The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: Today, David, our guest, looking more at the political side of the Chinese question, is Minxin Pei.
David: Juxtaposed against such massive and largely positive economic and social changes, however, is China’s political system. Despite more than two decades of rapid socioeconomic changes, the core features of a Leninist party state remain essentially unchanged. The pace of political change has significantly lagged behind that of economic progress.
Minxin, several years ago, you penned that, yes, there is a way forward economically in terms of the economic reforms that need to take place in China, but there are a number of political barriers – the Chinese political system, itself, even. That is where we would like to start today, with an exploration. In past weeks we have covered China and its economic challenges.
With your background, professor of government at Claremont/McKenna today, before that professor of politics at Princeton, and the scholarly works that you have done, both on the demise of communism in China and the Soviet Union, and more recently, your book, China’s Trapped Transition: The Limits of Developmental Autocracy, you deal, specifically, with the politics embedded in this issue. Maybe we can start there.
Minxin Pei: Oh yes, absolutely, I think people who look at China’s economic growth, possibly forget that at the end of the day what determines policy is political power, not economic rationality. What is economically desirable is not always politically desirable and that appears to be a blind spot a lot of us have when we look at China, and I would also say when we look at many other countries.
David: We have the semi market-based economies, the “hybrids,” the mixed command and market characteristics of, say, a Singapore, a Beijing, a Moscow, maybe even Caracas, and they flourished in a certain financial environment. Globalization has opened fresh opportunities. Credit has flowed freely in the past 30 years, and as Michael Pettis has argued, if you take away credit, you begin to reverse the progress that comes with globalization, referring to the liquidity theories explored by Minsky and Kindleberger.
Might we have a very different opinion of the Chinese economic miracle or these other autocratically directed market-oriented economies, if credit was tightening and globalization trends thereby moved in reverse? Is it the system, or is it these global liquidity flows that are helping any and all systems?
Minxin: I would say that global liquidity flows are certainly part of this picture, but not the only part of this picture of globalization. I would say if you look at China’s economic growth for the last 30 years, credit played a far more important role inside China than between China and the rest of the world. The money that flowed out of China, of course, helped sustain Western demand for China’s consumer goods.
That helped. But it was not the sole driver. I think the sole driver in the West is the explosion of credit. But there is a similar explosion of credit inside China that played a very critical role in helping the Chinese government finance trillions of dollars in infrastructure spending.
I would modify your point a little bit. I think credit flows are important. Global credit flows are very important for the last two decades, but the China story is essentially a domestic credit boom, and its relationship with the rest of the world is that China was willing, actually, China found that it was in its interest to recycle its export earnings abroad in the form of reverse credit flows to the developed country, essentially like paying Americans for purchasing China’s goods.
David: That’s one of the many issues we would like to explore – the impact on the U.S. Treasury market, if the Chinese trade and investment reorientation will, in fact, have an impact on demand for Treasuries.
Minxin: I would say if China’s export growth slows down, if China starts to run a trade deficit, then we are going to see the Treasury market severely affected, because China will, at least, not be in the market to purchase more issues. In fact, China will very likely sell some of its holdings to cover account deficits.
Right now, China enjoys a current account surplus. But China’s merchandise trade account is showing less and less. In some months, it actually registers a deficit, so we can conceive of a period sometime in the next 5-10 years when China’s current account surplus could become a deficit account rather than a surplus account, and by that time, of course, there will be a huge source of demand for U.S. Treasuries that will dry up.
David: For most investors, they look at the purchase of any asset as, in fact, an investment – what is my rate of return going to be on this particular investment? And there is concern over whether or not you make money or lose money. Is it fair to assume that there is more of a political calculus involved in the purchase of Treasuries on the part of the Chinese?
Minxin: Not necessarily. It think politics plays a very insignificant role in China’s decision to purchase the Treasuries. In fact, they would love to purchase less. Purchasing more would mean that they have effectively tied their future income, future returns, to America’s fiscal and monetary policies, and if you are a great power, you don’t want to do this.
