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China: Building Capitalism with Socialist Characteristics

To analyze the different dimensions of Chinese culture. To analyze the Political risks and its impact on foreign firms. To analyze the prevalent risks in the Chinese economy. To analyze the stages of China s development using Rostow s Model. To analyze the impact of Banking Reforms in China and its impact on the overall economy. To give a brief overview of the current Chinese economic model. To understand the rising inequalities in the Chinese society and the causes for it. To put forward a broad outline of the strategy that China should adopt in the final stage of reform.

Hofstede s Cultural Dimensions

140 120 100 80 60 40 20 0 China USA India 20 80 60 40 40 62 46 40 118 Power Distance 91 77 61 56 48 40 IndividualismCollectivism Masculinity-Feminity Uncertainity avoidance Long Term Orientation

Hofstede s Cultural Dimensions Contd.

Power Distance: At 80 China sits in the higher rankings of PDI. The subordinate-superior relationship tends to be polarized and there is no defence against power abuse by superiors. Individualism-Collectivism: At a score of 20 China is a highly collectivist culture where people act in the interests of the group and not necessarily of themselves. Masculinity / Femininity: At 66 China is a masculine society success oriented and driven. The need to ensure success can be exemplified by the fact that many Chinese will sacrifice family and leisure priorities to work. Uncertainty avoidance: At 30 China has a low score on uncertainty avoidance. The Chinese are comfortable with ambiguity; the Chinese language is full of ambiguous meanings that can be difficult for Western people to follow. Chinese are adaptable and entrepreneurial. Long Term Orientation: With a score of 118 China is a highly long term oriented society in which persistence and perseverance are normal.

Human Nature Orientation(HNO)

China- Negative HNO Stability is considered as the most priced commodity by the CCP. The Chinese govt. has always dealt with disgruntlements and rebellions with an iron hand. Tiananmen Square in 1989. No national elections. Absence of civil liberties. Intent on maintaining their unique brand of political control.

PDI/HNO Relationship
HIGH PDI Laws challenged to a certain degree LOW PDI Pragmatic rules; most people respect and obey

Positive HNO

Formal, unrealistic rules.

Negative HNO

Society does not trust people to obey laws.

Political Risk Analysis

Typology of Political Risks in China
Government Risks Firm Specific Risks Discriminatory Regulations Nepotism towards SOEs and TVEs Instability Risks Firm specific boycotts Example : Google

Country Level Risks

Risk of mass nationalization (happened in 1949) Currency inconvertibility

Cross border issues with India. Instabilities pertaining to the issue of Tibet.

Impact of Political Risks

Uncertain, politically influenced investment climate
Poor legal protection for foreign firms The financial system is murky and favours state-owned entities, which, despite all the private-sector growth, still make up 40% of China s economic activity Threat of retaliatory protectionist policies deters foreign investors Foreign companies are also holding back due to the reputational risks they face in home countries due to their operations in China. E.g. Microsoft, Google. Companies are also closely monitoring the social instabilities in China and deferring their investments for a much favorable climate or taking it somewhere else.

Economic Risks
Type Exchange Control Prevalent in China Fixed currency exchange rate Yuan valued at 8.51 in 2005 Recent revaluation in 2010 Chinese exports are cheaper

Local Content Laws Price Control

Strict censorship Curtailing media freedom Currently the Chinese economy follows a market driven pricing system, thereby mitigating the inherent risks of state-fixed prices. Divided tax system in 1994 Streamlined the tax system and enabled it for the socialist market economy 2006 China started facing shortage of unskilled labor Increasing labor costs has forced companies to look towards companies like Bangladesh or Philippines. Fixed exchange rates makes it unfavorable for other countries to export to China

Tax Control

Labor problems

Import Restrictions

The Rostow Model as Applied to China

Stage 1: Traditional Society Agriculture driven economy Ascent of Chinese Communist Party (CCP) Closed economy and protectionist policies of Mao Zedong and CCP No links to the market and no influence of market forces Great Leap Forward Massive communes of agricultural collectives Back yard steel production Slow down in agricultural production GNP declined by a third in 1960 Tyranny of Red Guards The famine of 1960 Conflicts and fighting between factions of Red Guards Total Anarchy by 1976

Stage 2: Pre-Conditions to Take-Off

The Rostow Model Contd.

Stage 3: Take Off Mao s death in 1976 and subsequent leadership change Deng Xiaoping coming into power Breaking up of the agricultural communes and replacing them with Household Responsibility System Family planning and One child policy Opening up of four SEZs New tax incentives, foreign exchange provisions to attract potential investors Establishing the system of Dual Exchange Rates More direct control over factories and longer lease periods

The Rostow Model Contd.

Stage 4: Drive to Maturity China is currently in the fourth stage of Rostow s Model of Development. The fifth and final stage is the Mass Consumption Stage . Developed countries like the US, UK, etc are currently in this phase. Introduction of Contract Responsibility System More control to SOEs Establishment of TVEs Easy availability of credit Move to bring the country closer to a market based system of pricing. Tightening of import norms and credit availability in the early 90 s. Establishment of new stock exchanges Creating new institutions for an increasingly market oriented economy Introduction of Divided Tax System Adjustments in dual exchange rates Disinvestment of SOEs and TVEs More open attitude towards Privatization WTO membership Banking Reforms Setting up AMC s Reduction in NPLs

Banking Reforms
People s Bank Of China (PBOC) had absolute control over the monetary system and the four state owned banks. Incessant lending to troubled SOEs and TVEs. Steep increase in the number of Non Performing Loans(NPLs) In 2004,total NPLs amounted to 1.7 trillion RMB or 13% of total GDP The banking reforms adopted by the Chinese government can be classified into two phases.

