In China The State Still Controls Critical Economic Sectors The Chinese leaders are using state controlled banks to induce artificial growth. The goal is to keep people happy

WASHINGTON – Financial reform aimed at introducing real competition and market driven principles in China’s banks? Or keep using the state controlled financial system as a tool to promote growth at all costs, even if this means wasting capital by funding money losing enterprises?

Growth is a political imperative

Well, it seems that China decided once more to push “growth at all costs”, even if the price to be paid is the perpetuation of systemic inefficiencies in the bloated state controlled banking system, and in the vast universe of State Controlled Enterprises (SOEs) that benefit from cheap credit allocated to them for political, rather than economic, reasons.

But why choose this very wasteful course? Very simple. In China, economic policies and growth targets are a matter of politics even more than economics.

And right now there is yet another instance in which China’s leaders will use their ability to control critical economic levers for political ends.

China slowing down

The fact is that China, while still growing very fast compared with the sluggish West (around 6 or 7%), is slowing down, and there seems to be no cure for this.

And here is how the slow down becomes a political problem. Much of the political legitimacy of the Chinese Communist Party rests on its proven ability to deliver more and more growth. China’s 30 years of incredible expansion lifted hundreds of millions out of poverty. A most remarkable achievement.

The economic miracle

But this truly extraordinary success was due in large part to uniquely favorable circumstances. Simply stated, with surprising dexterity, the Chinese Communist Party, beginning in the 1980s, managed to quickly liberalize part of the old state controlled economy, so that thousands of new, privately owned, export oriented manufacturers could emerge.

And these new companies did extremely well selling to the US and Europe mostly by exploiting the incredible advantage of China’s ultra-cheap labor. The West bought and bought “made in China” everything, because it was ridiculously inexpensive.

But now the party is almost over. Export markets cannot grow for ever at 10% a year. At the same time, China’s labor costs are rising. China will continue to export, but not at the same pace.

Grow the domestic market?

Of course, there are other ways to grow the economy. One way is to develop the domestic market by favoring consumption. Yes, great idea. But this would also imply introducing new efficiencies, and a more rational allocation of capital, so that there can be real competition and better choices for consumers.

Indeed, this would make sense if China wanted to become a real capitalistic economy. Yes, except that China is not a real capitalistic economy, nor does it intend to become one. Notwithstanding its remarkable reforms, China is still in many ways a command economy run by an autocratic political elite.

Still a state controlled economy

It is obvious that the Chinese Communist Party uses its direct control of large sectors of the economy as tools to reinforce its political control over the country. This is really important.

Sure enough, as noted above, there are large private sector firms in China. Many Chinese individuals have become extremely rich by behaving just like Western capitalists. All true.

However the most critical sectors of the economy: banking, insurance, telecoms, energy, railways, and what not are still controlled by the state. State Owned Enterprises are often inefficient. But it does not matter. The point is that these powerful corporations are also the critical tools that enable the Communist Party to keep a grip on the broader economy and therefore political control over Chinese society.

Use SOEs to stimulate the economy

And now, in what may be a prolonged new phase of economic slow down, the obvious reflex is to use in a deliberate way these economic tools for political ends. China is losing economic altitude. If this goes on too long, the leadership is worried that stagnation may lead to social unrest.

Well, then let’s inject more oxygen into the system, in order to create a powerful counter trend. And the easiest way to do so is by pumping more easy credit into the economy using the Central Bank and all the state controlled financial institutions.

Inefficiency is OK

Of course, the risk involved in this pump-priming exercise carried out through compliant state-owned banks is that good capital will be wasted in bad ventures.

But it does not matter. At the moment, the Chinese leadership is mostly concerned with preserving its (carefully air-brushed) image of extremely competent, flawless manager of China’s immense economy. If this entails wasting precious resources and delaying needed reforms, so be it.

Political goals have an economic price

Let’s be clear. The overriding imperative here is political: keeping the engine running in order to secure society’s political approval; rather than making sure that the engine functions efficiently.

Of course, there is a price involved in delaying needed market-oriented reforms. But this will become obvious later on. At the moment, China’s leaders believe that they need to give the impression that all is well, that economic growth targets will be met. Their goal is to make sure that the people will stay happy.

Will this work?

Ironically, by delaying reforms and perpetuating inefficiencies, the Communist Party leaders are making it more likely that sooner rather than later the Chinese economy will stall.

And that may be the time in which social restlessness may morph into organized opposition.

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