But if you look at the economic calculations, they make a lot more sense. There are not really a lot of other assets the Chinese can put their export earnings into, and I think for the past few years, they have done very well in getting into the Treasuries, because the Treasury markets have boomed. The rate dropped from 4% a few years ago to now 1.5% on the paying bond, and the Chinese are sitting on a lot of capital gains. Of course, these capital gains are offset by depreciation of the U.S. dollar against the Chinese currency. But by and large, I would say they are extremely conservative when it comes to investing their foreign currency earnings.
David: We have the idea of the Washington consensus, which is that there is the liberal Western democracy, with all the institutions and norms that come with it, that can be used as a model for any country seeking to advance their prospects in the global community. And then, there is the Beijing consensus, if you want to call it that, which is more of an acknowledgement that authoritarianism, mixed with the market economy, works, and has been legitimized by the success story witnessed in China today. Would you come to that conclusion? Is this a success story, or are there things that we are overlooking in that appraisal? Or as folks have written about the Beijing consensus, is there something that is missing there in that analysis?
Minxin: I would say, if I were very charitable, and if I am in a very good mood today, I would say, “At best, China’s economic story is a mixed story.” There are plusses and minuses. We can go into that later on. If we look at the plus side of the Chinese economy and we want to explain who is responsible for China’s achievements in those areas, let me just tick them off: A very rapid reduction in poverty, largely through economic growth.
Then you would say, for some time the Chinese government actually followed the Washington consensus. What is the Washington consensus? The key component is liberalizing trade, especially liberalizing trade with the outside world. China’s foreign trade boomed. China utilized its comparative advantage, which is cheap labor.
Another Washington consensus is fiscal conservatism. China’s government has been relatively conservative in borrowing money, explicitly, and the debt-to-GDP, if you measured China’s sovereign debt, is relatively low – 20% of GDP. So inflation gets under control. That is another Washington consensus.
Then the Washington consensus also says that the government should provide key infrastructure for building. So that’s what China has done. In other words, what China has done is in line with the Washington consensus, and also, I would say that in this process China has a very powerful tailwind. That tailwind was a very young population, 20 years ago.
For the last 30 years China enjoyed something called the demographic dividend. That is, having a lot of young people, and not a lot of old retired people, the country did not have to spend lot on health care or retirement, so savings could be plowed back into building factories and roads. That’s why China has very modern factories and roads.
But the downside is that it is a mixed story. In this process, China actually has not been very effective in fighting the corruption in government. It has not been effective in delivering social services. So environmental degradation is very serious. Healthcare is becoming a huge problem. It’s expensive, a lot of people do not have access to it, and it’s of low quality.
If you look at the sustainability of growth, also there is a huge question mark, because China, in the last 20 years, has followed the so-called East Asian model, which is an investment-driven model, export-driven model, and now this model is coming to its end.
So it is, at best, a very mixed story.
David: So, if they have followed a model which is consistent with the Washington consensus, then the Beijing consensus, really, is not much of a story to speak of. Their success has had less to do with autocracy, or authoritarianism, and more to do with the things that you just mentioned – reduction in poverty, liberalizing trade, fiscal conservatism, keeping inflation under control, investing in key infrastructure, and things of that nature. With a major transition afoot, perhaps you can frame for the listener the importance of the most recent (12th) five-year plan, and then contrast the constraints that leadership is under with their stated intentions of reform.
Minxin: Frankly, I think most Chinese analysts do not pay attention to the 12th five-year plan. Things like this are produced for official consumption and propaganda. They may reflect desired goals of the Chinese government, but the achievement of these plans is always suspect. Based on what I know about the desired goals of the Chinese government, and I’m sure they are spelled out in the plan, the Chinese government would like to bring the economy more or less into balance, which means they want to have more consumption by Chinese households.
Right now, Chinese households consume only 35% of GDP, the lowest of a major economy. In the U.S., by contrast, household consumption accounts for about 70% of GDP, which is double the Chinese rate. And of course, to offset that, you have to bring down investment in China. What’s wrong with investment? Investment in China can produce a lot of excess capacity – new factories that produce things that nobody would buy, highways, ports, that have very little utilization, so it is a waste.
David: It does improve your growth numbers in the short run.
