Tag Archives: State capitalism

China And The United States: Reverse Merger

US President Donald Trump and China's President Xi Jinping walk in the grounds of Trump's Mar-a-Lago resort in Florida, April 2017.

SINCE AT LEAST World War 2, the lodestar of US foreign policy has been to steer authoritarian regimes towards norms of free-market democracy on the American model through engagement backed by the United States’ economic and military supremacy.

On basic empirical measures, the policy has been successful. In 1946, there were 21 democracies; today there are more than 80. The number of people living in democracies has risen to more than 4 billion from 385 million over that time, and the biggest authoritarian empire of the second half of the 20th century, the Soviet Union, has collapsed.

US President Donald Trump has thrown out that notion. He has declared that engagement with authoritarian regimes, including China, and perhaps particularly China, to bring them into convergence with the international system does not work for the United States, but diminishes it.

He has thus reverted to the late 19th century-early 20th-century view of international relations as a contest between great-power nation-states in the pursuit of national interests, with hard power being the final arbiter. This is what students of international relations call realism. They contrast its competitive and conflictual nature to the cooperation and shared values emphasised by liberalism.

The America First agenda on which Trump campaigned for office was a clear exposition of realism. The Trump presidency has now enshrined that as policy. Three newly published documents, the National Security Strategy (NSS), the Pentagon’s National Defense Strategy (NDS) and the US Trade Representatives annual report on China’s WTO compliance, lay out that sea-change in America’s stance in the world.

As far a China goes, it is now declared a revisionist power and a geostrategic rival along with Russia, Iran and North Korea.

It has been a policy switch in the making since the September 11, 2001 attacks on New York and Washington. The United States then started to act unilaterally to overthrow regimes perceived to be hostile through military intervention or the encouragement of local uprisings in Europe, Asia and the Middle East.

That was followed by the challenge that the global financial crisis of 2008 posed to both the Western model of free-market capitalism and the underlying assumption that the US was the nonpareil of economic strength.

The decade since 2008 has opened space for China to demonstrate that it has an alternative economic model — and one that is appealing to many regimes in as much as it came without the accompanying baggage of political liberalism. In place of untrammelled free trade, free capital flows and large-scale cross-border migration, China offered a model that uses markets to allocate some resources but in which the state continues to run the economy (and in China’s case the Party also runs the state).

The United States’s new NSS suggests this model of state-run capitalism has cost the United States hundreds of billions of dollars a year of commercial technology conveyed to China as a result of either the openness of the economic relationship on the US side or, as the Trump administration prefers to emphasise, through plain theft.

Trump has declared that that will stop. He repeated his intention in his first State of the Union address last month and has already made it evident by tariffs imposed on solar panels and refrigerators and stricter screening of inbound foreign investment on security grounds. (China has already countered with an investigation into alleged US subsidies of sorghum grain.)

Trump has said he has held off on more punitive trade actions against China only because he needs its help on pressing North Korea’s leader Kim Jong-un to halt his nuclearisation programme.

This year is likely to test Trump’s patience in this regard, especially as this is a Congressional election year in the United States. The political support base that Trump needs to mobilise in the Republican cause, and particularly deindustrialised blue-collar workers, believe China to be the cause of everything ill that has befallen them. He will need to rile them up to vote.

The critical question about the trade measures that Trump takes against China — and it seems a matter of when not if — is their scope; whether they are narrow and targeted, say, anti-dumping duties on specific products such as types of steel and aluminum, as recommended by the US Commerce Department last week, or broad and sweeping, such as high duties on virtually anything shipped from China and a blanket ban on inward Chinese investment to the US.

If it is the former, the damage to the global economy (and US multinationals’ supply chains) would be containable; if it is the latter, the damage could be considerable.

The latter might satisfy Trump’s appetite for ’fair trade’ but at a massive cost to both the US and global economies.

As national security is the other pillar of Trump foreign policy, the proposed build up the US military and the expansion of the US nuclear weapon arsenal is also aimed at China. It has elicited the expected denunciation by Beijing, which accused Washington of reverting to a ‘Cold War mentality’.

It would be a mistake to regard the shift in US policy towards China as being particular to Trump. The latest issue of Foreign Affairs, the house journal of the blue-chip US foreign affairs think tank, the Council on Foreign Relations, carries an article entitled the The China Reckoning. The authors, Kurt Campbell, a former senior Obama-era official the State Department, and Ely Ratner, a former deputy National Security Advisor to the same administration, and who thus would both have been involved in President Barack Obama’s ‘Asian pivot’, write:

Neither carrots nor sticks have swayed China as predicted. Diplomatic and commercial engagement have not brought political and economic openness. Neither U.S. military power nor regional balancing has stopped Beijing from seeking to displace core components of the U.S.-led system. And the liberal international order has failed to lure or bind China as powerfully as expected. China has instead pursued its own course, belying a range of American expectations in the process.

