This article is a summary of an essay on reform in China published in the February 23rd edition of The Economist. Those wishing to study this topic further can begin by reading the original essay.
Three factors underpin China’s growth.
- Cheap publically owned land. Land is not privately owned in China. The government, represented by the Communist Party, can expropriate any parcel and then sell it to developers for a large profit. Many Provinces make as much money form land sales as from taxes. However, this not completely straight forward. In order to sell or lease land so profitably the government must develop it. This means it must build roads and bring in utilities such as power, sewer, and water. All this employs thousands and creates a growing middle class. The influence of this middle class is growing, both economically and politically.
- The process of developing and selling land is opaque. A close relationship between business and government encourages this development. Everyone benefits, governments get revenue, business gain profits, and the people involved get huge bonuses. Finally, China, which was largely undeveloped only 50 years ago, gets much needed infrastructure.
- The process of development is facilitated by debt. The government borrows to develop parcels of land. Developers borrow to build. When these buildings are completed, other businesses borrow to lease and start their own operations. Total debt in China soared from 150% of GDP in 2008 to more than 250% today.
China has become a consumer driven economy. After reclaiming the title of The World’s Factory a strong middle class has emerged. This has centred primarily in its many large cities. The countryside remains poor but in its cities people can own property. They also have better schools, better health care, and access to many more opportunities. Depending on how one measures the level of discretionary spending, this means between 100 and 600 million people, far greater than the entire population of Canada. Whereas Canada depends on trade to maintain its standard of living, countries such as the United States and China can rely on internal growth generated by investment and consumer spending.
The major source of China’s growth is the private sector. Officials there refer to what is called the 56789 formula: this sector accounts for 50% of tax revenue, 60% of GDP, 70% of innovation, 80% of jobs, and 90% of companies. Despite this obvious source of growth, the Communist Party still favours state firms. In Mandarin it is call guojin mintui (the state advances, the private sector retreats). The Party strongly favours things it can control, including the press and state firms. These companies do not perform nearly as well as those in the private sector. However, cronyism with the party delivers to them a large share of bank loans (from state banks) at rates that are better than those available to others. The 150,000 state companies, with preferred access to banks, now account for 70% of corporate debt. This results in misallocation of funds and a less efficient economy.
China commands huge market power. It is the world’s biggest buyer of passenger cars, smart phones, luxury goods and beer. It also gobbles up a huge portion of the planet’s resources. The Party does not hesitate to use this market power to bend others to its will or to punish those who oppose it. Examples are many:
- Lotte Mall is a high end South Korean department store chain. In March of 2017 it fell afoul of the Chinese government when South Korea decided to install an American anti-missile system to defend itself against North Korea. China perceived this as a threat against itself and ordered its state media to lash out against South Korean companies, including Lotte. Lotte has not recovered and is considering selling all of its 100 plus properties in China.
- In December 2018 Meng Wanzhou, vice-chair and CFO of Huawei, was arrested in Canada at the request of US authorities. Chinese ministers then decided that the quality of Canadian canola did not meet international standards, despite strong evidence otherwise. This means a huge loss to Canadian farmers, all because Canada complied with a treaty obligation.
- Also in 2018, US President Donald Trump ordered increased tariffs on a list of Chinese goods. China retaliated by increasing its own tariffs on US products, including soy beans. American farmers now stand to lose a significant part of their market.
These examples show how China has used its huge market power. It is especially notable in the way it wants the world to treat Taiwan. Only 19 counties, plus the Vatican, recognize the sovereignty of this country. Most countries, including Canada, prefer a trade relationship with the mainland. Most African countries enjoy Chinese loans and infrastructure development, provided they have no diplomatic relations with Taiwan and support China in the UN.
It also uses its market to obtain intellectual property. It does comply with the letter of the World Trade Organization’s (WTO) regulations, but use subtle methods to circumvent it. Foreign companies must partner with Chinese companies to operate. So transfers of design and patent rights have the veneer of voluntary commercial agreements. Even when companies win, they lose. A former Canadian company, IMAX, is a good example. In 2014 it won a $7 million court judgement against former employee Gary Tsui. Mr. Tsui then refiled these patents in China under his local name, Cui Xiaoyu, and is still very active. He is now chief engineer of China Film Digital, a state owned firm.
The United States and the European Union wants China to recognize international patents and copyrights. So far China has resisted. Ironies of these policies include:
- Opening more industries to competition would boost China’s private sector and productivity.
- Curbing subsidies would ease pressure on their public purse and curtail excess production.
- Better protection of intellectual property would stimulate innovation.
In other words, these would actually benefit their economy. However, China is governed domestically. It has a long history of resisting outside pressure and must come to these conclusions on its own.
The conclusion is that there are weaknesses in their present growth model. It has sustained China in the past, but can it do so in perpetuity? Consensus is that its government policies must be updated. However, this is a government that is not accountable to its own people. The Communist Party does not deal well with criticism. It would mean admitting that it could have been wrong and cause doubts about its ability to lead in the future. For now, Canada must be aware of the nature of the country it deals with and proceed cautiously.
William Petryk is the resident resource reviewer here at TheGAAP.net. A graduate from the Schulich School of Business at York University and designated CPA, CMA, William Petryk is an accomplished accountant with years of experience.