Raghuram Rajan on the China model: repressed households, party control and crony competition

What worked for foreign direct investment also worked for local private investment, especially construction and real estate, which employed many unskilled workers and had the collateral benefit of creating infrastructure. The key input here was cheap credit, land, and permissions, all of which the mayor could secure. Land, especially farmland, could simply be expropriated from the current occupier for little compensation, especially since all land technically belonged to the state. The expropriated land could then be turned over to the real-estate developer, sometimes at a significant markup that added to the coffers of the city government.

Such actions became increasingly necessary as the central government started retaining most of the tax revenues in the early 1990s, forcing city and provincial governments to become entrepreneurial in raising money. Invariably, some of the funds generated from such legally murky actions also went to bolster the personal income of the party officials as compensation for their “entrepreneurship”.

Corruption was not the only motivator. Many party bosses showed keen interest in such investment because economic growth in their region was an important consideration for their promotion up the party hierarchy. Others did so because the local government obtained shares in the start-up, which gave it a continuing stake in the company’s growth.

At any rate, the onerous rules and regulations as well as the relatively murky property rights were an important obstacle to any ordinary person setting up business, but were not a problem for those with party connections. The party thus fostered private enterprise while keeping control over who was allowed to open businesses or expand.

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The Repressed Household

The subsidised inputs to corporations had to be paid for by someone – that was the ordinary householder. Given her productivity, not only were her wages lower than they would have been in a more developed economy (as in many developing countries, they were held down by massive surplus labour in agriculture), her taxes paid for the other subsidies granted to the corporate sector, she paid the high prices charged by local monopolists, and she re- ceived low interest rates on her deposits (the government capped the rates payable on deposits at a low level, in order to allow banks to profitably make cheap loans to corporations and developers).

Even while the household received miserable returns on its deposited savings, the government had taken away its promise of a safe job and guaranteed pension. Chinese labour unions did not really fight for worker wages or rights, except when signaled to do so by the government – they were essen- tially there to control and channel worker dissatisfaction. Furthermore, in 1979, China’s one-child policy effectively mandated a maximum of one child per couple. It resulted in six adults – four grandparents and two parents – depending on that one child for support in their old age, if they did not have savings of their own.

The household had further challenges. Its most important property – the house and the land it stood on – was insecure, as we have already seen. Also, industrial growth, as well as the blind eye that was turned to violations of regulations, polluted the air people breathed, the water they drank, and the food they ate. China was becoming the workshop to the world, but its people were paying for it with a deteriorating quality of life as the country drew in the dirty factories and power plants that were closing everywhere else.

China therefore followed a unique growth path. Ordinary households bore a burden that would not have been possible in a more democratic environment. There were important compensations. Because the system generated very modern infrastructure and investment rapidly, the economy grew fast. Many new jobs were created, and the productivity of existing jobs increased quickly. So average wages grew fast, even though they were lower than the additional value each worker created. China was growing rich quickly, so it was easy to ignore the distortions.

Nevertheless, a large share of the income generated in the country ended up as savings rather than final consumption by the households – partly because it was locked up as corporate profits of state-owned corporations that were not paid out but reinvested and partly because households saved more, worried about the removal of the safety net and the insecurity of property. Chinese private consumption to GDP fell from about 50 per cent in 1990 to about 47 per cent in 2000. In the next decade, when China grew very fast, consumption fell further to a meager 35.5 per cent of income in 2010.

The Chinese household paid a price for the jobs that growth generated, but the growth was spectacular. Hundreds of millions of Chinese have been lifted from poverty into relatively comfortable middle-class lives since the reforms started.

Party Control and Crony Competition

The party therefore facilitated growth, not by opening access to all but by using its good offices to clear the path for select business. At the same time, it tightened its political control. A 2005 white paper by the party defined democratic government as “the Chinese Communist Party governing on behalf of the people”. This meant more than single-party rule, it meant extending the party’s tentacles more directly into business.

Every large state-owned enterprise had a party cell, with the party boss often a more powerful figure than the company CEO.13 The party decided overall strategy and senior appointments in the company. This ensured the party had firm control of the state-owned enterprises, and their enormous funds. Of course, this also enabled party members to do favours for one another, including appointing one another’s children to cozy jobs.

Membership in the party was increasingly the route to success in China. Private-sector firms soon read the writing on the wall and created their own cells. In the internationally known consumer electronics and home appliances product company Haier, its CEO also served as the secretary of the company’s Communist Party committee. The party made it clear that it wanted both information and the ability to intervene in every organisation that might be a possible threat to its political monopoly. The private sector complied.

Such strong political control over business, without a vocal public com- munity that can enforce separation between the state and business, raises concerns about inefficient crony capitalism and possible authoritarianism... Has China been special in avoiding these ills? In a sense it has...thus far...

As political scientist Daniel Bell argues, the Chinese Communist Party is in many ways a meritocracy, which trains and tests its members in the practice of governance. Each of the nine members of the Standing Committee of the Politburo, the apex body of the party, has come up the hierarchy after proving themselves in regional or city governments.

With an important element of their performance appraisal being how much they grew the local economy, local party bosses were ferocious in attracting potential investors to their locality, facilitating the set-up and growth of local firms, and protecting them against authorities elsewhere including at the centre. Chang-Tai Hsieh points out that many of the big cities in China have taxis of only one make – the make produced by the automobile joint venture of the city government. By forcing local taxi owners to buy the favoured brand, the local authorities support their local champion.

So there is extensive cronyism within a locality. Moreover, the subsidies to firms in a locality can keep them alive even if they destroy economic value. Also, the party has favourites at the national level, including some very large state-owned firms that monopolise the national market. Therefore, it is hard to call China a fully competitive market.

Ferocious business competition is, however, sustained between the champions of the myriad localities. Competitive cronyism is probably a more appropriate term for Chinese practice. It has worked thus far. Does China have the right system for continued growth, though? To answer that, we have to understand the post–financial crisis change in China’s model of growth.