This shift of position is also endorsed increasingly by US business, which has hitherto has been a strong advocate of engagement to open China’s vast and growing market to foreign trade and investment.

One of the intangible dangers in the new policy is the possibilities of missteps and missignalling resulting from a weakening of working relationships between officials at all levels. Many agency-to-agency channels built up over the past decades are on hiatus, and relatively few US officials are visiting China (or anywhere else). Of the high-level government-to-government economic dialogues only the military-to-military one appears still to be open, mostly on account of the need for channels on North Korea.

More broadly, the new policy will also likely reverse the long-standing practice by the United States of making unlimited provision of visas to Chinese journalists, researchers and students to visit, work and study in the United States while China strictly regulates the flow of their American counterparts in the opposite direction.

FBI director Christopher Wray told a US Senate Intelligence Committee hearing last week that Chinese students could be a threat since they could be gathering intelligence for China while studying in the United States.

A cutback in the number of foreign graduate students studying or researching in science and technology disciplines is under consideration by the White House as the FBI now considers them an intelligence risk. Wray told the Senate committee:

One of the things we’re trying to do is to view the Chinese threat as not just a whole of government threat, but a whole-of-society threat, on their end. And I think it’s going to take a whole-of-society response by us. It’s not just the Intelligence Community, but it’s raising awareness within our academic sector, within our private sector, as part of defense.

Wray also said that his agency was monitoring ‘warily’ the Confucius Institutes. The risk to the bilateral relationship is that such investigations stoke xenophobia public sentiment against Chinese activities in the United States.

Beijing’s soft power campaigns to influence politics and civil society abroad are also likely to fall under greater US suspicion, especially in light of the Mueller investigation into Russian attempts to interfere with US elections.

For its part, Beijing no longer describes its policy objectives in terms of convergence with international norms. Instead, it emphasises the differences brought by doing everything ‘with Chinese characteristics’. It has been building an alternative architecture, such as new multilateral mechanisms like the Asian Infrastructure Investment Bank and the Belt and Road Initiative, even as it continues to seek more influence in existing institutions such as the IMF, WTO and United Nations.

Beijing has been taking a more aggressive foreign-policy posture since 2008 when it believed it saw a United States entering into a period of accelerating relative decline which created an opportunity for it to act more assertively on the global stage. This posture has intensified since Xi Jinping’s rise to power in 2013. In particular, it has become more transparent about its desire to displace the United States as the preponderant regional power.

Two examples that are cases in point: island building and increasing military deployment in the South China Sea to reinforce China’s claims over the waters and resources off its eastern coasts; and its disruption of trade and tourism with South Korea following Seoul’s decision to permit deployment of the US THAAD missile defence system.

That goes hand in hand with the modernisation of the People’s Liberation Army, and particularly the PLA-Navy, which, eventually, will challenge US naval control of the Western Pacific.

There is a certain irony in two powers pursuing their national interest using not dissimilar mercantilist and military-minded means. China and the United States are following a similar model, though perhaps in not the way round that Washington had for so long imagined.



Filed under China-U.S., Defence, Trade

China’s Collectivisation of Capital

THERE IS A vacuum in the state’s control of the economy. The combination of powerful private companies arising in new areas of economic activity from which state was absent, such as within the tech industry, and the breaking up of the patronage networks within state-owned enterprises (SOEs) as a consequence of President Xi Jinping’s anti-corruption campaign has created it.

The Party abhors a vacuum and has stepped in to assert its control as the state’s wanes. Under Xi, the People’s Daily opined in June, the Party has sought to address the “weakening, watering down, hollowing out and marginalisation” of party leadership at state enterprises.

Two months ago a government statement made it clear that private-sector business should follow Party guidance, including ‘patriotism’, ‘observing discipline’ and ‘serving society’ within its definition of entrepreneurship.

The mechanism for exercising Party control is the Party branch within companies. These have long existed within SOE’s (they are present in 93% of the 147,000 SOEs big and small) and have become prevalent in the private sector. Qi Yu, deputy head of the Central Organisation Department, said in October that 68% of 2.73 million private businesses had Party branches as of the end of last year.

Party cells are also becoming more common in joint ventures with foreign firms, and are being pushed on foreign firms with wholly owned local operations as part of the ‘new era’. Qi said 70% of foreign-funded firms in China – or 750,000 – have set up Party branches and 106,000 foreign-invested companies, against 47,000 in 2011.