Minxin: It improves your growth numbers in the short run, because when you spend the money, when you put stuff on the ground, you have to dig a hole, and if you pay somebody to dig the hole, that’s GDP. (laughter)
The Chinese government would also like to reduce environmental degradation, because the environment in China has suffered, grievously, in the last three decades, so they have to roll back. And the Chinese people are not willing to breathe very hazardous air day in and day out. Also, they are very worried about China’s competitiveness in a wide range of technology sectors, so they want to make the country more competitive.
All desired goals, but can they do this? I am very skeptical. Going back to the so-called Washington consensus and the Beijing consensus, very ironically, if you want to explain China’s success, the Washington consensus does a very good job. If you want to explain China’s failure, the failure all comes from its authoritarian political system. In other words, autocratic politics is holding back China. China would have become a much more dynamic, efficient economy that benefits its people more, had its politics been different.
David: Let’s digress for a moment to the territorial issues of the Ryukyu Islands, the Paracel-Spratly Islands, the Mischief Rocks, and generally, the South China Sea. Regionally, there are reasons for Chinese leadership to be resisted. The Philippines, Vietnam, Singapore, Taiwan, Japan, Malaysia, Indonesia – they all have interests at stake in these geographic disputes. Does this compromise China’s ability to lead regionally, using soft power? Let’s call it that.
Minxin: Oh, absolutely. I think China’s problem with its neighbors is that China is simply too big, and its neighbors are frightened of China’s power. Also, of course, more complicated, is that China has maritime disputes with Vietnam, Japan, Southeast Asia, and China’s positions on these disputes have been quite firm.
I think that the dispute over Diaoyu Island, or Senkaku Island, with Japan, is a special case. I think with that issue, probably, if you consult international lawyers, they would say the Japanese have a weaker case. But in the South China Sea, China has a weaker case in most of the disputed areas. That does not mean that other countries have a watertight case, but what bothers the other countries in the South China dispute is that China is unwilling to change its negotiating position.
China says, “We’re going to negotiate only with individual countries on a bilateral level. We’re not going to hold an international conference to solve the issue.” And China does not invoke the United Nations Commission on the Law of the Sea which would put China’s position at a significant disadvantage, so that bothers people, as well.
If China wants to reassure its neighbors, it has to give up a lot of its territorial aspirations. Otherwise, I think its neighbors will have all kinds of reasons to be very close to the U.S., because they alone, or even collectively, cannot constrain China, cannot make China behave responsibly, so they have to bring in Uncle Sam to balance against China.
David: And maybe that’s what we see today in U.S. foreign policy, as U.S. foreign policy-makers appear to be buttressing Indian and Japanese relations, again, with some emphasis on regional Asian countries, going back to the South China Sea example. Is there anything that U.S. policy-makers should do to recalibrate these more or less aggressive postures, or is this just what it takes to offset the Chinese leviathan? They are now so big and so powerful that this is just our way of holding that balance of power in Asia?
Minxin: Please let me clarify that. Even without territorial disputes, the U.S. will be involved. What the territorial disputes have done is to make the door even wider for the U.S. to come in, make the U.S. presence, or the U.S. redeployment of its military assets more welcome to people in the region.
I think what the U.S. needs to be careful about is that its primary goal has two components: One is deterrence. That is, to make it clear to China that in its disputes with its neighbors it should think twice, if not three times, before it uses force. There is another, much bigger guy on the block now. That is deterrence.
The other component of the American strategy is to balance. That is, it will not allow a single country to dominate a part of the world. So, if it’s China, the U.S. will be friends with Japan and be supportive. If it is some other country, the U.S. will be friends with China to counterbalance. That is the U.S. underlying strategy. In doing this, the U.S. has to be very careful about one thing. It does not want to be used by those countries involved in the disputes, because their objectives are very different. They want to bring the U.S. in, in order to enhance their positions against China, which is fully understandable, but they may not want to avoid conflict with China, because sometimes they miscalculate, as well.
