LIFTING THE VEIL ON CHINA’S STATE CAPITALISM: Q&A WITH JOE ZHANG

 

OCT 20, 2014 || OPENMARKETS,When China built the world’s second-largest economy, it was not just an economic miracle but a political one. It did so by re-writing the rulebook on capitalism and placing the ruling Communist Party at the center of this remarkable transformation.A unique model of state-capitalism was born with the Party at the head of an elaborate apparatus of political control over vast tracts of the economy.  While flagship state-owned enterprises (SOEs) were listed in New York or London, its top executives were still appointed by and answerable to the Party in Beijing.But now as growth slows, this pivotal role in the economy is under increasing scrutiny, as well as pressure to reform. China has built some truly giant corporations across sectors from banking totelecoms to energy, yet there is now growing unease at the unwelcome side effects of state-led growth; from industrial overcapacity, inefficiency and wealth inequality to environmental degradation.It is these issues that author Joe Zhang tackles in his timely new book“Party Man, Company Man: Is China’s State Capitalism Doomed?”  With a colorful background that includes stints as an official at the People’s Bank of China, an investment analyst at Western banks, as well as managing a listed SOE, Zhang has a breadth of China experience to reflect on. We sat down with him to discuss how he sees the future of China’s state capitalism.

 

One of the big conclusions in your book is that the state is not doomed but is actually going to become more dominant.  Can you explain your  fundamental thinking behind this?

 

The conventional view is that the private sector will inevitably become more dominant in China.  But the reality is the state sector has actually been getting stronger in the past 10 years and regained prominence. I expect this to continue.People forget that China did have a capitalist system before from 1911 – 1949.  This was a period of continuous war and the bad memories remain. The public clearly rejected the feudal system based on capitalism because it was unregulated. It even went to the point of revolution.While China’s economy has various problems today, there is still a feeling it has made great progress under the state-led system. In the 1970’s the economy collapsed as a result of rigid central planning and market reforms were introduced. Since then if you compare China to India, Africa, South America or even some countries in South East Asia, it has done well.My impartial observation is that in terms of public opinion, the Chinese population seems to embrace or even want a bigger role for the state sector.This also means they support strengthening regulation, be it adding more bank regulators or central planners.

 

There is also criticism that China’s protected and over-sized state sector is inefficient and generates low returns?I disagree that China’s state sector performs less well than the private sector. There have been arguments that data shows the return on assets is substantially less in China’s state sector compared to the private sector.But this falls down on two counts.  First you have to consider that China’s huge banks only appear in the state data as they are all state-owned and make up about 50 percent of the market capitalization of the domestic stock market. This will inevitably skew ROA measurement, as banks by definition are highly geared businesses with a low return on assets.The correct way to get a fair measure of performance would be return on equity, which comes in at around 20 percent for Chinese banks. The other issue with this measurement is the tens of thousands of private companies that go bankrupt each year. This gives a survival bias to the numbers as they then exit from the data.

 

But what about the argument returns are only good because China’s SOE’s are operating in monopolies or protected markets?I would argue that there is still active competition even within sectors where there is majority state ownership. For instance, China’s state owned banks compete fiercely with each other, as do its telecom companies.Another factor that effectively enhances competition is the power of social media in today’s economy, which allows the public to hold companies to account and force them to adopt better behavior. My experience tells me SOEs are already adapting to public pressure for greater efficiency and transparency.

 

One well-recognized problem in China’s state-led economy is the scale of corruption.  As we witness an anti-corruption campaign led by Premier Xi Jinping, can this truly be effective?I would commend Premier Xi for launching this campaign as it is long overdue and it is has a lot of public support.  But there is still the issue of how you root out the fundamentally fertile soil that gives rise to corruption in the first place, without a multi-party system. This is an entirely different game.  You need an independent third party with checks and balances Who will monitor the monitors?

 

Given your view on the state sector’s continuing dominance, do you expect China to embark on meaningful reform? Last November there was considerable enthusiasm over a reform blueprint announced at the plenum meeting, as well as the Shanghai Free Trade Zone launch.I want to see genuine reform. My prediction is we will see very little.  Too many analysts confuse wishful thinking with cool-headed analysis. Human nature is if it isn’t broken don’t fix it. Do not underestimate the Chinese ability for inaction and to muddle through.   The only reason we saw big reforms in China during the 1970’s with Deng’s Xiaoping was because the economy was effectively collapsing.While I’m no longer in the forecasting business, for full currency convertibility, I don’t expect anything meaningful in the next 5-10 years. The inertia is simply too strong.

 

There has been a lot of controversy over the spate of recent antitrust raids on foreign companies in China.  Is this aimed at detracting attention from the high profile anti-corruption campaign, or is it some sort of mercantilist clampdown to boost domestic firms?I do not believe the government needs to use these antitrust actions as cover or is related to being populist. Overall, authorities do not feel under any great pressure. Growth is reasonably strong and the Party retains a very firm grip on the economy and society. My view is that these antitrust actions, in part reflect we are witnessing a Chinese economy that is now more mature and developed.In the past authorities have shied away from enforcement as they needed investment and tended to bend over to accommodate foreign companies. There was also generally a feeling they had better governance, so we will leave it to them. But it went too far in one direction and now dealing with issues such as price fixing and transfer pricing, is simply long overdue.

 

In your book you warn that China’s economy needs to address its property bubble and excessive money supply growth.  Where are we now?I still see no slowdown in the rate of money supply growth, which continues to expand at around 13-14 percent per month in the latest data.  Today’s money supply is already 372 percent of what it was at the beginning of 2006.  This has been far more aggressive than the quantitative easing in the U.S. or Europe. China has to deflate the credit bubble and property bubble, but I cannot predict how it will end.