Samsung and Nokia are two foreign companies who have acknowledged publicly that they have set up Party branches in their local operations; The medical systems division of Japan’s Toshiba has had a branch since 2007. The US chemicals multinational DuPont had one when it set up in Shanghai in the 1990.

The influence of Party cells varies greatly between companies and industries. At their best, or at least as portrayed by authorities, they promote goodwill and communication between the company and the Party. They run companies’ internal labour unions and be a source of labour through the agencies that coordinate them.

Some are little more than a cost irritant (the company foots the bill for Party branches’ activities). In joint ventures, especially with SOEs, they can make operational decision making more opaque and cumbersome. At the other end of the spectrum, they can seek to determine strategic and operational investment and business decisions.

Some SOEs listed in Hong Kong have gone as far as changing their articles of association so as to give the party a leading role in management decisions. And there are reports circulating of joint ventures being pressed to rewrite their terms of agreement to give the Party a more formal say in operations and management, including a final say over investment decisions.

It is that direction of travel — expanding the party’s presence in areas where it has previously had a limited role, such as in private and foreign joint-venture companies and the boards of listed firms, that is exercising foreign multinationals operating in China.

In late July, executives from more than a dozen top European companies in China met quietly in Beijing under the aegis of the EU Chamber of Commerce in China to discuss their concerns about the Party’s growing role in the local operations firms like theirs. Last month, the Delegations of German Industry and Commerce in China, representing German chambers of commerce, also raised their concerns and said some German companies might consider withdrawing from the market if the Party’s influence on their local operations grew.

Part of their argument was that companies from multi-party democracies should not be bound to promote a particular party, especially one that claims a monopoly on political power. However, the concern is that once Party presence is written into governance, commercial management autonomy is lost for good. In addition, Party members are subject to the Party’s disciplinary procedures, which, of course, is beyond any internal policies a company may have.

A statement from the State Council Information Office earlier this year, saying that “company party organisations generally carry out activities that revolve around operations management, can help companies promptly understand relevant national guiding principles and policies, coordinate all parties’ interests, resolve internal disputes, introduce and develop talent, guide the corporate culture, and build harmonious labour relations” is less reassuring to foreign investors than the Office probably intended.

The other end of the telescope is that the Party should intervene to assert the collective interest of the whole over the that of the part, the whole, in this case, being the state capitalist class.

An old-school Marxist ideologue might describe the presence of Party units in companies, and the guidance and discipline they would provide, as a precursor to the collectivisation of capital, in which individual companies become units of a state corporate whole.

In these more pragmatic days, this Bystander sees it just as the Party extending an strengthening its presence and control over all sectors of society, even in areas where it has previously had a limited role, which might be much the same thing.

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China’s State Capitalism: Leviathan Major and Minor

Three of ten largest corporations in the world are owned by the Chinese state–two energy companies, Sinopec and China National Petroleum, and a utility, State Grid. There are four state-owned enterprises in all on Fortune magazine’s list of the 500 largest companies in the world. As recently as 2005 there was none. The sluggish recovery of the developed economies from the 2008 global financial crisis has brought a bout of self-doubt to free-market capitalism. China’s model of state capitalism–dirigisme through state shareholding would be a shorthand description–is touted as the coming alternative.

Though much discussed and surprisingly widely practiced in countries rich and poor, relatively little is known about the functioning and economic implications of state capitalism in its new incarnation. The 20th century model of command economies–state-owned enterprises acting as the agents of government allocation of resources–has evolved into a 21st century one in which the state provides capital to corporations–either via equity or debt–and in the process becomes a controlling shareholder that seeks to optimize economic and political returns on its investment. The political returns manifest themselves as a wide range of public goods from industrial policy to social benefits.

Two academics, Aldo Musacchio and Sergio Lazzarini, take a look at this new state capitalism in a newly published Harvard Business School Working Paper*. First, some definitions. Musacchio an Lazarini identify two flavors of 21st century state capitalism.  One is through state majority control of publicly traded companies. China’s state-owned enterprises, such as the three mentioned above, are a prominent example. The other relies on minority investments in companies by official agencies such as development banks, state-controlled pension funds and sovereign wealth funds as well as national and local government. They summarize the two as,

the widespread influence of the government in the economy, either by owning majority or minority equity positions in companies or through the provision of subsidized credit and/or other privileges to private companies.

In short, Leviathan major and Leviathan minor.

The authors look at state capitalism around the world, not just in China. One point that leaps out of their study is how widespread the model already is, even in what are thought of as free-market economies. We pluck out of their paper this snapshot of it in China, using 2010 data, and by comparison in the other Brics.

