China’s immense promise will not be fulfilled, thanks to its government
I was recently asked the following question. Will China be the future engine of global economic growth? The answer is no. Almost every economic forecast predicts China’s economic growth in every area and places it in the forefront if not the top spot as a global economic superpower. However, every economic forecast at some point will be wrong and sadly China’s immense promise will not be fulfilled.
The reason is simple, China’s government. Its government and the communist party have no intention of giving up power. This is hardly surprising. What political party would voluntarily give up power? But political power is only part of the problem. The real problem is that the communist party does not want to give up economic power. China is still not a market economy. As long as the communist party remains in power, China will not be a market economy and that is why it will not fulfill its promise.
Let us start with something simple, information. Markets are about choice. To make a good choice, whether it is a car or an investment, requires good information. In China information is restricted and tightly controlled. The government believes that it understands the difference between important and dangerous information and that it always has access to both. It doesn’t.
Information has enormous value. It is not provided except for consideration or because there is an enforced legal requirement of disclosure. In societies with protected speech and free press, it is often difficult to cover up fraud, corruption, misdeeds, and even mistakes, because there is a market for their disclosure. In China and other restrictive societies the flow of information is severely regulated if not totally curbed. As a result everyone from investors to consumers and even bureaucrats do not have timely, accurate and complete information. The result is that investors make inefficient allocations of capital. Consumers buy poor sometimes even poisonous products and government officials make and execute ill-informed decisions. Over time the result of this information control can be disastrous.
The second problem is the banking system. In China almost the entire banking system is in the hands of the State. As we saw in the past year Chinese banks lent an amount equal to $1.4 trillion, which any sane economist would question. Much of this money was lent to local governments and other State-owned companies, all political entities. During this spree about 20% of the private export sector went under and another 20% was in danger of doing so. While inefficient State-owned companies were given more money than they knew what to do with, the more efficient private sector, which is responsible for much of the employment, was systematically starved for capital.
The result is two-fold. More of China’s economy has been transferred from the efficient private sector back into State hands. Economic development and economic growth is based on productivity growth. Productivity growth requires gains in the efficiency with which capital, labour and technology are used in an economy. More output from a given input. The Chinese banking system impedes productivity growth; because it has failed in its role as a financial intermediary by allocating capital inefficiently, while restrictions on information impede productivity growth through technological inefficiency. Restrictions also fail to provide a free exchange of ideas and protection for intellectual property.
The second problem is that much of the money lent by the banks will never be repaid. Many of the bad debts left over from the last recession are still on the books of the banks and listed as part of their capital. The bad loans from this recession are sure to be enormous.
Much of the money that was lent was lent to local governments. According to Victor Shih, a professor at Northwestern University the amount of bad loans could be as large as 11 trillion yuan, or about $1.6 trillion.
Toxic assets normally indicate the potential for a banking collapse followed by an explicit bailout often with taxpayer dollars. In China this does not happen, but it does not mean that growth will not be affected. As Professor Pettis of Guanghua University points out, a banking collapse will not happen in China because they are the result of a liquidity crisis. This does not mean that toxic assets will not affect growth. “The bailout implicitly requires that bank depositors subsidise the cleaning up of the banking industry. This in effect represents a large transfer of income from the household sector to the banks, to government and to businesses, equal annually to several percentage points.”
To continue growing China must either continue to export its surpluses or rebalance its economy in favor of consumers. It cannot do the former in a world awash with debt and it cannot do the latter with a system that favours banks, government and business over consumers.
In China power is wielded by the few without question or challenge. These few have and will continue to reap enormous benefit from the system they created and see no reason to change.
The government has stipulated stringent norms, as a result of which only persons with government experience, domain expertise, finance or academic backgrounds can join as IDs of PSUs
The government has now made it “practically impossible” for political appointees to find a place on the boards of public sector units (PSUs) as independent directors (IDs), a top official has said.
“Now, we have worked out a system by which it is practically impossible (for political nominees to join PSU boards as IDs),” secretary, department of public enterprises, Bhaskar Chatterjee told PTI.
He said that stringent norms have been stipulated, as a result of which only persons with government experience, domain expertise, finance or academic backgrounds can join as IDs of PSUs. “If you study the appointments of the past two years, you would not see a single case where a non-professional has been appointed as ID,” Mr Chatterjee said.
The presence of people (as IDs) with just political background has become “totally zero”, he said.
As per the norms, any unlisted company should have at least one-third of the directors on the board as ‘independent directors’.
A listed company headed by an executive chairman should have at least half of the directors as independent directors.
However, PSUs are facing shortages of IDs. “There is a shortage of more than 50% independent directors in the country,” said Mr Chatterjee.
As on March 2010, there are over 380 independent directors in PSUs, according to official estimates, Mr Chatterjee said. The department is “mulling changes” to reduce the time period for selection of IDs, he added.
A Tobin Tax is a tax on foreign currency transactions to discourage destabilising short-term inflows of international capital into a country
The Reserve Bank of India (RBI) governor D Subbarao has said that India is not contemplating imposing a Tobin Tax on capital inflows, but did not rule out introducing it later, reports PTI.
“Depending on what flows come in, we would employ measures, including if necessary something like a Tobin Tax,” Mr Subbarao said in response to a question after giving a speech at the Peterson Institute for International Economics, a Washington-based think-tank.
“At the moment, we are not contemplating one and I do not believe there is a need for one, but it is not off the table,” Mr Subbarao told the US think-tank.
Earlier in his prepared remarks, the RBI governor said: “The surge in capital flows into some emerging market economies (EMEs) even as the crisis is not yet fully behind us has seen the return of the familiar question—the advisability of imposing a Tobin-type tax on capital flows.
“Both before and after the crisis, there are examples of countries, notably Chile, Colombia, Brazil, and Malaysia that have experimented with a Tobin Tax or its variant.
“Even as there are some lessons to be drawn from the country experience, on the aggregate, it does not constitute a sufficient body of knowledge for drawing definitive conclusions,” he said.
Critics of the Tobin Tax—a tax on foreign currency transactions to discourage destabilising short-term international capital into a country—contend that the tax is ineffective, difficult to implement, easy to evade, and that its costs far exceed the potential benefits, and all this because financial markets always outsmart policymakers, he said.
Supporters of the tax argue that if designed and implemented well, the tax can be effective in smoothing flows and that evading controls is not such a straightforward option as efforts to evade require incurring additional costs to move funds in and out of a country, which is precisely what the tax aims to achieve, he observed.
“In India, given the overall thrust of policy, we are quite agnostic on the choice of different instruments. The stereotype view is that we have an express preference for quantity-based controls over price-based controls,” Mr Subbarao said.
“A critical examination of our policy will show that this view is mistaken. For example, on bonds we impose both a limit on the amount foreigners can invest as well as a withholding tax. Similarly, our policy on external commercial borrowing employs both price and quantity variables,” he said.
“We have not so far imposed a Tobin-type tax nor are we contemplating one. However, it needs reiterating that no policy instrument is clearly off the table and our choice of instruments will be determined by the context,” the RBI governor said.