Since the ascendancy of Hu Jintao to the top job in China, it is fair to say that Western observers have been disappointed with the reforms carried out so far. While there are a number of reasons for this, I believe that two specific issues and one historical one are tying Hu's hands.
The historical reason is easy to understand and can be encompassed in two words: Mikhail Gorbachev. As for the structural causes, the first is the banking problem that I mentioned before, August 3), while the second has much to do with today's geopolitical situation.
The reforms that I am concerned about are transformational economic reforms, mainly in the areas of industrial organizationand capital efficiency. I am not concerned about political reforms at this stage, believing instead that the general population will some point embrace the Taoist principles of self-preservation to overthrow the Confucian ethic that has been imposed on them, and which only the ruling elite hold dear.
It is fair to say that confidence in money, if not banking systems per se, has always been central to the functioning of any Chinese government. Throughout history, we have seen kingdoms fall when traders stopped extending credit to their sovereigns. One of the main reasons that Chinese traders used precious-metal ingots for many centuries was the lack of faith in paper money, ironical given that China invented the idea.
Banking, though, has been more of a modern invention. Until very recently, Chinese found the idea of depositing their savings with an unknown and, worse, unrelated person odd. This led to the use of banking-type institutions mainly by rich traders, and mainly for the purposes of settling transactions. It is no coincidence that today's bamboo networks across Asia center on very specific banks that were all formerly family-owned. This can be observed in Taiwan, in Hong Kong, in Singapore and across Southeast Asia.
The general public's confidence in banks is connected with confidence in their rulers. More than any occupying power and certainly more than the Kuomintang, China's communists have appreciated this, which is why they have approached the subject of banking reforms carefully. However, as I mentioned in my previous article on Chinese banks, the survival of any government in China depends its success in generating jobs.
The day that the millions of people thrown off from the agricultural labor force join hands with the hundreds of thousands left unemployed by China's privatizing the public sector must be the stuff of nightmares in the Zhongnanhai.
This is where the need to maintain public confidence in the banking system comes in conflict with the need to continue to maintain employment levels. While strong and successful banks would rather have little to do with moribund but employment-generating, state-owned enterprises, they have little option but to feed them credit. If they failed to do so, they would lose state backing and risk a run on deposits.
The government's approach to this problem has been to open up parts of the banking system to foreign ownership in preparation for a more complete opening by 2009 as required by World Trade Organization. To entice foreigners into owning shares in problem banks, the government in essence segregated bad assets into separate areas, leaving the shell of a profitable entity with good assets available for public ownership.
But the root causes of problem loans, namely the state's directing banks to lend money to unprofitable state-owned industrial organizations to maintain employment, have not been addressed, which is why today's good banks will be tomorrow's bad ones.
Why not more industrial reforms?
As I explained before, the average price charged by Chinese manufacturers on their exports has been falling, rather than rising in line with commodity prices and other cost factors, including labor and land. With few Chinese companies commanding brand recognition - notable exceptions being Lenovo and Haier - the bulk of Chinese production goes to own-brand products distributed from the likes of Wal-Mart. Unable to make profits on their exports, Chinese manufacturers have instead taken to making money speculating on property.
It stands to reason that American consumers purchasing cheap home appliances from Wal-Mart would like prices to stay fairly low - all the more as they are probably borrowing the money to pay for the purchases as well. Mass-market consumers in the US, who buy the bulk of Chinese exports, are in essence living on borrowed money.
Keeping them in the buying mood entails keeping interest rates low, which is why the Chinese government has been buying up so many US Treasury bonds in addition to all securitized bonds.
Leaving all that to one side, what would be the best circumstances for real industrial reforms? Clearly, this would require elimination of unprofitable capacity, creation of new product capacity and for existing capacity to become more profitable. The three conditions are inter-linked, since more profitable companies are the ones that will create new products.
They are the ones that will eventually employ the people thrown out of work by companies shutting down product lines rather than continuing to sell to Wal-Mart at prices below costs. Hence it is easy to surmise that raising prices will be the key element in China's succeeding in its industrial reforms. That is where the second part of the story plays a spoiler role.
Now think of World War III
I've already written about the challenging geopolitical situation. I hope readers won't accuse me of caring more about China's welfare than that of billions who will directly suffer from the conflict. However, I remain of the view that China and India will be the biggest strategic beneficiaries of a mutually destructive war between the West and Islam, even if such a benefit only unfolds over the long term.
Mounting tensions in the Middle East will cause oil prices to double, at the very least. Increased fears of terrorist incursions will keep consumers off the streets. To entice consumers back to shops, prices will either have to be very low even as borrowing costs remain negligible (which is affected by interest rates). Any way you look at it, China remains vulnerable.
There is an old saying that if you owe a million to the bank, you are in trouble, but if you owe the bank a hundred million, it is the one in trouble. The Chinese government is roughly in this position - its trillion-dollar holdings of foreign-currency reserves depend very much on these economies not encountering disastrous inflation.
It also needs Western economies to keep ticking on, because otherwise there would be no one to buy the billions of dollars' worth of exports being produced every day.
As I wrote before, China has little baggage to carry into any battle between the West and Islam, and will therefore align with whichever side suits its interests best. To keep the oil flowing in, and its exports of goods flowing out, China is constrained by being unable to participate in the hostilities. Instead, it will cooperate fully with the West to ensure that no weapons of mass destruction from the likes of Iran and Pakistan are delivered against the US and its allies.
Back to the reform question - the above are the reasons Hu Jintao and his comrades refuse to engage more aggressive reforms. The dangers of mis-timing are too great at this stage, and the benefits are long-term in any event.
Thus it is that reforms are the dog that did not bark in Hu's China, much like the canine character in the famous Sherlock Holmes story. It's a curious incident, but one that becomes understandable when you realize that some people love dogs, especially with black bean sauce.
Asia Times Online