Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise
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As a counterpoint to the Olympics and 2008, Deng Xiaoping, during his first, brief, political resurrection in 1974, led a large Chinese delegation to a special session of the United Nations. This was a huge step for China in lifting the self-imposed isolation that prevailed during the Cultural Revolution. Just before departing for New York, the entire central government, so the story goes, made a frantic search through all the banks in Beijing for funds to pay for the trip. The cupboard was bare: they could scrape together only US$38,000.1 This was to be the first time a supreme leader of China, virtually the Last Emperor, had visited America; if he couldn’t afford first-class international travel, just where was the money to support China’s economic development to come from?
How did it all happen, because it most certainly has happened? How were these brilliant achievements of only one generation paid for? And the corollary to this: what was the price paid? Understanding how China and its Communist Party has built its own version of capitalism is fundamental to understanding the role China will play in the global economy in the next few years. The overall economics of China’s current predicament is well understood by international economists, but the institutional arrangements underlying its politics and economics and their implications are far less understood. This book is about how institutions in China’s financial sector—its banks, local-government “financing platforms,” securities companies and corporations—affect the country’s economic choices and development path. Of course, behind these entities lies the Communist Party of China and the book necessarily talks about its role as well.
Prior to the Lehman shock of September 2008, the trajectory China’s financial development had been tracing generally followed a well-established path taken by more advanced economies elsewhere in the world. This approach was not easily adopted by a political elite that had been devastated by its own leaders for nearly 20 years and then suffered a further shock in 1989. The general story, however, has become the Great China Development Myth. It begins with the death of Mao in 1976 and the second restoration of Deng Xiaoping two years later. These events freed China to take part in the great financial liberalization that swept the world over the past quarter-century (see Figure 1.1). Looking back, there is no doubt that by the end of the 1980s, China saw the financial model embodied in the American Superhighway to Capital as its road to riches. It had seemed to work well for the Asian Tiger economies; why not for China as well? And so it has proven to be.
FIGURE 1.1 Thirty years of reform—trends in regulation
Source: Based on comments made by Peter Nolan, Copenhagen Business School, December 4, 2008
In the 1990s, China’s domestic reforms followed a path of deregulation blazed by the United States. In Shenzhen, in 1992, Deng Xiaoping resolutely expressed the view that capitalism wasn’t just for capitalists. His confidence caused the pace of reform to immediately quicken. China’s accession to the World Trade Organization in 2001 perhaps represented the crowning achievement in the unprecedented 13-year run of the Jiang Zemin/Zhu Rongji partnership. When had China’s economy ever before been run by its internationalist elite from the great City of Shanghai? Then, in 2003, the new Fourth Generation leaders were ushered in and things began to change. There was a feeling that too few people had gotten too rich too fast. While this may be true, the policy adjustments made have begun to endanger the earlier achievements and have had a significant impact on the government itself. The new leadership’s political predisposition, combined with a weak grasp of finance and economics, has led to change through incremental political compromise that has pushed economic reform far from its original path. This policy drift has been hidden by a booming economy and almost-continuous bread and circuses—the Olympics, the Big Parade, the Shanghai World Expo and Guangzhou’s Asian Games.
The framework of China’s current financial system was set in the early 1990s by Jiang and Zhu. The best symbols of its direction are the Shanghai and Shenzhen stock exchanges, both established in the last days of 1990. Who could ever have thought in the dark days of 1989 that China would roll out the entire panoply of capitalism over the ensuing 10 years? In 1994, various laws were passed that created the basis for an independent central bank and set the biggest state banks—Bank of China (BOC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC)—on a path to become fully commercialized or, at least, more independent in their risk judgments and with strengthened balance sheets that did not put the economic and political systems at risk.
Reform was strengthened as a result of the lessons learned from the Asian Financial Crisis (AFC) in late 1997. Zhu Rongji, then premier, seized the moment to push a thorough recapitalization and repositioning of banks that the world at the time rightly viewed as more than “technically” bankrupt. He and a team led by Zhou Xiaochuan, then Chairman and CEO of the China Construction Bank, adopted a well-used international technique to thoroughly restructure their balance sheets. Similar to the Resolution Trust Corporation of the US savings-and-loan experience, Zhou advocated the creation of four “bad” banks, one for each of the Big 4 state banks. In 2000 and again in 2003, the government stripped out a total of over US$400 billion in bad loans from bank balance sheets and transferred them to the bad banks. It then recapitalized each bank, and attracted premier global financial institutions as strategic partners. On this solid base, the banks then raised over US$40 billion in new capital by listing their shares in Hong Kong and Shanghai in 2005 and 2006. The process had taken years of determined effort. Without doubt, the triumphant listings of BOC, CCB, and ICBC marked the peak of financial reform, and it seemed for a brief moment that China’s banks were on their way to becoming true banking powerhouses that, over time, would compete with the HSBCs and Citibanks of the world.
