ECONOMIC DEVELOPMENT IN CHINA

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ECONOMIC DEVELOPMENT IN CHINA EAST ASIA
LESSONS FOR INDIALeslie YoungProfessor of
FinanceExecutive Director, Asia Pacific
Institute of BusinessThe Chinese University of
Hong Kong
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Macro Comparisons
Russia China India
GDP/head (US) 2003 2730 1070 507
GDP/head (US) 2001 2740 790 450
Average GDP Growth 90-99 () -6.1 11.6 6.0
Average Inflation 91-00 () 166.4 7.2 9.0
Literacy () 99.0 82.9 53.5
Female Life Expectancy 72.5 73.5 64.6
Male Life Expectancy 60.0 69.1 63.6
Births per 1000 8.5 14.3 23.7
Deaths per 1000 15.3 7.0 8.4
Pop Growth 95-00 () -0.36 0.90 1.69
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Geopolitics
India China
Afghanistan/Central Asia developed military skills but racially/ culturally distinct. Repeated conquest only implanted temporary, distinct, extractive elite Wei River Valley land within the passes developed military skills but not racially/ culturally distinct Conquered Yellow River Valley Chou and Qin dynasties
Ganges Valley not large enough to dominate South. Some internal barriers but not enough for secure states Yellow River Valley dominated South Few internal barriers
Extension of culture by conquest. Culture integrated population that remained stratified and diverse. No political tradition of unified empire Steady southward expansion of Chinese civilization, assimilation of racially similar populations Homogenous population, cultural unity, political unity
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Geography and Political Norms
India China
Ganges Valley is worlds largest, deepest alluvium bed Ganges has many tributaries, hence alternative sources of water. River control important but not critical Yellow River has no tributaries below Wei Valley. Break in dikes causes massive disruption of irrigation systems Dike maintenance metered corruption
Can support dense population with light management Yellow River valley requires intensive management and organization to support dense population
Change of rule by external conquest. New rulers required no justification Change of rule by internal revolt New dynasty had to justify rule
Extractive elite Responsible authoritarians justifying rule by performance Mandate of Heaven
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Spiritual Framework
India China
Deep oral culture gt Self as universe Tolerant, inclusive, multifarious religion Alphabetic culture gt transcendental thought/religion Tension between oral and written gt Enlightenment Logographic writing Analogical/Immanental thought Taoism gt quietism, laissez faire Confucianism gt social ethics Legalism gt ruthless state control, rule by law
Philosophical/intellectual depth and creativity. Detached, introspective elite No duty to provide practical leadership Stable literary culture restricted creativity and change. Duty to provide practical leadership
Concept of enlightenment exported to China via Buddhism Interpreted Buddhist enlightenment as breakthrough to understanding structure immanent in world (Zen)
Japan used Chinese logographs to write agglutinative language. Constant tension between transcendental and immanental attitudes. Welcomed Zen. First non-western modernization. Unique institutional/organizational creativity Japan used Chinese logographs to write agglutinative language. Constant tension between transcendental and immanental attitudes. Welcomed Zen. First non-western modernization. Unique institutional/organizational creativity
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Institutional Structure
India China
Distinct castes of priests and warriors Brahmins monopolized ritual but validated rather than constrained power No ideology unifying the culture area No unified civil service Viceroys broke away at first opportunity Unitary elite class of scholar/ gentry/administrators open to recruitment from homogenous population by examination. Principled critics of emperors Viceroys circulated around empire to disrupt personal power bases
Indo-Aryan languages spoken by 65 Many scripts Putonghua spoken by 85 Universal written language
Periodic attempts at unification never completely successful or long-lasting Attempts to capture wealth of Deccan let in more invaders from North Political unity the norm Empire stable and secure when unified
Multiple regimes Short-lived dynasties Unified dynasties typically lasted about 350 years
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Peripheral States
India China
Exported culture to Ceylon, Southeast Asia Exported culture to Korea, Japan, Taiwan, Vietnam
Indian emigrants successful in business but insufficient numbers to transform overseas economies Massive 19th Century emigration to Southeast Asia Overseas Chinese developed business skills and networks
Peripheral states failed to provide alternative models for India. After WWII, peripheral East Asian economies dominated by Overseas Chinese followed Japan in export-led growth
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Alternative Modernizations
India West East Asia
Democracy integrates diverse peoples Democracy legitimized redistribution of economic power Authoritarians earn legitimacy by improving livelihoods
Bureaucracy of rent seekers Rule of Law, politically manipulated by lobbies Meritocratic civil service Insulated from lobbies
Multi-generational lawsuits withdraws disputed property from use Law of Contract Objective enforcement and regulation Business networks and extended family relationships substituted for contract Regulators not independent
Import substitution Black economy Market driven economy Export led growth Concept of laissez faire native to China from Taoism
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Mainland Modernizations
India China
Colonial period reconfigured institutions, property rights West introduced industrialization but affected only the Treaty Ports.
Assimilated Fabian Socialism at Liberation Converted to Marxism by revolution
Stable democracy maintained modest growth. Upheavals of Great Leap Forward and Cultural Revolution decimated Communist Party, led to crisis of legitimacy
No alternative models from Overseas Indian economies Mauritius too small Success of Overseas Chinese economies challenged mainland
Some experimentation amongst states. NRIs discouraged by bureaucracy from investment Experiments in Special Economic Zones and coastal provinces relaxed bureaucracy Overseas Chinese provided capital, entrepreneurship skills
Rent-seeking interest groups cripple economic efficiency. Bureaucrats impede growth Growth leadership brings bureaucratic promotions and share in profits
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Mainland Modernizations
India China
Polity divided by class, caste, language/region, religion Homogenous population
Democracy gave each group a voice and a veto over policy changes Authoritarian government divided into factions, but few differences in policy
Economic reforms often disrupted by unrelated events and agendas Consensus forced by need to keep power that is not legitimized by democracy
Democratic leaders overloaded by problems of managing diverse coalitions Leadership divided into political managers and economic managers but integrated at the top in Standing Committee and Politburo
Elections introduce unpredictable element into policy execution. Leads to foot dragging Turnover of leaders managed by having top leader appoint the next leader but one. Reputation for fairness and integrity a strong plus.
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Reforming Socialism
Capitalism with Russian Characteristics Socialism with Chinese Characteristics
No Overseas Russians Overnight promulgation of Anglo-Saxon formal rules without supporting institutions. Overnight formal democracy, collapse of Party leaves no-one to enforce laws. Overseas Chinese provide entrepreneurship Evolution from state to collective enterprises Contract enforcement via tacit relationships (guanxi) and through conglomerates of political units. Cross-holdings by political conglomerates control agency problems, limit free riding
Wholesale expropriation of state assets, transfer to offshore havens. Financial and economic collapse. Large-scale corruption, but basic order and political control maintained. Capital account kept closed. Strong economic growth
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Socialism with Chinese Characteristics