Patterns of State Ownership in Brics
Country SOE output to non-financial GDP Listed SOEs SOEs as % of market cap. Number of SOEs with majority control No. of firms with federal govt. minority ownership
Federal State/
Brazil 30 14 34 247 n/a 397
China 30 942 70 17,000 150,000 n/a
India 13 29 4,014 217 837 404
Russia 20 12 40 7,964 250 1,418
S.Africa n/a n/a n/a 270 n/a n/a
Source: Musacchio and Lazzarini

Using Musacchio and Lazarini’s analogy of Leviathan as a majority investor and Leviathan as a minority investor, China falls under the rubric of the former. Government majority holdings in publicly traded companies outstrip minority holdings by a ratio of three to one. The average for the Brics is less than two to one. As a general rule, minority holdings are the result of state investment holding companies investing in a portfolio of firms. China Investment Corporation (CIC), the world’s third largest sovereign wealth fund by assets under management, fits that model. Though not particularly delved into by the authors, China’s state capitalism is also characterized by an upstream oligopoly of large state-owned enterprises in strategic industries, as, again, the three mentioned above illustrate.

Musacchio and Lazarini’s paper is descriptive, not prescriptive, but it does raise questions about some common consequences of 21st state capitalism that are readily applicable to China, where the 121 largest state-owned enterprises own $3 trillion in assets (2010 figures). Does China’s version, as entrenched and widespread as it is within the economy, promote or hinder the development of deeper financial markets and more professional and skilled corporate management and governance? Just as in the political realm, state, government and Party are often interchangeable, so are ownership, governance and management in the world of Chinese state capitalism.

The authors note that Leviathan major state capitalism tends to establish itself in response to market failure, notably where capital markets and corporate governance are weak. In an ideal world, it leads by example to improvements in both. Yet in China’s case, the big state owned banks are so dominant in the financial system and are such an important arm through which the government exercises monetary policy, that that may not happen, regardless of how hard the reformers are now pushing for financial reform. Which leads directly to a bigger question, whether vested interests and cronyism are so entrenched that the system is captive to its agency problem–that those running China’s state capitalism use its as a way to create and distribute public goods in order to legitimize the Party’s monopoly grip on power and to allow the ruling elite rather than the state as a whole to capture the economic rents it generates. John Hempton of Bronte Capital has provocatively described this as  China as a kleptocracy. That may be over-egging the pudding, but to what extent will determine how China continues to ascend the ladder of economic development.

*Leviathan in Business: Varieties of State Capitalism and Their Implications for Economic Performance by Aldo Musacchio, associate professor in the Business, Government and the International Economy unit and a Marvin Bower Fellow at Harvard Business School, and Sérgio G. Lazzarini, Insper Institute of Education and Research, HBS Working Paper Number: 12-101, May 30, 2012

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The One Question That Matters About China’s Model Of State Capitalism

Monday’s publication will push the World Bank’s report, China in 2030, to center stage in the emerging, if ultimately pointless debate about whether China’s state-directed capitalism is better than the U.S.’s free-market capitalism. The later has undeniably damaged its case with the self-inflicted injuries that caused the 2008 global financial crisis. The revival of the 1930’s blend of banker and gangster, bankster, is timely and apt, in that regard, just as are the Occupy protests that have sprung up around the free-market world. But, in their rush to throw out some fetid bathwater, capitalism’s critics risk tossing out the baby, too. Nor is the Chinese model a proven substitute. For all that it has seen China though the post-2008 crisis period with higher growth rates than the Western Economies, the long-term costs have yet to fall due.

The World Bank report reportedly argues that the dirigiste model that has seen China through a remarkable three decades of economic development has run its course. We don’t yet know the details of the Bank’s arguments, but this Bystander has long argued the necessity of structural change if China is to move up the development ladder. The heart of the real test for China’s state capitalism is not whether it is better than banksterism. It is, can it vault the country from the ranks of poor countries to rich. To do so, it will need to clear the middle-income trap or the economic Great Wall–choose your metaphor–something no developing country has done without institutional change. This Bystander thought it timely to republish China’s $10,000-12,000 Question, first published in January last year, examining whether China can defy history:

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

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Market Guidance Chinese-Style

If China can have state guided capitalism and state-owned corporations there wouldn’t seem to be any reason that it can’t have state-guided markets, too. Its proposed carbon trading market due to start in 2014 would seem to fall squarely into that category. Feng Shengbo, deputy director of the China Clean Development Mechanism Project Management Center of the Energy Research Insititute of the National Development and Reform Commission (NDRC), told Bloomberg that authorities are drawing up rules for a market to be run by “associations” overseen by  government. “The government will not directly control the market,” Feng said, “but if the associations make misleading policy it’s for the government to guide them.” Not exactly Adam Smith’s invisible hand.

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