For example, Vietnam wants the U.S. to be in Cam Ranh Bay, to increase its military presence. In the meantime, Vietnam has purchased diesel submarines and fighter aircraft from Russia. What if Vietnam gets into a fight with China by some accident? How would the U.S. respond? The U.S. has to be extremely cautious in maintaining a balance between its strategy and avoiding getting directly involved in territorial disputes.
David: Let’s come back to the economic issues and the rebalancing which needs to take place in China. Some analysts have taken the economic bearish case on China, and they cite a looming debt crisis. They have exaggerated this by loose provincial lending, and almost a form of shadow banking where unofficial channels and special purpose vehicles have been used to extend credit, again, nontraditionally. By doing so they have increased the inherent risk in the financial system.
One of the questions that lingers for us is, in your view, is there a debt crisis looming for China? And when you look at nonperforming loans in an environment like China, is there something really to even worry about? They can always be evergreened, or perhaps with a banking system that is controlled by the state, maybe nonperforming loans can simply be ignored.
Minxin: There is a debt crisis looming in China, but this is a debt crisis for local governments, for real estate developers, and for the railway system which has borrowed too much money and probably cannot repay it. For China, as a nation, there is no debt crisis. In other words, China is still solvent as a nation. Its net international position is positive, and it owes very little in terms of sovereign debt to the outside.
The problem with China is that if the current trends continue for another five years, then the nation, itself, will become bankrupt, because it can afford to bail out local governments and various debtors maybe one more time, but not two more times, or three more times. That is the problem for the medium term, but not for the immediate term.
David: When we think of the organizations which have dominated the business community in China, the state-owned enterprises, are they an example of Chinese success in business, or in your opinion do these state-owned enterprises grow at the expense of other areas within the economy?
Minxin: They are not examples of success, they are actually examples of failure of the Chinese economic model, because if you look at the state-owned enterprises, you will find two things. One is that most of them are not very profitable or competitive, and those that are very profitable are monopolies, like China Mobile, big Chinese banks. And their profits would evaporate if you introduce market competition.
They survive by gouging Chinese customers who have to endure high prices and low quality in terms of service. Most of the other state-owned enterprises that are in some sort of semi-competitive sectors cannot survive without access to cheap credit or free capital by the state. I have seen many studies that showed that if they get their cheap credit, tax subsidies, or monopoly rents taken away, they will all be losing money.
David: And this has a similar echo to what we have here in the United States. There are a number of sectors which, without cheap capital, would not be surviving, and the issue is that cheap capital comes at some cost. It is cheap to the person receiving it, but it is drawing resources from elsewhere in the economy, essentially creating a subsidy. It is a repression of the household sector, an additional tax on the household sector.
This brings up this problem with reform in the Chinese economy, because, with the five-year goal, even if they can’t pursue their desired goals, if the achievement of them is unlikely, what you have is the household sector which will continue to be repressed in favor of the state-owned enterprises, unless, of course, the state-owned enterprises are privatized or competition is allowed. That is very difficult, isn’t it? When you consider that the old guard has benefits which are being conferred via this sort of rent extraction? Key sectors in the economy are benefiting the most powerful people in the country, and they don’t have to be efficient to basically be skimming profits and cash flow from the larger economy. Am I making sense with that?
Minxin: Absolutely. I think you identified a key problem with the Chinese economy. That is, state-owned enterprises get cheap capital, largely at the expense of households. Chinese households suffer from another hidden tax – the tax on their deposits. Economists calculate that tax amounts to about 4-5% of GDP. So every year 4-5% of GDP goes into state-owned enterprises in terms of subsidies, and taking away the subsidies is very difficulty politically, because why do state-owned enterprises exist? It is for mainly political reasons. For the Chinese government, which tends to think that state-owned enterprises are strategically things they cannot trust – capitalists, domestic or foreign, to provide China’s telecom services, financial services, or explore China’s natural resources. They just don’t have that trust.
Secondly, state-owned enterprises constitute a huge patronage machine. If you are a child of a communist party official, you can get a very good job in a state-owned enterprise. All you need to do is to ask your dad or relatives to help you get the position. In other words, if you get rid of state-owned enterprises, how are you going to take care of your children, your relatives, or the officials, themselves? That is why it is extremely difficulty, politically, to change the status quo.