• Collective (township and village) enterprises.
• State owns land, natural resources, key
  industries and financial institutions
• State holds shares in many other industries and
  institutions. Blocks Russian-style expropriation
  of state assets.
• Entrepreneurship by Overseas Chinese and by
  investment trusts spun off by many centres of
  political power local governments, ministries
• Extensive cross-holdings by central government,
  local government and collectives. Gives political
  leaders leverage over business performance.
• Peoples Liberation Army owns Hong Kong taxi
  company and rents artillery for recreational
  shooting outside Guangzhou.
• All governmental units participate in growth and
  rewards through tax-sharing formulae that allow
  them to keep a share of revenue collected.
• Political competition within elite channeled into
  competition in economic performance

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Socialism with Chinese Characteristics
State Legal Persons A Shares Employees B Shares
Shanghai 34.2 27.4 28.5 0.4 6.3
Shenzhen 27.7 29.9 34.5 0.4 6.0
About one-third of the shares are owned by the
State, by individuals (A Shares) and by legal
persons. Employee and foreign (B share) ownership
is insignificant.
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Socialism with Chinese Characteristics

• Corporate performance improves with
• Lower private ownership private shareholders
  have little leverage
• Lower state ownership state administrators
  concerned with welfare of workforce.
• Higher ownership by legal persons, i.e.,
  institutions such as stock companies, securities
  firms, trust and investment companies, finance
  companies and mutual funds. Such legal persons
  have substantial representation on the
  corporations Board of Directors and Supervisory
  Committee and thus have substantial leverage over
  management. This leverage they exert to improve
  corporate performance and thus the payoffs to
  their own units.

