Does China’s politics facilitate economic growth or suppress it?

Does China’s politics facilitate economic growth or suppress it?

23rd August 2015 Ideas 0
By Surong He, Bexley Grammar School

Acknowledgements

I would like to express my appreciation to my economics teacher Mr L Deliss for his valuable suggestions and time which contributed to constructing this final essay.

Introduction

Economic growth and interventionist policy; China’s government has shown itself to be exceedingly fond of both. This essay sets out to explore the relationship between the two and examine the degree to which they can effectively co-exist. Since 1949, China remains a socialist country with the Communist party ruling the People’s Republic and taking the form of an authoritarian, one-party state. The Chinese government long ago began the journey in search of prosperity and economic competitiveness for the economy, starting with Chairman Mao and the catastrophic Great Leap Forward in 1958. Much of Mao’s plans were based on centrally directed production focussing heavily on capital goods, and it wasn’t until 1979 that China started market oriented reforms under Chairman Deng. It was no longer smelting down pans and door knobs to produce ultimately useless metals, but rather was using resources to produce goods with high levels of demand. Whilst the Chinese economy increasingly resembles a free market economy, its politics remain relatively authoritarian and centralised.

The Chinese government is known for its autocratic leadership style which more liberal policy-makers are quick to condemn, but can this style of government find justification in China’s average GDP growth rate of 9.1% since 1989? Were policies in China effective in generating growth? Some would argue so, but critics are quick to provide arguments against this hypothesis. The following study will therefore analyse the effectiveness of the Chinese government in facilitating economic growth through its adoption of certain policies and actions during the last three and a half decades. Is its response to the global financial crisis a success-story for Chinese government intervention or a worrying sign of its propensity for excess? Have China’s high-levels of inward FDI been encouraged or inhibited by government policies? Is the corruption observed at various levels of Chinese politics a genuine threat to growth and prosperity? Are China’s restrictive policies with regard to the internet and freedom of expression more generally antithetical to innovation and entrepreneurship?

The financial system

The banking sector of China was one of the first to be fully socialized and consists of the four state owned banks: the Bank of China, China Construction Bank, Industrial and Commercial Bank of China and Agricultural Bank of China. Under the Ministry of Finance, the banking system was centralized. Consistent modifications to the system have been undertaken ever since the civil war 1949-52 to suit new conditions and policies, and changes were identifiable especially during the start of the reform in 1979. Under the control of the government, the banks were flexible during the financial crisis by boosting lending and cutting interest rates. It was undeniable that the central bank, the People’s Bank of China, which served as the government’s treasury as well as acting as the main source of money supply for economic units, shared its responsibility in stabilising the economy during the crisis.

With the global impact of the financial crisis, the roles of governments were incredibly important in maintaining and recovering the economy to a post crisis state. One significant role of the Chinese government in generating economic growth up to the modern day was clearly demonstrated through the policies employed during the global financial crisis 2007-2009, the result was a relatively stabilised financial system at the same time that several advanced western economies faced severe downturn.

Firstly, it is important to understand that during the financial crisis China was inevitably affected in a negative way as was other countries; UN data presented China’s GDP growth to have substantially dropped from 14.2% in 2007, prior the crisis, to 9.6% in 2008, during the crisis1. Nonetheless, compared to foreign economies, the growth rate of China during the crisis was seen as approvingly competitive. For example, the growth rate of the United States (world’s leading economy) in 2008 was -0.3%, for Japan, what was once accounted as the second largest economy in the world, the annual growth rate of 2008 was -1.0% and of the UK the figure stood at -0.8%2.

So how did China maintain a high growth rate during the financial crisis? It was inarguably a rather successful result of the stimulus package adopted by the government, primarily before the crisis reached severity, with the effort of avoiding damages from the crisis as reflected in affected countries, a lesson learnt from Asia’s financial crisis 1997-98. On the 9th November 2008, the State Council of the People’s Republic of China announced the staggering (RMB) ¥4 trillion stimulus package in an attempt to minimize the effect of the global financial crisis. The package consisted of plans for the investment into infrastructure (¥1.5 trillion) and social welfare (¥1 trillion)3, and was funded heavily from the state owned banks. Whilst many countries widen their budget deficit through borrowing, China’s financial system was relatively stable because of the government’s authoritative command for banks to loan credit; a command which allowed no rejection. By 2010, it was evident that China’s economic growth was sustained by the stimulus, resulting in the surpassing of Japan’s economy and, up to time of writing, China stands as the second largest economy in the world4.

In contrast, the financial systems in the Western economies, such as the UK, exposed its flaws through lack of government control. The UK economy experienced what is known as the ‘Boom and Bust’ cycle during the crisis, whereby the period of rapid growth, in the UK this was mainly characterized by growth in the housing market, was followed by a sharp contraction in economic activity. When crisis hit the UK economy, the government tried to mitigate the effect by encouraging banks to lend and borrowers to borrow for investment and consumption, but lacking confidence both banks and consumers were reluctant to follow government suggestions. Figure 15 shows the reduction in lending to businesses, and according to the Bank of England this “reflects the increasing perceived riskiness of corporate borrowers”6. The situation demonstrates the lack of government control over the financial system, though this promotes democracy to an extent, economic activities cannot be managed in effective ways in situational changes such as during the crisis, this had led to the fall in economic growth between 2008 to 2009 (using GDP indicator) as illustrated in figure 27.