David: Let’s go to some specific points that you have made in your book, China’s Trapped Transition: The Limits of Developmental Autocracy. You have written that few authoritarian regimes can rely on coercion, alone to maintain power. This is the point you were just making. Most autocracies mix coercion with patronage to secure support from key constituencies, such as the bureaucracy, the military, and business groups. Let’s talk a little bit more about patronage – how it works, and the limits it places on economic reforms.
Minxin: Let me talk about business groups, because this is something the outside world may not be aware of very clearly. If you are a private entrepreneur, or if you are in a group of private entrepreneurs, you also want the government to take care of you. So how do you take care of the government? You want to reassure the government that you are not going to allow free labor unions in your factories, and the government will be very happy to help you make sure that happens.
And then you also want the government to maintain low currency because your main products are for export, so cheap currency helps you. And in return, you are not going to criticize the government, and you are not going to organize yourselves to become an independent political lobby. So there is this quid pro quo. That is the patronage.
And of course on the individual level, if you are a college graduate in China, and you really want this very nice job in a state-owned bank, or in a bureaucracy, the first thing you want to do is to join the communist party, because that is like pledging your political allegiance. “I am not going to make political trouble, so please give me this good job, and here is my application for party membership.” That’s how political patronage works in China.
David: Addressing the issue of rampant official corruption, you say that partially reformed economic and political institutions provide a fertile environment for official corruption because institutional rules are either unclear or politically unenforceable in such environments. Rough estimates of the total cost of corruption, as you have noted in your book, range from 4% to 17% of GDP, which is a substantial amount of resources diverted from public coffers to private pockets.
Just to illustrate, in dollar terms, we are talking about a range, in the Chinese economy, of 239 billion, if we are taking current GDP statistics – a minimum of 239 billion dollars, to upwards of 1.1 trillion dollars, in bribes, financial fraud, purchase of land, illegal real estate transactions, the purchase or sale of government appointments – these are huge numbers! (laughter)
Again, when you look at a system that has endemic corruption, if we read something like the World Bank’s report on economic reform and the road map for China from the 1978 period through 2030, here, very simplistically, are the economic reforms that need to be put in place. And yet, there are these barriers to reform, whether it is corruption, or as we were just talking about, patronage, the subsidies to the state-owned enterprises – these are the things that make up a large percentage of the Chinese economy. How do you get vested interests to simply walk away from those interests?
Minxin: I think, traditionally, there are two ways to deal with that. One is to throw them out. That is revolution. You have something like the Arab Spring, or the Soviet collapse, the revolution in Indonesia, that threw out those parasites in the system – very costly, and sometimes these elites can come back. Or another group of elites will come back and take over their position. It may not be successful.
A second way would be to buy them out. That is, “We know you have accumulated a lot of ill-gotten wealth. What we want you to do is to get out of those sectors. We are not going to take your wealth back, but you are not going to be allowed to continue to be parasites on the economic system.” So you cut their access to future profits from economic activity.
I don’t know what China will do, or can do, but one thing we know is that if it does not do the second option, that is buying them out through some sort of one-time bribery, then we are looking down the other path – that is, a revolution that can overthrow all of these rent seekers, or parasites, in the economic system.
David: This brings us back to the issue of: Does the politburo have the political courage to take these steps, or is it more inclined to just let things play out gradually? As we talked a few weeks ago – wait, wait, wait; talk, talk, talk. That is more of their operating strategy, even if they set forward ideals and a road map for people to look at and admire and assume that they are acting on, when in fact, they may do nothing.
Minxin: I think still they still wait, wait, wait; talk, talk, talk; and do nothing, because China, today, has a very weak leadership at the very top – politburo 25 people, or politburo standing committee, nine people. They cannot make a fundamentally different decision. What happened in the past in China is that if you were in survival mode, if the regime was in survival mode, then you could think more creatively, more courageously, and do something major. But right now I just don’t see the stars lined up for the Chinese government to do something that will represent a dramatic break with the past.
