WASHINGTON – The Chinese government’s reaction to the recent Shanghai and Shenzhen stock market crashes and ensuing panic provides a welcome reminder of what China really is. No, China is not a capitalistic market economy. And —no— there is no clear indication that the Chinese leaders are really working on a real transition from state control to open markets.
The stock market crash is the result of a frenzy propelled by small investors who, lacking other opportunities, thought that stocks could be reliable investments. Well, too many people had the same idea at the same time and this resulted in absurdly high valuations.
When the sell off started, the Chinese Government panicked. Instead of allowing the market to find its bottom, even though this would have caused huge losses for retail investors, the Government decided that a major crash would be a political embarrassment. And so it stopped it, with non market means. The cost of this artificial support? $ 200 billion. Yes, this is a lot of money. This is more than double the amount of the latest, gigantic EU funded rescue package for Greece.
Other measures, combined with this massive injections of funds used to buy stocks, stopped the decline. Public authorities halted trading in most stocks. They ordered certain classes of shareholders to hold on to stocks. They forced brokers to buy stocks; and they ordered banks to lend money so that purchases could be executed.
Well, guess what, as most investors could not sell, while others were ordered to buy, share prices stopped falling. In fact, aware that the government is actively supporting share prices, some investors went back and bought. As a result of all these massive interventions, the market rebounded, somewhat. But it is obvious to all that current share prices have nothing to do with market values. Bottom line, China does not have real stock markets.
The Chinese economy is a hybrid
What does this tell us? Very simple. China is and probably will remain for an indefinite future a peculiar hybrid of socialism and capitalism. It will continue to be a centrally controlled society, with state ownership of strategic economic assets, (steel, insurance, banking, telecoms and more), and routine state interventions, (such as this one to prevent a real stock market crash), blended with a relatively new and in some cases quite impressive private sector.
This model does not work any more
The fact is that this peculiar mix, while it launched and sustained the unprecedented 30 year economic boom, does not work very well any more. The export-led boom featuring thousands of manufacturers fueled by ultra cheap labor is over. Going forward, China needs a flexible, decentralized, innovative economy with market-driven free movements of capital and human resources.
And this implies real capital markets in which investors determine share prices on the basis of an assessment of where value is. But you cannot have a reasonably good allocation of scarce private capital when markets are manipulated, while critical sectors of the economy are closed to the private sector, let alone foreign investors.
Likewise, you cannot have optimal allocation of capital, when state-owned enterprises –even if unproductive and poorly managed– will always get bail outs in the form of easy credit from state-owned banks.
But why is China not completing its conversion to real capitalism? After all, it is clear that their system is inefficient. Very simple. The Chinese hybrid is indeed inefficient. But, for the time being, state ownership of critical economic assets provides a very good instrument to retain political control over a gigantic nation of over 1.2 billion people.
At the end of the day, the main objective of the Chinese leadership is self-preservation, and not optimal allocation of resources in order to maximize economic growth. If the price of political self-preservation is economic inefficiency, so be it.
From Beijing’s perspective it is better to have an inefficient state controlled steel conglomerate whose party-appointed leaders will do as they are told, than an efficient conglomerate run by private investors who will not take orders.