RMB would likely decrease the trade deficit with China but not the overall deficit of the
United States. American importers would merely turn to other low-cost-labor countries to replace
no longer competitive Chinese exports. (China's $1 trillion of purchases since 2001 include
U.S. dollars and other currencies converted to dollars.)
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THE CHOICES THAT AWAIT CHINA
centration in the 1980s, when everyone was uniformly poor, the emergence
of a society in which income disparity is judged by the World Bank to be
greater than that in both the United States and Russia is truly astounding.
Another headache is the Chinese banking system, which to this day remains
a long way from being effectively reformed. Yet stock prices of Chinese
banks soared through 2006 and into 2007. The state-controlled Industrial
and Commercial Bank of China raised $22 billion in 2006, the largest-ever
initial public offering. Other state-controlled banks had large IPOs and
overseas listing of shares as well. But much of the rush into Chinese state-
controlled institutions reflects investors' presumption that the Chinese
government is in effect guaranteeing the liabilities of these banks. It has already
recapitalized the banks with $60 billion from China's huge foreign-
exchange reserves and in the process removed many of the banks' bad
loans. Chinese banks have historically financed a lot of politically useful investment,
but much of it is obviously serving no useful economic purpose.
Moreover, the still inchoate banking system does not afford the degree
of flexibility needed for economic adjustment. Market-based economies
are continuously slipping out of balance, but market-driven changes in interest
rates and exchange rates, along with product and asset price adjustments,
quickly rebalance them. The Chinese government does not allow
interest rates to float with supply and demand but changes them administratively
along with changes in reserve requirements of the banks—but
only after the evidence of economic imbalance is unambiguous. That is invariably
too late, and a good deal of the time the resulting moves are insufficient
or even counterproductive. Monetary officials give administrative
guidance to banks on loan growth when they perceive growth to be too large,
but again belatedly. These initiatives rarely properly address financial imbalances.
Ironically, the disconnect between finance in China and the rest
of the world insulated China from the financial crisis that spread around
the globe in 1997-98.
China is in dire need of financial expertise. No wonder, because people
with such expertise had little role to play under central planning. Neither
did business marketers, accountants, risk managers, or other experts so essential
to the day-to-day workings of a market economy. These skills have
3 07
THE AGE OF TURBULENCE
entered the Chinese education curriculum in recent years, but it will take
time before the economy especially the banking sector, becomes adequately
staffed. In December 2003; Liu Mingkang, the new chairman of the China
Banking Regulatory Commission, visited the Federal Reserve Board. He acknowledged
that Chinese banks lacked the professional expertise to judge
what enabled a loan to be repaid. Liu indicated that increasing the foreign
bank presence could help. I suggested that what China really needed was
people who had worked in a market economy and had the sharp eyes and
competitive judgment of able loan officers in the West. Much progress has
been made since, but much needs to be done.
Because finance has little role to play in central planning, Chinese banks
have not been banks as we know them in the West. Responding to political
directives, state-owned banks in years past transferred funds to pay for state-
initiated commitments. There were no bank loan officers to make loans that
would be expected to be repaid, just transfer agents. Bad debts in national
income accounting are part of the reconciliation between GDP, the presumed
market value of production, and employee compensation and profits,
the claims to that production. To the extent that there are a lot of bum
investments, part of the measured GDP is waste and of no value. Chinese
bad-debt levels raise the same questions about what the published Chinese
GDP numbers mean. However, I should point out that even investments
that turn out not to have any continuing value nonetheless consume raw
materials. Accordingly, the published levels of Chinese GDP are probably
reasonably useful in evaluating the resources needed for its production—
that is, as a measure of the value of needed input.
Even after adjusting for the questionable quality of some of China's
data, the results of the reforms that commenced in the late 1970s remain
truly remarkable. One needs only to observe the vast changes in Beijing,
Shanghai, and Shenzhen, and the lesser but still real changes in the rest of
the country, to conclude that China is anything but a Potemkin village.
In my experience, it has been the technocrats in the Chinese
government—mostly in the central bank, the finance ministry, and, surprisingly,
the regulatory agencies—who have pressed for market initiatives.
Most of them, however, serve only in advisory capacities. The key policy de
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THE CHOICES THAT AWAIT CHINA
cisions are made by the State Council and the Politburo, and it is to their
credit that they have largely embraced market-friendly advice. A remaining
critical hurdle, and one that threatens Communist Party rule at its core, is
its ideological challenge. Deng Xiaoping's goal of raising China to the status
of "intermediate developed country" by midcentury requires additional
reinforcement of property rights, even in the face of resistance from old-
guard Marxists.
There has been progress on rights to urban property. Rights to land in
the countryside, where 737 million Chinese reside, is another matter.
Granting property rights to farmland is too unambiguous a break with
Communist traditions to be countenanced easily. Farmers can lease land
and sell products in open markets, but they have no legal rights to the land
they till, and so cannot buy or sell it or use it as collateral for loans. In recent
decades, as urbanization has encroached on rural China, local authorities
have seized enormous expanses, granting as compensation only a small
fraction of what the land would be worth as part of an urban enclave. Such
seizures have been one of the main contributors to recent rising levels of
protests and unrest. A top Chinese police official reported that the number
of public protests nationwide rose to seventy-four thousand in 2004 from
ten thousand a decade earlier. Estimates for 2006 were somewhat lower.
Granting legal title to peasant land could, with the stroke of a pen, substantially
narrow the wealth gap between urban and rural residents.
While economic supremacy is at the heart of Party initiatives, the leadership
has other agendas, not the least of which is the status of Taiwan.
