How Fear of Economic Shock Drove China's State Control and Forex Hoarding

In an interview by The Browser discussing Yasheng Huang’s book, Capitalism with Chinese Characteristics: Entrepreneurship and the State, Northwestern University political economist Victor Shih looks inside the searing-hot, state-controlled economy.

He notes the consolidation of economic control first got underway as state leaders grew increasingly fearful of financial crises and the potential turmoil that could ensue. The policies that resulted, as he describes them, were to provide a cushion for any economic shock by shoring up a substantial base of foreign exchange reserves. China’s government managed to achieve moderate stability and maintain accelerated growth… but at what cost?

From The Browser’s interview:

“[Victor Shih:] There was a period of healthy organic growth in the 80s, driven by the de facto private sector. Many township and village enterprises were collectives or owned by the local government. But in reality they were private enterprises. This changed in the mid-90s, especially with the adoption of the ‘grasping the large and letting the small go’ policy that circumvented the special interests in the state sector. When Deng Xiaoping was alive, his executive vice premier, Zhu Rongji, wanted to bankrupt or merge many of the smaller state-owned enterprises into larger ones. It was a political tactic to further reform. And it worked.

“The problem was that it created these giant, state-owned enterprises. Recent statistics reveal the state sector made a profit of 2 trillion renminbi last year, of which the 122 largest SOEs made 1.35 trillion. They have combined assets of over 10 trillion dollars and have become an enormously resourceful and powerful interest group. Their CEOs have numerous ties with top political leaders and sit on the party’s central committee. Most bank loans, issued bonds and stock-listing proceeds in the system go to these conglomerates. There’s still a private sector but it has been squeezed tremendously, especially in the last two years.

“Yasheng does a great job of explaining the genealogy of this process. He shows us the evidence on a national basis and in terms of Shanghai. People think of Shanghai as this dynamic, market-oriented city that symbolises the future of China. But Yasheng points out – and I know this because I’ve done fieldwork in the city – that the largest enterprises in Shanghai are state-owned. From energy, steel and car manufacturing to taxi firms and newspaper stands, the state dominates.”

The problem, as Shih explains, is that the state is failing to allocate capital very efficiently. Because, as he puts it, “it’s not their money, after all. That’s what you see in China: a lot of wasted money.” Much of the infrastructure that has wowed the world as emblematic of China’s ascent, for example the Olympic stadium in Beijing, includes expensive projects that have yet to find ordinary and consistently productive use. Shih provides several other examples and many more details in his interview with The Browser on how China’s blazing economy may find uncertain times looming.


Rocky Vega,
The Daily Reckoning