China mustn't shy away from bank­rupt­cies

The Pak Banker - - OPINION - Christo­pher Bald­ing

ECO­NOMIC re­forms are much like New Year's diet res­o­lu­tions: eas­ily an­nounced and eas­ily for­got­ten. So per­haps it shouldn't be sur­pris­ing that the pro­nounce­ments that have emerged from China's Na­tional Peo­ple's Congress - pledges to slash over­ca­pac­ity, open up the fi­nan­cial sys­tem, ac­cept lower growth - echo un­ful­filled prom­ises from pre­vi­ous Party gath­er­ings.

Still, China prides it­self on be­ing dif­fer­ent. The coun­try can seem­ingly cre­ate new in­dus­tries overnight, and has waged an an­ticor­rup­tion cam­paign that re­port­edly pun­ished 300,000 of­fi­cials in 2015. Why does a state that holds so much power have so much trou­ble fol­low­ing through on its re­form pledges? Part of the an­swer is per­cep­tion. Ob­servers tend to hear more than is in­tended in China's dec­la­ra­tions. This year, for in­stance, many pun­dits have wel­comed the shift from a hard GDP growth tar­get to a sup­pos­edly more re­al­is­tic range - be­tween 6.5-7 per cent.

The real growth rate is al­most cer­tainly lower than that al­ready, how­ever. The num­bers them­selves tell us lit­tle: Since 2010, the govern­ment has missed its tar­get by only 0.16 per cent on av­er­age ev­ery quar­ter. We should ex­pect sim­i­larly un­be­liev­able con­sis­tency this year, re­gard­less of what's hap­pen­ing in the econ­omy.

In other cases, Chi­nese of­fi­cials pur­sue re­forms in ways that ac­tu­ally re­in­force the sta­tus quo. To stim­u­late con­sump­tion and thus re­duce the econ­omy's re­liance on cred­it­fu­elled in­vest­ment, the govern­ment plans to in­crease in­vest­ment this year - in part to keep work­ers at fail­ing state com­pa­nies em­ployed.

Au­thor­i­ties say they also want to sup­port com­pa­nies in more vi­brant emerg­ing in­dus- tries with tax cuts. But they plan to make up for the loss in rev­enue by is­su­ing new bonds, thus giv­ing lo­cal gov­ern­ments more re­sources to cod­dle so-called zom­bie com­pa­nies.

The con­tra­dic­tions be­come clear in the way Chi­nese of­fi­cials talk about re­form. Re­spected cen­tral banker Zhou Xiaochuan was quoted as say­ing, "Be­cause our coun­try is mov­ing from a cen­trally planned econ­omy to a mar­ket econ­omy the govern­ment should play a big­ger and bet­ter role."

The regime's fo­cus on con­trol gives the im­pres­sion that au­thor­i­ties can mi­cro­man­age most parts of the econ­omy. In fact, China's cen­tral govern­ment has less sway than one might imag­ine over lo­cal gov­ern­ments, and not just be­cause of the vast dis­tances in­volved.

Lo­cal of­fi­cials are re­spon­si­ble for around 85 per cent of govern­ment spend­ing. Though cen­tral au­thor­i­ties do con­trol roughly 40 per cent of the rev­enue lo­cal gov­ern­ments re­ceive, Bei­jing of­fi­cials mostly have to rely on the bully pul­pit, ap­peals to party unity and the threat of cor­rup­tion in­ves­ti­ga­tions to get their pri­or­i­ties im­ple­mented.

Per­haps more im­por­tant are the cul­tural bar­ri­ers to re­form. Within the bu­reau­cracy, there's lit­tle re­ward for over­see­ing fail­ure. Top of­fi­cials may say they want to slash the over­ca­pac­ity that's drag­ging down the econ­omy, but sub­or­di­nates know the best way to get ahead is by meet­ing growth tar­gets.

Provinces that de­pend on steel, ship­build­ing and coal com­pa­nies for pub­lic rev­enue are al­ready push­ing back against plans to shrink those in­dus­tries. En­trepreneurs don't want to ad­mit fail­ure any more than of­fi­cials do.

Even in good years, the US econ­omy sees some­thing in the range of 50,000 bank­rupt­cies an­nu­ally. China had barely 41,000 in the decade be­tween 2003 and 2012, ac­cord­ing to one study. Such num­bers hardly sug­gest a sys­tem that ac­tively ad­dresses prob­lems.

None of this means that the govern­ment is pow­er­less. Lead­ers can take a num­ber of steps, both tech­ni­cal and cul­tural, to en­sure re­forms gain more trac­tion. First, they can do a bet­ter job of cre­at­ing in­cen­tives for cadres to fol­low through. Rather than de­mand­ing that lo­cal of­fi­cials pro­vide video ev­i­dence that they've shut down un­prof­itable fac­to­ries, for in­stance, cen­tral lead­ers can base pro­mo­tions in part on re­duc­ing over­ca­pac­ity. Sim­i­larly, the govern­ment could re­ward re­form­ers who seek to high­light key prob­lems, such as pol­lu­tion, rather than try­ing to si­lence them. If the only av­enue for suc­cess or ad­vance­ment is to agree with a su­pe­rior, bu­reau­crats will only im­part the in­for­ma­tion their bosses want to hear.

Fi­nally, China is go­ing to have to en­cour­age more mar­ket-based risk-tak­ing. If au­thor­i­ties want Chi­nese com­pa­nies to in­no­vate, they have to tol­er­ate some spec­tac­u­lar fail­ures along with re­sound­ing suc­cesses.

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