of many unsuccessful businesses.

An advocate of capitalist development in China, Zhiwu Chen (a Yale professor), recently wrote an article in the Financial Times demanding the acceleration of privatisation and a reduction in the role of the state sector. “When reforms started in 1978, almost all productive assets were state-owned in China. But reforms since then have not included privatisation. Today the government owns more than 70% of China’s productive wealth”. (Privatisation Would Enrich China, 7 August 2008)

By ‘productive wealth’, Chen means state-owned assets, including enterprises, resources and land. Chen approves of the concentration of assets in government hands during the first phase of economic reform. It “served a good development purpose, allowing the creation of infrastructure and expansion of industrial capacity”.

Chen points to the growing share of the government in China’s economy, which in his view is one of the main reasons for the relatively weak growth of domestic demand. “The government’s share in China’s income has been rising at the expense of private citizens. From 1995 to 2007, the inflation-adjusted annual growth rate was 16% for government tax revenues (not including state enterprise profit or proceeds from selling land usage rights), and 8% and 6.2%, respectively, for urban and rural household disposable income. In 2007, government tax revenues increased by 31% but urban and rural disposable income went up by just 12.2% and 9.5% respectively. As private household share in China’s income pool is shrinking fast, consumption growth can only be slow”.

Chen, with some justification, points to ‘over-investment’ in industrial capacity and infrastructure, which limits the growth of private consumption. His answer is a sweeping privatisation of state assets which, he claims, would become a source of disposable income for Chinese consumers (who currently rely overwhelmingly on their income from wages, which are notoriously low).

“It is fundamental”, claims Chen, “for China to distribute ownership rights of the remaining state assets equally among its citizens. This private ownership would return the missing wealth effect to millions of families”.

In reality, as the experience of privatisation in the former Soviet Union and Eastern Europe has demonstrated, most of the privatised assets would end up in the hands of a small minority of wealthy business-people or would-be entrepreneurs. At the same time, the Chinese leadership fears that sweeping privatisation would undermine its strategic control of the economy and, through the growth of the already huge inequalities in income and wealth, would further fan the flames of social protest.

Nevertheless, Zhiwu Chen’s argument underlines, for the purpose of our debate, the continued weight of the state sector in China. The majority of state-owned or state-controlled firms are no longer operating under a plan. Most of them “grew out of the plan” (as Naughton puts it) when the regime directed them to operate as individual corporations according to market criteria. However, such ‘corporatized’ or ‘marketised’ state firms are not identical with private capitalist forms. Undoubtedly, they exploit their workers just as ruthlessly as private capitalists. Many state-owned firms (and private firms), however, have pursued a ‘profit zero’ strategy.

In an article in the Far Eastern Economic Review (Issue 171, March 2008), Paul Midler explains that manufacturers can successfully “enter into business arrangements in which they [earn] zero profit – and that somehow this strategy [proves] economically efficient”. By increasing capacity and raising output rates (often on the basis of soft – in reality, non-repayable – loans from the state banks), businesses win government approval. In many cases, they sell their goods on the official market (for example to overseas corporate customers) at a loss but, at the same time, sell similar or identical (often branded) goods on the unofficial market at a handsome profit to their directors.

Regional variations

THE BALANCE OF state and private firms varies from region to region. For instance, in regions like Wenzhou (in the southern coastal province of Zhejiang) the local authorities have a record of encouraging private firms. In contrast, in areas inheriting big concentrations of SOEs from the Maoist era, the authorities have tended to discriminate against private firms. Again, in regions with a large presence of foreign firms, the local authorities have encouraged those foreign-owned businesses, discriminating against local firms.

In a recent article, Niall Ferguson points to the role of the state in facilitating the development of private companies (such as Ford, BP, Ericsson, Carrefour, Isuzu, and Suzuki) in the rapidly growing industrial city of Chongquing, in the Three Gorges Dam area of the Yangtze river. They have been attracted by a combination of generous tax incentives and labour costs that are about 40% lower than in the coastal regions of eastern China. At the same time, Chinese companies like the Lifan industrial group are transforming Chongquing into the motorcycle manufacturing capital of Asia.

“Yet [comments Ferguson] the explosive growth of Chongquing’s industry would not be happening without a very large dose of central planning. Since 1997, Chongquing has been a municipality under the direct control of the government in Beijing. Its transformation from sleepy backwater into the economic hub of western China has been an objective of national policy. That has meant a state-led bonanza of fixed investment, which has grown at an average rate of 20% over the past decade. Local officials beam as they reel off the statistics: there will be 30 new bridges over the river, ten new light railway lines, 2,000km of new highway, and millions of square metres of new office space. On the long drive from the airport to the city centre, it is impossible to keep count of the number of new tower blocks under construction or the number of cranes perched on the city’s hills”. (China’s War on Nature, Financial Times, 14 July 2008)

Ferguson points to the problems of “a semi-planned economy”. There are no legal or political limits on the “negative externalities” of economic development, particularly in the form of pollution and environmental destruction. Moreover, “the semi-planned economy allocates resources to infrastructure investment but does nothing to mitigate social inequality. The economic gulf between insiders (officials and entrepreneurs) and outsiders (construction workers and the rest) is now huge. If this is the ‘harmonious society’ of which China’s leaders boast, then São Paulo is an egalitarian paradise”.

Central government’s policy

THE ROLE OF the state sector has undoubtedly been reduced and the growth of private capitalist businesses, as well as the ambitions of local government bureaucrats, has set in motion powerful centrifugal forces in the Chinese economy. Nevertheless, in recent years, the regime has attempted to strengthen its levers of control through macroeconomic policy and strategic objectives.

During the first period of economic reforms from 1978-93, the trend was overwhelmingly towards decentralisation, as both central and regional governments encouraged the mushrooming of private businesses and the growth of foreign-owned firms. After 1993, there was a policy of the recentralisation of policy making.

“Zhu Rongji’s policies were consistently associated with stronger, more authoritative government institutions and more decisive policy-making”. (Naughton, p100)

“During the second period [of reform], management responsibilities were more clearly divided between centre and local, but in a way that tended on balance to be recentralising in terms of the ultimate control of resources. The central government needed to strengthen its regulatory and macroeconomic management functions”. (Naughton, p101)

Referring to the rapidly growing Chinese car industry (mainly based on joint ventures between Chinese and foreign car makers), another writer comments on the role of macroeconomic policy: “All of the manufacturers are to some extent dependent on the macroeconomic strategy of the government, which is unknown in the west”. Moreover, “No large foreign enterprise – be it in the steel, chemical or pharmaceutical, banking or insurance industry – can take a direction in China with which the government is not in agreement”. (Frank Sieren, The China Code, 2007, pp220-21)

Moreover, the crisis in the US and the global capitalist economy is now causing China’s leaders to reassess their policy approach. “At a bilateral economic summit earlier in June, Zhou Xiaochuan, governor of the People’s Bank of China, the central bank, said China, which in the past had looked to learn from the US’s management of its economy, is also looking to learn from America’s mistakes”. (Troubles and Fannie and Freddie Could Deepen Asia’s Credit Problems, Wall Street Journal, 14 July 2008)

With the deepening of the world financial crisis and the slide into a global economic recession, we are likely to see further shifts in the economic policies of the regime, both at home and internationally. The continuing economic power of the Chinese state will be a key factor in the situation.

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October 2008