Many, perhaps most, of the leaders know that a military confrontation
would spook foreign capital investment and gravely damage the nation's
aspiration to build a world-class economy.
In sum, the Communist Party leadership is confronted with very difficult
choices. The track it is currently on will ultimately lead the Party to
abandon its philosophical roots and more officially embrace some form of
market capitalism. Does it then morph into a democratic socialist party, as
has occurred in many states of the former Soviet bloc? Does it acquiesce in
the political pluralism that is a likely consequence, thereby threatening the
Party's hegemony? Or does the Party abandon reform and revert to an or
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THE AGE OF TURBULENCE
thodox regime of central planning and authoritarianism, which would almost
surely undermine the prosperity on which the leadership depends for
legitimacy?
I have no doubt that the Communist Party of China can maintain an
authoritarian, quasi-capitalist, relatively prosperous regime for a time. But
without the political safety valve of the democratic process, I doubt the
long-term success of such a regime. How those choices evolve will have
profound implications not only for China but also for the world at large, an
issue to which I will return.
310
FIFTEEN
THE TIGERS AND
THE ELEPHANT
B
B
efore China reinvented itself as East Asia's eight-hundred-pound
economic gorilla, the nations nicknamed the "Asian Tigers" tested
and perfected the economic model China has chosen to pursue.
China's export-led explosion in economic growth has clearly followed the
earlier path of these Tigers—particularly Hong Kong, Taiwan, Korea, and
Singapore. Their model is simple and effective. The developing nation
opens up part or all of its economy to foreign investment to employ a low-
wage, but often educated, workforce. Sometimes it is politically easier to
set up designated geographic areas such as China's Special Economic Zones
to welcome foreign investment and its technology. Critical to this model is
that investors receive assurances that, if successful, they will be able to reap
the rewards. This requires that property rights be respected by the developing
country.
Given the devastation of Asia in World War II and the wars in Korea
and Vietnam, economic advance started from a very low base. Per capita
GDP of much of East Asia was not far above levels of subsistence. Major
progress was possible merely by bringing together protected investment
capital and low-cost labor. These were not free-market economies at the
THE AGE OF TURBULENCE
beginning. Forms of central planning and government ownership were
widespread. Korea, mimicking Japan, granted favored positions to large
business conglomerates [chaebol). Taiwan had significant government-
owned companies and, like the other Tigers, heavy trade protection of domestic
industry.
Most had charismatic but autocratic leaders. Singapore's Lee Kuan Yew
sparked the emergence of a small but world-class city; other autocrats, like
General Suharto, who ruled over Indonesia's system of crony capitalism,
were arguably less successful. Malaysia's prime minister Mahathir Mohamad,
still harboring resentments of his country's colonial past, was a very
forceful nationalist leader.
I have met, but cannot say I have gotten to know, many of these leaders.
Over the years, I have had the most contact with Lee Kuan Yew, most
recently in 2006, and have always found him impressive, even though we
do not always see eye to eye. I met him first when he was George Shultz's
guest at the famous (or infamous, depending on your perspective) Bohemian
Grove, a male-only bonding retreat among the redwoods of California.
[Time magazine once sent a woman disguised as a man to report on the
club's clandestine doings.)
When I visited Dr. Mahathir at Blair House (Washington's official guest
house for heads of state and other visiting dignitaries) in May 2002,1 found
him less fiery than I had expected. In fact, he appeared both thoughtful
and interesting so long as I put out of mind his jailing of Anwar Ibrahim,
Malaysia's finance minister and Mahathir's presumed political heir apparent.
Anwar was widely respected by those of us in leadership roles in international
finance. I suspect U.S. vice president Al Gore spoke for most of us
when, in 2000, he denounced "the show trial... [that] mocked international
standards of justice." At our most partisan, I cannot imagine such political
hardball being played in the United States.
When G7 finance ministers and central bank governors visited Thailand
in 1991 and were given a tour of the ornate palace, I kept looking for traces
of Anna Leonowens, the legendary nineteenth-century British schoolmarm
who was recruited to tutor the children of the king of the nation then known
as Siam. One of his descendants, King Bhumibol Adulyadej, has now reigned
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THE TIGERS AND THE ELEPHANT
for more than sixty years. I am particularly fascinated by the role the monarchy
plays in Thailand. King Bhumibol has murky legal authority but is
revered and apparently wields considerable moral authority. When a political
deadlock led to a military coup d'etat in September 2006, the king
smoothed the transition of government by appearing on television next to
the coup leader, army commander Sonthi Boonyaratglin.
The leaders of these authoritarian governments all had initial success
reviving their prostrate economies. The heavily subsidized and protected
industries of East Asia produced rising exports and improved standards of
living for their people into the 1970s. Despite the massive waste and inefficiencies
of planned or quasi-planned economies, many did achieve progress.
But the rigidities of economies jacketed by heavy intervention can carry
progress just so far. So to avoid stalling out, the Tigers of East Asia lowered
their barriers to foreign trade and, by the 1980s, were largely off the competition-
stifling subsidies to which much of the Asian economy, excluding
its export industries, was still addicted.
Export producers continued to compete effectively in international
markets, as productivity-enhancing technologies (borrowed from developed
countries) coupled with low wages created high rates of return.
Export-oriented companies in turn were required to raise wages to attract
the workforce they needed to fill their rapidly rising new orders, and domestic
industries, in response, had to bid their wages higher to hold on to
workers. Workers' standards of living in East Asia, as a consequence, moved
markedly higher.
The Tigers, in addition to exporting to developed countries by the
1980s, were soon trading with one another. Concentration on ever-narrower
