Saturday, November 29, 2014

The Global Stake in China’s Anti-Corruption Reform

STANFORD – The recent trial of Bo Xilai highlighted the biggest challenge facing contemporary China: the corruption and abuse of power by some government and party officials. Until his fall, Bo, a former Politburo member and party leader of Chongqing, a megacity of 30 million people, was a potential candidate for China’s ruling seven-member Politburo Standing Committee.

Bo’s trial occurred at what is a critical moment for China. Millions of rural Chinese annually flood into the country’s cities in search of employment; but China’s export-led growth, which previously masked the macroeconomic costs of corruption and excessive state intervention, is slowing. As China enters an era of more subdued growth amid increased competition from other low-cost countries, this damage will become increasingly apparent – and increasingly destructive.

An economically successful China is more likely to be stable and geopolitically constructive; a China beset by serious economic problems would be far less so, and, as the first-ever developing economy to become a global power, could even become a source of systemic risk. Chinese manufacturing assembly is integral to global supply chains for many products. Moreover, China is the largest holder of US Treasury securities (aside from the Federal Reserve), has significant euro holdings, is likely soon to become America’s largest trade partner, and looms large in trade with many European and Asian economies.

Research reveals that strong enforcement of property rights and stable, predictable, and non-confiscatory tax and regulatory regimes are essential to long-run economic prosperity. The key to China’s reform, and what the Chinese people want most, is John Adams’s “government of laws, not men” – even-handed administration of reasonable laws, not special favors for the connected few. Indeed, Finance Minister Lou Jiwei echoed Adams (and Adam Smith) when he proclaimed, “…resources should be allocated by prices and markets, not government officials.”

Chinese President Xi Jinping has said that a crackdown on corruption is a top priority, and that unless it reaches both “tigers” (higher-ups) and “flies” (lower-level officials), there may well not be another orderly leadership transition of the type that brought him to power earlier this year. Indeed, reducing corruption is essential if China is to join the small list of developing economies – Japan, South Korea, Singapore, Hong Kong, and Taiwan – that have escaped the “middle-income trap” that ensnares most developing countries and prevents them from attaining advanced-economy status. More than the unseemliness and capriciousness of many officials’ behavior, this is what is really at stake in Xi’s anti-corruption campaign.

China’s future prosperity requires restricting government officials’ administrative discretion, reducing state-owned enterprises’ power and subsidies, and strengthening the rule of law by developing an independent judiciary. But these reforms imply a change in culture and incentives. Some officials use their considerable discretion in granting licenses, permits, and contracts to solicit favors and side payments. The fortune accumulated by Bo’s wife (reliance on proxies, especially relatives, is a common tactic of corrupt officials everywhere) highlights the opportunities for the well connected to get ahead. Many Chinese, regarding this as just the way things are, behave accordingly.

To be sure, rent-seeking and favor-dispensing corruption exist to some degree everywhere; but they are more widespread in developing than developed countries and in resource-rich and/or centrally planned economies than in capitalist democracies. The time and other resources that individuals and firms devote to seeking government favors would be far more valuable if redirected to producing goods and services.

Some promising anti-corruption ideas have successful antecedents in Chinese history, from the Ming Dynasty to modern Hong Kong. Under the Ming Dynasty, the emperor’s officials came from other provinces and were frequently rotated. To protect China’s central bank from local political pressure, reformist Premier Zhu Rongji, on my and others’ advice in the 1990’s, reorganized the People’s Bank of China along regional lines, similar to the Federal Reserve’s district banks.

In Hong Kong, corruption was so pervasive as late as the 1970’s – if your house was on fire, the fire department demanded payment before pumping water! – that an independent anti-corruption commission was appointed specifically to investigate and prosecute both public and private corruption. Hong Kong greatly reduced corruption and improved administration with an amnesty, pay increases, and financial-disclosure requirements for officials.

China’s current leaders should revisit these precedents. A truly independent judiciary will take time to establish, but some judges can be appointed and paid by – and report to – the central government rather than local officials. And, as in Ming China, judges and other officials could be rotated every few years.

Likewise, as in Hong Kong, an amnesty could be granted, conditional on financial disclosure and a fine for “unexplainable wealth,” for all but the most egregious behavior, thereby leaving the past behind. At that point, judges’ and government officials’ pay could be raised to competitive levels, which would weaken the incentive to continue corrupt practices – particularly if officials must regularly file financial-disclosure statements and are penalized for withholding information.

The recent willingness of ordinary Chinese to condemn corruption publicly is a harbinger, one hopes, of real anti-corruption reforms from the country’s new leadership. An independent judiciary, financial disclosure by government officials, and other independent institutions have been essential to limiting and forestalling – though not fully eliminating – corruption in the United States and most other advanced capitalist democracies. That is a lesson that China needs to learn far more quickly than some members of its entrenched elite will find comfortable.

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    1. CommentedScott Wolfel

      Wen will they ever learn?