China at last acceded to the World Trade Organization (WTO) in late 2001 after 15 years of difficult negotiations. Zhu saw membership of the WTO as the guarantee of an unalterable international orientation for a China that in the past had too frequently been given to cycles of isolationism. He believed that the WTO would provide the transformational engine for economic and, to a certain extent, political modernization regardless of who controlled the government. His enthusiasm for engagement with the world paid off as trade with China turned white hot in the years that followed (see Figure 1.2).
FIGURE 1.2 Trends in imports, exports and total trade, 1999–2007
Source: China Statistical Yearbook 2008
It was not just trade; foreign direct investment also poured in, jumping to unheard-of levels of US$60 billion a year and peaking at over US$92 billion in 2008 as the world’s corporations committed their manufacturing operations to the Chinese market (see Figure 1.3). Chairmen in boardrooms everywhere believed with Zhu Rongji that China was on a path of economic liberalization that was irreversible.
FIGURE 1.3 Committed foreign direct investment, 1979–2008
Source: China Statistical Yearbook 2009
The commitment of these foreign businessmen was not simply a function of belief. In the early years of the twenty-first century, China’s market opened up as it never had before. At the start of economic liberalization in the 1980s, foreign investors had been forced to contend with the practical consequences of the famous “Bird Cage” theory. Trapped in designated economic zones along the eastern seaboard, just as they had been in the Treaty Ports of the Qing Dynasty a hundred years earlier, foreign companies were forced into inefficient joint ventures with unwanted Chinese partners. Then every local government wanted its own zone and its own foreign birds, so that during the 1990s, economic zones proliferated across the country and were eventually no longer “special.” Despite this, even as late as 2000, the joint-venture format accounted for over 50 percent of all foreign-invested corporate structures. After China’s accession to the WTO, this changed rapidly. It seemed that China was open for business after all: by 2008, nearly 80 percent of all foreign investment assumed a wholly-owned enterpri
se structure (see Table 1.1). At long last, the Treaty Port system seemed a thing of the past, as foreign companies had the choice of where and how to invest.
TABLE 1.1 FDI by investment-vehicle structure, 2000–2008
Source: US-China Business Council; as a percent of total utilized FDI
Over the past few years, they have undeniably committed their technologies and management techniques and learned how to work with China’s talented workers to build a world-beating job-creation and export machine. But they have done this in only two areas of China: Guangdong and the Yangzi River Delta comprising Shanghai and southern Jiangsu Province (see Figure 1.4). The economies of these two regions are dominated by foreign-invested and private (waizi and minying ) companies; there is virtually no state sector remaining. These areas consistently attract 70 percent of total foreign direct investment and contribute over 70 percent of China’s exports. They are the machine that has created the huge foreign-exchange reserves for Beijing and they have changed the face of these two regions. It is highly ironic that the old Treaty Ports, which once symbolized its weakness and subservience to foreign colonizers, are now the source of China’s rise as a global manufacturing and trading power, becoming in the process the most vibrant and exciting parts of the country and, indeed, of all Asia.
FIGURE 1.4 US$818 billion accumulated FDI by province, 1993–2008
Source: China Statistical Yearbook, various
China’s economic geography is not simply based on geography. There is a parallel economy that is geographic as well as politically strategic. This is commonly referred to as the economy “inside the system” (tizhinei ) and, from the Communist Party’s viewpoint, it is the real political economy. All of the state’s financial, material and human resources, including the policies that have opened the country to foreign investment, have been and continue to be directed at the “system.” Improving and strengthening it has been the goal of every reform effort undertaken by the Party since 1978. It must be remembered that the efforts of Zhu Rongji, perhaps China’s greatest reformer, were aimed at strengthening the economy “inside the system,” not changing it. In this sense, he is China’s Mikhail Gorbachev; he believed in the system’s capacity for change as well as the dire need for its reform. Nothing Zhu undertook was ever intended to weaken the state or the Party.
Understood in this context, the foreign and non-state sectors will be supported only as long as they are critical as a source of jobs (and hence, the all-important household savings), technology and foreign exchange. The resemblance of today’s commercial sector in China, both foreign and local, to that of merchants in traditional, Confucian China is marked: it is there to be used tactically by the Party and is not allowed to play a dominant role.
THIRTEEN YEARS OF REFORM: 1992–2005
Foreign investment has enriched certain localities and their populace beyond recognition, but foreign financial services have done far more on behalf of the Party and its system. It is not an exaggeration to say that Goldman Sachs and Morgan Stanley made China’s state-owned corporate sector what it is today. Without their financial know-how, SOEs would long since have lapsed into obscurity, out-competed by China’s entrepreneurs, as they were in the 1980s. In the 1980s, who could have named a single Chinese company other than Beijing Jeep, a joint venture, and, maybe, Tsingtao Beer, a brand from the colonial past? In Shenzhen, there is a huge billboard with a portrait of Deng Xiaoping located on the spot where he made his famous comments during his historic “Southern Excursion” of January 1992. If Deng had not said that capitalist tools would work in socialist hands, who knows where China would be today? His words provided the political cover for all others who, like Zhu Rongji, wanted China’s “system” to move forward into the world.