David: Since the ruling elite loses confidence in the future of the regime, essentially, there is that wait, wait, wait; talk, talk, talk. What do you think the behavior of the ruling elite will become when they realize that the regime is near its end? Maybe it’s five years out, maybe it’s ten years out, maybe it’s only two years out. How do you think their behavior will be impacted? Would you describe that as the “59 phenomenon,” which you allude to in your book?
Minxin: Yes, the “59 phenomenon” in China refers to the fact that most officials retire at the age of 60. By the time they are age 59 they become very corrupt. They take all kinds of bribes and try to hide their ill-gotten wealth. That is the “59 phenomenon.”
I would say that if nothing changes and the members of the ruling elite clearly understand the risks of the system, they see crisis coming before most other people can see it. What that means is that before these risks become overwhelming, or before a crisis is very visible, these ruling elites will most likely hedge. That is, they will send their children abroad, send their wives, mistresses abroad, establish a residence, move some money out, while they continue to collect bribes in China.
When they see the storm coming, there will be the equivalent of a bank run. That is, they will accelerate the process of moving their assets out of China. I have heard that in recent months China’s current account actually began to show a deficit. There was a lot more money flowing out of China than flowing in, which might suggest, actually, some of them are getting very nervous about leadership challenges, because a leadership challenge may not lead to democratic revolution in China, but leadership challenges can lead to the loss of jobs of a lot of officials. Once you don’t have jobs, you don’t have political protection, and their economic wealth will be insecure, so they are now moving assets out. So I am not personally surprised at all by these numbers.
David: This is what is fascinating from a Western perspective, and certainly, among Western academics, the literature of today sees China’s rise and its future ascendance as inevitable. This ascendance, the economic progress over the last 20-30 years, is taking them to an unparalleled position, ultimately surpassing that of the United States. Some people think that is 2030, some people think that is 2050, but wouldn’t you say, just to underscore many of the themes in our conversation today, that economic progress is necessary, but it’s not sufficient, to continue on a path of growth? And that, in fact, as we look back at the 21st century, we may not see the greatest superpower of the 21st century in the form of China? We may see one of the greatest missed opportunities because they were unwilling to reform politically.
Minxin: You are absolutely right. I think if you look at the predictions for the past 50 years, first the Soviet Union was supposed to surpass the U.S. Then Japan. Neither of those panned out. And I want to say that if China fails to change, politically and economically, it is unlikely it will sustain its economic growth, or surpass the U.S. as the world’s largest economy, in the next 20 years. So I would say that making future predictions based on past trajectory is always a very hazardous business.
And now I have to say that the market is recognizing this. The market is becoming quite gloomy about China. That is because for the last 5-7 years the market has been very patient, waiting for the Chinese government to undertake the economic reforms that will sustain economic growth. But the market has seen very little of it.
David: I have seen the Shanghai Exchange struggle to recover even half its losses from its peak a few years ago, and I think you are right. A number of major banks took early stakes in China and have now pulled out, and obviously the 2008-2009 time frame allowed them the excuse, or justification, to fortify their own balance sheet and get liquid, with a number of non-core assets.
But you are right, there has been a recognition in the market, to some degree, that China is not at the leading edge. We have seen other Asian countries, in which, in the post 2008 period, we have see a resurgence of growth – the Philippine stock market has been raging. It’s not as if all of Asia is in the same boat, so to say, but the Shanghai Exchange certainly has been lagging, significantly.
Minxin: Oh, yes, I think the Shanghai Stock Exchange was at 6,000 in 2007 and now it is around 40% of that, at 2,400. Investors both inside China and outside China are becoming very pessimistic.
David: I just want to comment again on the uniqueness of your contribution because as I read economists, whether it is Nicholas Lardy, or Stefan Halper, or many of the other commentators on China, very few are bringing in the political realities which ultimately do have a significant impact, and this is where we began our conversation today, talking about political power being a critical element.
One may have an economic road map, but it is ultimately going to be political power which determines the success of that endeavor, or not, and you bring that reality into the equation. I hope more academics pay attention to that, because it seems as though they are facing disappointment and an inexplicable set of circumstances for their ideas, if they had assumed that all one needs is a good plan, and there is no execution risk.
Minxin: You are absolutely right, and I am very appreciative of your emphasis on politics, ultimately, determining economics.
