Asia, Issue, Main Menu, World — December 8, 2010 at 4:03 pm

The Great Stall of China

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It is difficult to doubt today that China will ascend the power hierarchy and rise as a global superpower within the next century. News headlines constantly remind us of China’s remarkable economic growth and increasing political clout. Particularly as the power of the United States appears to be waning, speculation of a Chinese 21st century runs rampant. Boasting a GDP growth rate of 9.6 percent and surpassing Japan as the world’s second largest economy, China has unequivocally become an influential global power.

With a rapidly rising power come pessimistic critics ready to diminish its rise. These critics have been savvy in citing China’s political and social environment to substantiate predictions for China’s “nonrise.” An increasing number of worker strikes, last year’s Uighur uprising and Tibet’s cry for freedom, for example, seem to justify the claim that social issues are China’s greatest challenges. China has muffled most domestic discontent with one dictatorial hand while offering a higher economic standard of living with the other. In reality, the most pernicious threat to China’s economic expansion lies in the illusiveness of its economic gains. China’s growth, while miraculous, is overhyped by an excessive focus on one number: Gross Domestic Product. GDP has masked a spectrum of structural faults that are likely to obstruct China’s transition from a state-run market to a truly progressive, integrated and thriving global market.

The GDP Myth

Using China’s spectacular GDP growth as an indicator of its global influence is not accurate. The example of Japan in the 1990s is a reminder that large economies can stagnate with little effect on the rest of the world. In October, The Economist observes that around half of exports to China are then exported elsewhere and concludes that “China is not so much an engine of demand as a transmission belt for demand originating elsewhere.” China’s role in the global market as a supplier of cheap labor is not unique, and a number of Asian countries such as Bangladesh, Vietnam and Laos have already begun to match China in the organization and scale of labor while also offering more competitive rates. The Bank Credit Analyst, an independent research firm, predicts that should China suffer a “hard landing,” the impact on the world would be “benign.” The only sign of China’s economic ascent is in its exportdriven GDP growth, which cannot even be sustained with certainty.

The recent economic recession has shifted the forces of the market. A stronger consciousness of savings and fiscal austerity has and will continue to increase household savings across the globe. The global arena of the post-recession requires that China shift its dependence on foreign consumption to consumption within its borders to match its enormous output of goods. Michael Pettis of Peking University’s Guanghua School of Management postulates that “Chinese consumption would have to rise by nearly 40 percent (or roughly 19 percent of GDP) in order to accommodate an increase in U.S. savings equal to 6 percent of U.S. GDP.” In spite of this, China’s savings rate has actually increased since the late 20th century to around 50% of total GDP and is a dark hint that China’s consumption is nowhere near capable of being stimulated to new heights.

Even more of an obstacle to increased domestic consumption is the propensity of the Chinese economy to overproduce, creating excess goods that cannot be consumed. China’s State Council acknowledges this problem:”In many sectors the problems of excess capacity and redundant construction are still very serious, and in some areas they are even worsening.” Propelled by high liquidity and an economic stimulus package of four trillion yuan, major industries including steel, aluminum and refining continue expansion of new manufacturing plants to inefficient levels. The European Chamber of Commerce in China reports that China at the end of 2008 ran an excess capacity of 100 to 200 million tons of steel and had 58 million tons of new capacity under construction. China’s splurge on steel manufacturing is not only inconsistent with domestic demand but also with foreign demand, which had a 14.9 percent year-on-year decline. Weak enforcement of overcapacity regulations allows excess growth to continue which leaves unsold goods, deflates prices, and thus creates underperforming businesses. China cannot grow its way to prosperity simply by producing more, yet it operates its economy as if it can. There is a cap on China’s productive clout, which makes it incumbent on China to innovate and develop a new niche for itself in the global economy.

The Perils of Innovation
For China to gain a global edge in the market, innovation is necessary in all levels from production to marketing. This is because innovation provides the fuel for an economy to constantly reinvent itself and stay competitive and influential in a global market. At first glance, China appears to be strongly and aggressively pursuing research & development, as the number of patents awarded in China has increased 26 percent over the past five years to make China the world leader in patents. A closer examination, however, reveals that although China puts out a high volume of patents, the quality of the patents produced is questionable. According to The Economist in October, “bureaucrats in Chinese patent offices are paid more if they approve more patents.” Innovation in China has thus been streamlined into a bureaucratic magician’s hat in which dubious ideas are exchanged for profit on all ends. Bureaucrats enjoy bonuses for nominally enhancing Chinese innovation and patent filers receive benefits ranging from funding to career advancement. Under this corrupt mutualism, it is no surprise that plagiarism is common and that dummy academic journals have proliferated.

At the heart of China’s innovation problem are two issues. The first is education, which is structured around rote memorization and theory rather than practicality and problem solving ability. Furthermore, admission to China’s top tier colleges is based solely on one standardized national entrance exam, the gaokao, the grading of which has been described as “complex, opaque, and based on residence rights.” The test’s consideration of student residency tends to favor students from Beijing or Shanghai, denying bright students elsewhere a quality education. A combination of an institutional focus on theory and a biased system of higher education leaves China with a deficit of skilled engineers and effective managers. The Chinese market will increasingly require skilled labor, but an overhaul of the Chinese education system will take time that the Chinese economy does not have.

The second issue is in the strong ties businesses have with government. Businesses in developed economies are powerhouses of innovation, but in China, nepotism and cronyism link powerful businesses closely to government. State owned enterprises comprise a large sector of Chinese businesses and lack incentive to innovate cutting-edge technology to stay ahead of the market. Cozy relationships with government agencies reward corrupt business leaders, keep businesses artificially successful, and diminish the need for legitimate innovation. A mindset narrowly focused on profits within the confines of the Chinese political system impairs innovation. The tight-knit relationship business management has with government is a profound problem, and to resolve this relationship is to perform a major restructuring of Chinese government. This issue is only a facet of China’s enormous and rampant corruption, which in itself poses enormous risks to China’s development and is likely to continue for some time.