Lending to UK Businesses
GDP

Foreign direct investment

As part of the first stage reform process, the Chinese government opened up the economy to FDI, the “the long term investment by private multinational corporations (MNCs) in countries overseas”8 , this was done by issuing the Equity Joint Venture Law in 1979 by Chairman Deng. At current, China is the largest recipient of FDI with many MNCs being attracted to the growing economy of China and the potential customers. Approximately 90% of FDI inflow is brought in by Greenfield investment where a “parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up”9.However, gradual improvements in government understanding and interventions in relevant sectors of the economy have led to the increased FDI in China, for example amendments were made to the Equity Joint Venture Law of 1979 in 1990 and the Interim Provisions on Guiding Foreign Investment issued which provided guidance for FDI has also been revised, the latest catalogue is in effective use from 2012. Figure 310 shows us that FDI in China has increased dramatically from the beginning of the 1990s, and it seems rational to suggest that government laws played a major role in generating the FDI inflow, by building business confidence.

FDI in China

The Provisions on Guiding Direction of Foreign Investment, otherwise known as the catalogue, was initially formulated to provide guidance for FDI in the sectors suiting China’s national economic and social development rights as well as protecting the lawful rights and interests of foreign investors11.
The catalogue highlighted in article 8 that “a foreign invested project can be carried out “only in the form of equity joint venture or contractual joint venture”, “with the Chinese party holding the majority of shares”12. The implication of this on the Chinese economy is extreme because it dismisses the threat of foreign monopolies in the market which could be damaging to the economy.

Furthermore, the government’s act of issuing this article is beneficial for the economy because it allows the minimal outflow of income to return to the foreign countries. The majority capital from FDI will therefore stay within the economy, reducing potential leakages in the long run.

We have seen that the government is in favour of protecting the domestic market, i.e. by allowing joint ventures between a foreign firm and the domestic. However, certain policies are bound to discourage potential foreign investors. It has already been mentioned that the Chinese party within any joint venture will hold the majority of shares. Policies such as this one, some would argue, discriminate against foreign investors and discourages them from operating in China, creating a loss of potential FDI and consequent economic growth. Nevertheless, you could argue that the strength of the Chinese economy provides more incentive to invest which overshadows its more undesirable policies.

Corruption

Although economic freedom has weaved its way into China, Chinese politics has by no means improved to the same extent as its economy and corruption is certainly a theme. In 2013, “China wasranked 80th out of 178 countries in Transparency International’s Corruption Perceptions Index”13. Corruption is defined as the “dishonest or fraudulent conduct by those in power”14 and can take the form of bribery, extortion, fraud and embezzlement. Corruption of the Chinese government leads to the distortion of market allocation mechanisms and in the long term impacts economic development.

In 2011, the People’s Bank Of China published a report showing that since 1990, over “18,000 Communist Party and government officials, public-security members, judicial cadres, agents of state institutions and senior-management individuals of state-owned enterprises have fled China”, taking with them a total of $120 billion15.

Let us look at an example of corruption in Chinese politics exemplified through a former Chinese politician; Bo Xilai who was convicted of ‘corruption, embezzlement, and abuse of power’, was sentenced with lifelong imprisonment. Bo was convicted of “accepting bribes worth $3.6 million, of embezzling more than $800,000 in state funds”16, as well as this; he was also guilty of abusing his power to cover up his wife’s murder of British businessman Neil Heywood in 2011.

Corruption plays its part in reducing the net tax revenue of the Chinese economy by extending leakages out of the circular flow of income and this reduces the government’s spending budget which could make huge differences over time to economic growth. As mentioned before, government spending, a component of aggregate demand can be effective in generating a multiplier effect but this is restricted because of political corruption.

It’s near useless for the Chinese government to stop corruption when it is endemic to the highest levels of the Communist party. Bribery scandals in China are endless. GlaxoSmithKline (GSK), a “global healthcare company that is committed to helping people to do more, feel better and live longer”17, admitted that staffs of Chinese branches were guilty of bribery; the scandal involved “billions of Yuan”18. According to the Financial Times, GSK has admitted bribing government officials back in 2001, in order to boost drug sales in China. Such news had made its appearance on global media, creating a disincentive for firms to invest in China. We have seen the importance of FDI to China’s economy and if businesses lose confidence in the Chinese economy as a result of political corruption, it is likely that FDI inflow will fall.

In general corruption leads to the suppression of economic growth by creating uncertainties in economic actions. Levels of corruption are often difficult to monitor, but nevertheless cause damage to the economy of China by dividing the nation with power, restricting the economy to grow in the most efficient way in the long term, i.e. competition is destroyed and replaced with unhealthy incentive structures.

Internet

The global use of technology, including the internet, has undoubtedly risen in the last few decades, following innovative ideas which play an essential role in the modernisation of the world, in particular for developing countries such as China.