David: If you were to look ahead, with what we see in China today, do you believe that China will emerge from this global economic crisis, or do you think this is really the beginning of the end, in terms of their potential story for greatness? Or perhaps you think there are just too many X factors, unknown variables, to say?
Minxin: I would say that, fundamentally, China’s economic growth is sustainable, but they have got to change course, because the country is still at a level of economic development that has a lot of potential, has very hard-working people. The private sector is very dynamic, even though today laborers are under a lot of political constraint and economic disadvantages because of government policy in China, and China is so deeply connected with the rest of the world.
So I would say that fundamentally I just don’t see why China cannot grow at, for example, 5%, or even 6%, a year, for the next 10-15 years. Given that China, today, is already $7 trillion economy, that can make China a much richer country in the future.
Economically, there is no reason to write off China, but, of course – you always notice there is a political “but” – they have to change the government from one that is solely interested in self-enrichment to one that is interested in providing welfare to as many people as possible. And without changing a one-party state, can you do this? I am very skeptical.
The trouble for China is that you have two transformations rolled into one. An economic transformation, graduating from an investment-led, state-dominated development model – that is one transformation. Another transformation is a transformation from a one-party system to a more democratic system. Can you accomplish this without revolution? A very big question for everybody, and I spend my waking hours thinking about this, all the time.
David: You have given a great word picture contrasting these two alternative roles of the state. On the one hand, the grabbing hand, which is represented by the predatory state looking at getting what it can from the public, and the other is the helping hand, and perhaps that is what we need to see – that second transformation you are discussing.
Minxin Pei, thank you so much for joining us for our conversation today, and the insights you have brought into a larger conversation, trying to understand the world we live in, and determine perspicacious action – where do we go from here, and what can we expect to see in terms of changes, politically, geopolitically, economically, financially? We appreciate your contribution.
Minxin: Thank you. It’s been a pleasure.
Kevin: David, if you could keep the political, and the economic, and the financial, separated, it would be much easier to do this, but we have to find how it interweaves. Minxin Pei said that what is politically desirable is not necessarily economically desirable.
David: And that is where you see the divergence. There are the folks at the top who have an interest in the old way of doing things. The last 20 years of success have been a money-making machine for them, and they are not about to just hand that over to the hoi-polloi. That is to say, there is an elite. They used to represent the hoi-polloi, and now the elite is its own class in China. That has changed radically since 1979.
Kevin: I think it is fascinating. Michael Pettis, last week, talked about it, you talked about it the week before, and now Minxin Pei is talking about it – repression of the citizenry, repression of the household, by keeping interest rates unnaturally low. That has to shift before they become a consumption-based society.
David: Fascinating, too, to look at the state-owned enterprises as a patronage machine, where they are taking advantage of cheap capital, and that being an additional tax on households, the equivalent of an extra 4-5% of GDP. We talked about corruption, we talked about how, if they don’t make this transition, politically, that allows for real economic change, they could be nationally bankrupt within five years.
Kevin: With the change, he does see continued growth in China. Pettis, last week, said that he saw, over a ten-year period, maybe an average of 3% growth per year. Minxin Pei is a little but more optimistic. If they can have a change, he is looking at in the 5, 6, 7% range on growth.
David: But certainly in question is this idea of an economic miracle, and the point that Russia was considered the economic miracle of 4-5 decades ago, Japan the economic miracle of three decades ago.
Kevin: And now, bring on China.
David: The current day economic miracle. And the verdict is still out. I think the singular point, the greatest contribution from Minxin Pei in our conversation today, is that there are political issues which have to be addressed, it is not simply an economic plan that has to be devised, and that is where we are going to have the sticking spots. That is where it may not happen.
And so that is what we are going to keep our eye on. Certainly, we are interested in the outcome, we hope for a positive outcome, and we’ll have to see. We certainly would never underestimate the Chinese. They are very hard-working, as both of our past guests have mentioned, and very smart in terms of their perspective, looking at problems to solve over a 25-50 year period. With a great deal of respect, we look forward to seeing if they can, in fact, get past these challenges, both economic and political.