In early 1993, Zhu took the first big step forward when he accepted the suggestion of the chief executive of the Hong Kong Stock Exchange to open the door for selected SOEs to list on overseas stock markets. He knew and supported the idea that Chinese SOEs would have to undergo restructuring in line with international legal, accounting and financial requirements to achieve their listings. He hoped that foreign regulatory oversight would have a positive effect on their management performance. His expectations in many ways were met. After several years of experimentation, companies began to emerge with true economies of scale for the first time in China’s 5,000-year history.
Where did such Fortune Global 500 heavy-hitters as Sinopec, PetroChina, China Mobile and Industrial and Commercial Bank of China come from? The answer is simple: American investment bankers created China Mobile out of a poorly managed assortment of provincial post and telecom entities and sold the package to international fund managers as a national telecommunications giant. In October 1997, as the Asian Financial Crisis was gathering momentum, China Mobile completed a dual listing on the New York and Hong Kong stock exchanges, raising US$4.2 billion. There was no looking back as China’s oil companies, banks and insurance companies sold billions of US dollars of shares in initial public offerings (IPOs) that went off like strings of firecrackers in the global capital markets. All of these companies were imagined up, created and listed by American investment bankers.
To symbolize this transformation, the government planned a new target. After China Mobile’s successful IPO, Beijing sought as a matter of policy to place as many Chinese companies on the Fortune Global 500 list as possible. With the willing help of international investment banks, lawyers, and accounting firms, China has more than achieved this goal. The country is now proudly represented by 44 companies on the list (see Table 1.2). Among these companies are five banks, including ICBC, which ranked eighty-seventh by total revenues (as compared to twenty-fifth for JPMorgan Chase). Sinopec and the huge State Grid Corporation ranked seventh and eighth, respectively. The “National Team” was born.
TABLE 1.2 Chinese companies in the Fortune Global 500, FY2009
Source: Fortune, July 26, 2010
Rank Company Revenues (US$ million)
7 Sinopec 187,518
8 State Grid 184,496
10 China National Petroleum 165,496
77 China Mobile Communications 71,749
87 Industrial & Commercial Bank of China 69,295
116 China Construction Bank 58,361
118 China Life Insurance 57,019
133 China Railway Construction 52,044
137 China Railway Group 50,704
141 Agricultural Bank of China 49,742
143 Bank of China 49,682
156 China Southern Power Grid 45,735
182 Dongfeng Motors 39,402
187 China State Construction Engineering 38,117
203 Sinochem Group 35,577
204 China Telecommunications 35,557
223 Shanghai Automotive 33,629
224 China Communications Construction 33,465
242 Noble Group 31,183
252 China National Offshore Oil 30,680
254 CITIC Group 30,605
258 China FAW Group 30,237
275 China South Industries Group 28,757
276 Baosteel Group 28,591
312 COFCO 26,098
313 China Huaneng Group 26,019
314 Hebei Iron & Steel Group 25,924
315 China Metallurgical Group 25,868
330 Aviation Industry Corporation of China 25,189
332 China Minmetals 24,956
348 China North Industries Group 24,150
352 Sinosteel 24,014
356 Shenhua Group 23,605
368 China United Network Communications 23,183
371 People’s Insurance Company of China 23,116
383 Ping An Insurance 22,374
395 China Resources 21,902
397 Huawei Technologies 21,821
412 China Datang Group 21,460
415 Jiangsu Shagang Group 21,419
428 Wuhan Iron & Steel 20,543
436 Aluminum Corporation of China 19,851
440 Bank of Communications 19,568
4
77 China Guodian 17,871
At the start of the 1990s, all Chinese companies had been unformed state-owned enterprises; by the end of the decade, hundreds were listed companies on the Hong Kong, New York, London and Shanghai stock exchanges. In those few short years, bankers, lawyers and accountants had restructured those of the old SOEs that could be restructured into something resembling modern corporations, then sold and listed their shares. In short, China’s Fortune Global 500 companies were the products of Wall Street; even China’s own locally listed version of investment banking, represented by CITIC Securities with a market capitalization of US$26 billion, was built after the American investment-banking model.
China’s capital markets, including Hong Kong, are now home to the largest IPOs and are the envy of investment bankers and issuers the world over. With a total market capitalization of RMB24.5 trillion (US$3.6 trillion) and more than 1,800 listed companies, the Shanghai and Shenzhen exchanges have, in the last 10 years, come to rival all exchanges in Asia, including the Tokyo Exchange (see Figure 1.5). If the Hong Kong Stock Exchange is considered Chinese—and it should be, since Chinese companies constitute 48.1 percent2 of its market capitalization—then China over the past 15 years has given rise to the second-largest equity-capital market in the world after New York. From 1993, when IPOs began, to early 2010, Chinese SOEs have raised US$389 billion on domestic exchanges and a further US$262 billion on international markets, adding a total of US$651 billion in capital to the US$818 billion contributed by foreign direct investment. Considering that China’s GDP in 1985 was US$306 billion, only US$971 billion in 1999 and US$4.9 trillion in 2009, this was big money.