The internet unleashes the types of opportunities which in the history would be classified as near impossible: providing access to mass information, e-commerce etc. In 2013, Chinese internet users approached 600 million, with expectations for e-commerce alone reaching up to $265 billion19. There exists even more potentials for both businesses and consumers, but a difficulty that agents face is the media censorship in China. The Chinese government controls the media to “avoid potential subversion of its authority”20. However, this behaviour causes imperfect knowledge of markets and sometimes acts as a barrier to innovation and trade.

An example of government intervention is demonstrated through the inaccessible Google search engine in China, and under the policy of internet censorship, more than 2600 websites are blocked in mainland China21. This stifling of freedom of expression may be unsettling, but does it have any meaningful impact on economic growth? Very few of the websites targeted by the Chinese government have expressly commercial purposes but rather are channels of political dissent. Their culling may not be particularly palatable, but this does not mean there will be an impact in terms of GDP per capita. On the other hand, it is undeniable that a sense of creativity and experimentation has been central to the growth of the most successful internet and technology-based companies of the last two decades. By stifling this inherently creative environment, the Chinese government may be prompting a hard-to-observe, yet significant slowdown in economic growth.

Conclusion

Reviewing the above analyses, it would seem China’s authoritarianism does more to facilitate growth than to impede it. China is the world’s most populous country, and the benefits of its authoritarian government are most evident when there is a need to for quick and decisive decision-making during crises. Authoritarianism is generally associated with an inability to adapt and react to changing circumstances, yet in contrast to this notion; China’s economic growth has often been a result of the flexibility of the government in times of downturn, demonstrated through experiences during the financial crisis. Additionally, government policies regarding investments have had huge benefits for the domestic market. Where other developing countries have struggled to channel high levels of FDI into genuine economic development, China’s hard-line approach with measures such as the FDI

Catalogue has ultimately promoted the welfare of the domestic market. China’s politics may not always be palatable to Western commentators, but disagreeable methods do not always preclude positive results. China’s government could do much to increase transparency, and this would benefit its population in a number of ways, but a higher rate of economic growth is not necessarily one of them.

1. http://data.un.org/Data.aspx?d=WDI&f=Indicator_Code:NY.GDP.MKTP.KD.ZG
2. http://data.un.org/Data.aspx?d=WDI&f=Indicator_Code:NY.GDP.MKTP.KD.ZG
3. http://en.wikipedia.org/wiki/Chinese_economic_stimulus_program
4. http://www.economist.com/blogs/freeexchange/2010/08/china_0
5.http://www.bankofengland.co.uk/publications/Documents/other/monetary/TrendsApril09.pdf
6.http://www.bankofengland.co.uk/publications/Documents/other/monetary/TrendsApril09.pdf
7. http://www.ons.gov.uk/ons/site-information/using-the-website/time-series/index.html#1
8. Economics course companion, J.Blink and I.Dorton
9. http://www.investopedia.com/terms/g/greenfield.asp
10. http://www.piie.com/publications/chapters_preview/3810/12iie3810.pdf
11. Foreign Direct Investment in China, pg.60, Chunlai Chun
12. http://english.gov.cn/laws/2005-07/25/content_16873.htm
13. http://en.wikipedia.org/wiki/Corruption_in_China
14. http://www.oxforddictionaries.com/definition/english/corruption
15. http://content.time.com/time/world/article/0,8599,2079756,00.html
16. http://www.washingtonpost.com/world/asia_pacific/chinas-ousted-official-bo-xilai-convicted-of-corruption-sentencedto-life-in-prison/2013/09/21/88b8d190-22b9-11e3-ad1a-1a919f2ed890_story.html
17. http://www.gsk.com/
18. http://www.reuters.com/article/2014/05/14/us-china-glaxosmithkline-idUSBREA4D03720140514
19. http://readwrite.com/2013/02/27/china-e-commerce-overtake-us-265-billion-infographic
20. http://www.cfr.org/china/media-censorship-china/p11515
21. http://en.wikipedia.org/wiki/List_of_websites_blocked_in_China

Bibliography

Books:

Economics course companion, J.Blink and I.Dorton
Foreign Direct Investment in China, pg.60, Chunlai Chun
Sustaining China’s Economic Growth After the Global Financial Crisis, Nicholas R. Lardy

Websites:

http://www.hindawi.com/journals/ecri/2012/961694/
http://en.wikipedia.org/wiki/Chinese_financial_system
http://english.gov.cn/2008-11/09/content_1143763.htm
http://www.piie.com/publications/chapters_preview/3810/12iie3810.pdf
http://press.anu.edu.au/wp-content/uploads/2011/08/ch063.pdf
http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS/countries
http://english.gov.cn/laws/2005-07/25/content_16873.htm
http://en.wikipedia.org/wiki/Corruption_in_China
http://www.rrojasdatabank.info/borner/borner10.pdf

About the author

Andrew Tan: Head of Technology and Website Development. 2nd year Economist at St. John's College. Please e-mail me with any inquiries/issues regarding the website at itofficer@marshallsociety.com!

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