Corruption’s Rut
Corruption in China manifests itself in a number of forms: theft of public money, bribery, defalcation, cronyism, graft, tax evasion, and capital flight. Even the most conservative estimates of corruption’s monetary cost are immense. Estimates of the direct costs of corruption total to 13.3 to 16.9 percent of China’s GDP throughout the 1990’s. The economic weight of corruption is hefty, and hundreds are executed each year after being found guilty of corruption. Corruption’s persistence in spite of punishment is particularly alarming and there is strong reason to support the claim that it is spreading.

As economic expansion continues, corruption proliferates and becomes more resistant to detection and punishment. Yong Guo of the China Quarterly points out that the average amount of money involved in a sample of pre-1990 corruption cases was 17,000 yuan, but that the average amount of money involved in cases filed between 1991 to 2000 jumped to 2,968,000 yuan. The average time taken for corruption to be discovered and punished has also increased from 1.8 years to 8 years. Systemically uprooting corruption is a colossal task, but the Communist Party’ Of China methodology of prosecuting corruption on a case-bycase basis does little to stop its spread. Corruption encumbers practically every level of bureaucracy, yet there is almost no indication of attempts to seriously address the issue.

The impact of deeply rooted corruption extends beyond simple monetary costs. Inefficiency from the large sums of vanishing funds affect the entire economy in such a way as to hamper businesses and stifle economic growth. As bureaucracies deplete their checkbooks through the black hole of corruption, they turn to alternative means of procuring funds by levying unnecessary taxes and fines on both citizens and businesses. Professor Xiaobo Lu of Columbia University points out that there are up to “3,000 fees, fines, and forced donations that businesses have to pay.” Under these conditions, revenue that could be invested in expansion and technology is instead wasted on a myriad of burdensome fines and fees. Such an environment does not breed successful and innovative businesses but rather is counterproductive to healthy economic growth and is another reason why Chinese innovation is greatly disadvantaged. So long as bureaucracies and business heads are kept with full pockets, there is little incentive to run an efficient and transparent business.

The growth of corruption appears to be paradoxical. An increase in economic growth and wealth is typically accompanied by gains in social freedom and movement towards democracy. Yet despite China’s booming economy, the Communist Party of China has maintained a firm grip for decades without weakening power or giving way to greater social freedom. Wealthy people with ties to the CPC enjoy perks and benefits that keep dissent from the higher echelons of society to a minimum. Minxin Pei of the Carnegie Endowment for Peace estimates that collusive corruption “among local ruling elites” constituted 20 to 65 percent of all corruption cases after 1990 and “has transformed entire jurisdictions into local mafia states.” And as corruption continues to decentralize and tighten lawless social networks, it becomes more difficult to combat corruption. Instead, a positive feedback cycle takes hold as corruption feeds the fragmentation of bureaucracy, which in turn makes corruption less prone to detection and more profitable.

Critics of corruption’s role in China portray corruption as a negligible factor in China’s economic expansion, but these claims are extremely shortsighted. On the contrary, corruption incurs enormous direct costs in lost revenue and unquantifiable indirect costs in reducded economic development. Corrupt officials are concerned more with maintaining their power than with fostering a healthy economy, a mindset that lends itself to contradictory and harmful economic policies. For example, the Greater China Group reports instances in which managers generate extra cash by creating “invisible workers.” In some workplaces where cash is used as payment, managers forge worker punch cards to log hours for nonexistent workers, who are paid for their labor. The extra revenue is then pocketed by corrupt managers. This process is characteristic of much of the corruption in China, where vanishing revenue is used to fund the checkbooks of managers at the expense of healthy business.

A Dim Future
Speculators may claim that China is well on its way to dominating the global economy, but closer examinations reveal that China’s growth is merely the result of exploiting its large population for cheap labor. The real test of economic strength is only beginning, and China faces monumental economic challenges in shifting its economic gears away from a manufacturing society towards an integral market capable of supplying highly demanded services and products. Already, as China’s manufacturing edge is reaching its capacity, weak domestic demand and shoddy attempts at innovation cast a dark shadow on China’s future. China is not near its proclaimed peak of economic power-it is still an infant in development with major challenges to surmount in the coming decades. Under the umbrella of a precarious economic infrastructure festers a dangerously corrosive form of corruption. The degradation of China’s political institutions is not simply a political threat but a complex and destructive economic one, which will only increase as economic expansion continues. Ironically, China’s greatest innovation yet has been its corruption, the likes of which the world has never before seen in a supposed rising superpower.

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3 Comments

  1. I disagree. Whoever wrote this is obviously an airhead.

  2. I share this view. China is facing its toughest challenges ahead. Failure to reinvent their political system and reform their judicial system will greatly reduce this huge nation to becoming a superpower.

    The gap between the very rich and very very poor in China is alarming and what is more alarming is that poverty is still common in China.

    The transformation of China into an economic machine
    must involve domestic demand growth and development. This means creating a strong middle class family. However middle incomers would expect higher standard from their government conduct and services bringing reform inevitable. Growing middle class also inevitable drive the cost of wages up making China not as appealing place as it used to be, especially with places such as Vietnam and Myanmar available for business.

    I say it is too soon to say with certainty that China is going to be a world superpower. Its toughest days are ahead and to get there Beijing needs to reinvent the state. Not an easy task. Having said this it is also worth mentioning that China ascend to be a global player is already on hand. But to be a superpower that remain to be seen whether it has been luck all this time or strategy that worked.

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