Phase Phase 1

Reforms Started in early 90 s Open market operations Interest rate controls Eliminated quotas on banking credit Restructured internal management system Establishing the China Bank Regulatory Commission(CBRC) Started in 1999 Govt. borrowed 1.4 trillion RMB from PBOC and state commercial banks Purchased NPL equivalents from state owned Banks Injected $60 Bn from Forex reserves into the banks through a new institution named China SAFE(Huijin) Established four new Asset Management Companies(AMCs)

Impact Recentralization of power in PBOC, pushing it closer to the market Failed to make an impact on NPLs

Phase 2

Transformed the banks into listed companies, ready for foreign investments Restructuring or disposing of debts Sharp fall in the number of NPLs Creation of modern capital markets in China However there was little interest from foreign investors

Revaluing Yuan
China dropped the Dual exchange rate system in the late 90 s The main purpose of this was to provide the Chinese manufacturers with an advantage in the international markets. The fixed exchange rate or pegged exchange rate system essentially kept the value of Yuan lower than what the market would have chosen. Chinese goods remain lower in price for purchasers in other countries thus benefitting all Chinese exporters. However a spew of revaluations and adjustments after 2005 should be considered as an effort by the Chinese in providing greater currency flexibility.

Socialist Market Economy

After the failure of the Great Leap Forward (1958-1961), Deng Xiaoping was willing to consider capitalist methods of economic growth so as to revitalise China's economy. However he remained committed to centralized control and the one-party state. It supplemented China s centrally planned economy and the high GDP growth rate has been attributed to it. Privately owned enterprises are a major component of this economic system, along with the central SOEs and TVEs. The fundamental distinction from the Western mixed-market economies is the underlying authoritarian political philosophy of absolute control.

Reforms under Socialism with Chinese Characteristics

Decollectivizing agriculture Allowing private businesses and foreign investment in the late 1970s and early 1980s liberalisation of trade and prices dismantling the welfare state in the late 1990s Banking reforms in the late 90 s and early 21st century Revaluation of Yuan Disinvestment of SOEs and TVEs

Private Sector
Due to the poor performance of traditional state enterprises in the market economy, China embarked on a massive restructuring program of privatisation. The private sector's share of the GDP rose from less than 1% in 1978 to 70% by 2005 Numerous sectors that were previously run by the state were privatised during the formation of China's current market economy. Under this scheme, the state retains ownership and control of large enterprises but the central government has little direct control over the operations of state-owned enterprises.

End of Reforms
By 2005 the market-oriented reforms, including privatisation, was virtually halted and partially reversed. In 2006, the Chinese government announced that the armaments, power generation and distribution, oil and petrochemicals, telecommunications, coal, aviation and shipping industries had to remain under "absolute state control" and public ownership by law. The state retains indirect control in directing the non-state economy through the financial system, which lends according to state priorities. Liberalization continues to be rolled back in the state-sector by the consolidation of state enterprises into large "national champions" with the goal of consolidating efforts and creating internationally-competitive national industries.

The state sector is concentrated in the 'commanding heights' of the economy with a growing private sector engaged primarily in commodity production and light industry.

Rising Inequalities
Gini co-efficient for China has been hovering between 0.4 and 0.5. External liberalisation may have facilitated more rapid growth, it has also been a major factor behind increasing inequalities. As profitability of the SOEs declined in the reform era, the system was marked by chaos with local governments imposing other revenue raising measures. Since 1984,, agricultural growth has decelerated and lagged behind industrial and service sector growth rates. Agriculture sector has not received much state patronage in terms of investment, nor has it seen proliferation of small enterprises on the scale of the industrial and service sectors. Restrictions on labour movements have been one important factor behind rural-urban inequalities in China. Govt. unwilling to eliminate Hukou system. Public resource mobilisation has shown an increasing in-equalising tendency and a bias towards richer, coastal areas. CCP s reluctance to slow down growth for dealing with rising inequalities.

Dealing with Inequalities

Abolition of agricultural taxes and all surcharges for peasants. Providing a basic standard-of-living allowance for low-income urban citizens Creating unemployment insurance for certain classes of employees. Create health and pension insurance programs Revitalizing the country s aging system of social security.

Strategies for the Final Phase of Market Reforms

Continue moving towards the market. Device and implement massive programs for redistribution of wealth. Increasing inequality can lead to civil unrest. Resort to the tried and tested strategy of controlled reforms. However the CCP has to give relaxations and move away from absolute control. Adopt more liberal trade policies. Consider private partnership in the AMCs. Encourage more foreign participation in the banking sector. Consider the possibility of a floating exchange rate. Less stringent norms regarding censorship, free press and content control. Make the provincial and central government more accountable.

Move to Democracy
Highly improbable after the existence of a single party for 63 years. This has led to a apolitical urban youth population. However, the growing middle class attributes their prosperity to the current government and its policies. Hence there is no mass consensus among the citizens of the country about democracy. Sudden move to a new system can hamper the growth and aggravate the issues in hand. Furthering the concept of Socialist Democracy is a better alternative for China s current set up.