      I agree that Bo is intra-party politics because of the threat and hypocrisy of his vocal Neo-Maoist rhetoric, and the anti-corruption campaign will be used for public relations and an intra-party purge.

      As Forbes writes, "....the fact that over 90% of the 1,000 richest people tracked by the Hurun Report are either officials or members of the Chinese Communist Party (CCP) is a troubling sign." This is not a "bug," it's a feature of Chinese state capitalism.

      While Xi may be able to swap a lot of "flies," and even bag a few unpopular "tigers" like Bo, if he angers too many of the real tigers, he is certainly right that there won't be another orderly transition. Let's not forget that "A Thousand Flowers" led to the Cultural Revolution and this pattern is common throughout Chinese Imperial history. That said, anti-corruption below may actually institutionalize the Plutocracy above. As in America, you do not necessarily need corruption to tip the scales in favor of the ultra-wealthy.

      Even with a closed society and filtered Internet, most of what goes on in China is an open secret, although the people don't always get the story straight. Making a public show of cracking down on select corrupt officials is a way to shore up the legitimacy of the party as the economy slows. The CCP is terrified of discontent morphing into public protest against the CCP and is, and will, do anything to suppress this. The anti-corruption campaign is part of the "soft" strategy for letting off public steam, but this strategy could backfire when the corruption persists.

      Other than export-led growth, the other driver of the Chinese economic "miracle" has been infrastructure and real estate development at the local and provincial level, backed by increasing amounts of shadowy debt funneled through the state banks and shadow banking system, and I'm pretty sure Tony Soprano would fit in any Chinese city. With 1000 sq. ft. flats selling at 20-30 times median income, multiples of our housing bubble, this game is over.

      They still love Grandpa Wen (must not have gotten the memo) and Xi's popularity is higher than Barack's. While the long-term legitimacy of the party may be threatened from below, both by the "liberalism" economic development promotes and unrest when it slows, the Party still maintains a monopoly on the instruments of power, and if Xi pushes too hard, the appropriate template won't be the Boston Tea Party, but Shakespearean tragedies.

      The legitimacy of the CCP is inherently threatened from below and within. To the same extent that the Gutenberg Bible and the printing press, which was funded by nascent capitalism, the censored Internet and liberal forces unleashed by economic reforms represent an existential threat to the CCP. If Xi pushes too hard against the "tigers," the next move will be "The Empire Strikes Back."

      That said, judicial reforms and protection of private property will actually institutionalize the Plutocracy and the Wens will become the Rockefellers or Kochs or Gates or Zuckerbergs of China with permanent seats on the Standing Committee, but let's not forget that Glasnost led to Putin and the Russian oligarchs.

      The problem with making analogies to the American Revolution, and Madisonian democracy is that America was effectively a stateless society with a vibrant civil society rebelling against an Imperial Monarchy. As Edmund Burke and others have pointed out, populist revolutions under other conditions, with an existing state and privileged elites, usually end badly. China has an extremely powerful state that is indistinguishable from economic, among other, privileges, almost no civil society and thousands of years of oppressive history and culture, starting with sexism and filial piety in the family all the way up to grandpa Wen and Xi, that bode against the CCP losing power. In China, you say "older brother" and "younger brother" to reinforce the Neo-Confucian hierarchical orering of society all the way up to the "Emperor." The Communist Revolution was not a change of the Imperial order and Confucian bureaucracy, Mao was just the new Emperor with a new ideology. When Mao lost the "Mandate of Heaven" after the Great Leap Forward and state induced famine of the late 50s, we got the Cultural Revolution and then Deng, who had been purged by Mao in the Cultural Revolution, opened the door to capitalism, which re-legitimized the authoritarian system. Xi is attempting to patch the cracks in the state capitalist foundation, but there's no intent to relinguish state power and the bigger threat will come from his right flank than the left since there is no cultural or political basis for a populist democratic uprising in Chinese culture or history.

      While China may eventually move in the classic liberal direction of our founding fathers, the next move will come from the right. Judicial reforms and enhanced property rights will freeze the existing social structure and distribution of wealth and privelege as it has here.

        CommentedShoshon Tama-Sweet

        "there is no cultural or political basis for a populist democratic uprising in Chinese culture or history"

        1. How would you describe Tienanmen Square?
        2. There was no political basis for a populist democratic uprising in France in 1789, nor much of one in America in 1775, nor much precedent for the revolution in Russia of 1917. Old systems do give way to the new.
        3. Yes, the Chinese elites will hold onto their positions through every trick available, including hard power. But they also are smart enough to evolve, and let slow reform take place. the rule of law will come, not to eliminate the privileged, but to protect privileged.

    2. CommentedYoshimichi Moriyama

      Bo's trial is not so much as the fight against corruption and abuse of power as deadly intra-party politics among different factions.

      Officials were not sent to their home provinces and their salary was a pittance of money, but they were enormously rich when they left the provinces, having lived off the country.

      Prof. Boskin's ideas could be adopted but would be carried out only in accordance with Chinese cultural or DNA rules. Corrution or bribery is lubiricant of Chinese society.