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CORPORATE GROUPS IN ASIA
Leslie Young Professor of Finance and Executive
Director, The Asia Pacific Institute of
Business The Chinese University of Hong Kong
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EXPROPRIATION, ASIAN STYLE

• Many Asian corporate groups are today organized
  to exploit low transparency and poor shareholder
  protection. The group structures and styles of
  expropriation depend on
• The type of entrepreneurship that originally
  created the surplus to be expropriated
• The maturity of the stock markets

Japan Overseas Chinese China
Entrepreneurship Bureaucratic/ Managerial Family Political units/ families
Stock markets Long-established Well established Recent
Objective of group organization Managerial control Expropriation of minority shareholders Theft of state assets
Downside Economic stagnation Asian Financial Crisis Unstable banking system
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MITSUBISHI KEIRETSU 1. Core. Mitsubishi
Corporation (trading) Mitsubishi Heavy
Industries (manufacturing) Mitsubishi Gingko
(bank) /Mitsubishi Trust and Banking/Tokyo
Marine/Meiji Life 2. Kinyokai (Friday Club)
25-30 Main companies 3. Group Companies several
thousand About 25 of Japanese derive livelihoods
from Mitsubishi companies
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MITSUBISHI KEIRETSU
Core companies about 3 of equity held by other
core companies Kinyokai about 30 of equity
held by core and other kinyokai Group companies
over 50 of equity held by keiretsu members
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MITSUBISHI KEIRETSU

• Suppose that companies 1,, 100 each hold 1 of
  the equity of each of the others. How to take
  control of company 1?
• Control all outside shares (1) of company 1 and
  control the shares held by companies 2,3,4,5,50.
• But control of company 2 requires control of all
  its outside shares plus control of shares held by
  companies 1,3,4,5,..,50.
• Thus to control company 1, must control all the
  outside shares of companies 1,2,..,50.
• But even this might not be enough..

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MITSUBISHI KEIRETSU

• To take control need to attend 50 shareholders
  meetings. At each meeting, argue that you have
  control because you control all outside shares
  plus each of the other 49 companies. Why?
• Because you control each of their outside shares
  plus each of the other companies. Why?
• Because you control. etc.
• This argument is difficult to press home at any
  one meeting since it depends on winning the
  arguments at all the other meetings, which depend
  on winning the arguments at all the other
  meetings..
• What if all shareholder meetings are held on the
  same day?
• What if shareholder meetings are held on
  different days?
• at each meeting hear the sound of one hand
  clapping.

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Figure 1 Ownership, Control and Group Affiliation
Ownership of company C 50 10 5 Control
of company C Min(5010) 10 Ownership/Contro
l 5/10 0.5 B is tightly affiliated to
group controlled by A (i.e., at the 20 level) C
is loosely affiliated to group controlled by A
(i.e., at the 10 but not at the 20
level) Example of expropriation C buys asset
from A overpriced by 10,000 Gain by A 10,000
(1-Ownership of C) 9,500
A
50OC
B
10OC
C
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Ownership and Control in Western Europe East
Asia
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Table 2 Group sizes in Western Europe East Asia
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Conclusions

• Higher dividends are paid by tightly-affiliated
  corporations
• For corporations tightly affiliated to a group,
  dividends are negatively related to the O/C ratio
  to offset investor anticipation of expropriation.
  
• For corporations loosely affiliated to a group,
  dividends are positively related to the O/C
  ratio investors less alert to expropriation.
• Most loosely-affiliated corporations belong to a
  few large Asian groups.
• Dividends are higher in Europe than in Asia
• Multiple large owners imply higher dividends in
  Europe (monitoring) but lower dividends in Asia
  (collusion). Why?
• In Europe, other large owners help contain
  expropriation of minority shareholders by
  monitoring the controlling shareholder.
• In Asia, other large owners collude with the
  controlling shareholder to expropriate minority
  shareholders.

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In the smaller East Asian economies, private
ownership of assets and stock markets have been
long established the structure of ownership and
control permits the controlling family to exploit
minority shareholders who have already
contributed capital. By contrast, the structure
of company groups in China appears designed to
exploit opportunities to expropriate the state
during the transition to private ownership. Since
Chinas companies have high state ownership, the
controlling family does not need a pyramid to
control a substantial portion of the shares
available to the public.
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Family company F buys Ds shares at a low price.
D then invests in Companies A, B and C which are
about to receive valuable state assets. When
these investments are announced, Ds stock market
price increases, benefiting the controlling
family via its holdings through F.
Expropriation takes place, not through
related-party transactions, but by exploiting
insider information and manipulating the news
reaching the market.
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Lessons from China

• Cannot transplant policies requiring
  authoritarian regime based on homogenous
  population
• Precipitate privatization can result in massive
  theft of state assets via manipulation of stock
  market
• Attract NRI investment to zones cleared of
  bureaucracy.
• Offer bureaucrats high rewards for measurable
  improvements in efficiency and productivity
• Convert state agencies into profit centres,
  gradually spin off as companies
• Keep capital account closed but make foreign
  investment attractive and simple.

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Opportunities for Collaboration

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