How International Competition Will Change China

A May 2000 report from U.S. Embassy Beijing

Summary: Chinese Academy of Social Sciences economist Yang Fan at a March gathering of business and Party leaders in central Henan examined how international competition will transform the Chinese economy. Yang said that the Chinese government's ineffectiveness and corruption make addressing China's problems more difficult. Chinese citizens by speaking out will not only help solve problems they will also foster the growth of democracy, said Yang. Problems such as chronic water shortages, feeding a growing population, creating a world class aerospace industry, and halting environmental deterioration can't be solved by the free market alone. The Chinese government must take an active role. Competitive pressures from abroad will force China to reform. An informal translation of a Yang Fan article on corruption in Chinese government arising from government departments acting as interest groups is in the appendix.

Yang Fan on Economics, Democracy and Patriotism

Yang Fan, a prominent Chinese economist and researcher at the Chinese Academy of Social Sciences, gave the talk summarized below to a mixed audience of business and Party officials at Luohe in central Henan Province. Yang Fan says that China needs free markets and democracy but the government still has an important role to play. Embassy Beijing Environment, Science and Technology Officer attended Yang Fan's talk and a subsequent dinner with the Luohe City business and Party leadership while traveling in Henan in late March. Yang's speech struck ESTOFF as both democratic and patriotic in spirit but not narrowly nationalistic. Yang Fan was a 1997 USIA International Visitor to the United States.

International Division of Labor Will Affect Henan Province

China does not compete directly with the United States but with other developing countries. Agriculture is the only arena of direct competition between the United States and China in the 21st Century. Today there is not very much foreign investment in Henan Province (population 100 million), but it will come said Yang. Big multinational companies make developing country products part of the company's product line. During the past thirty years the world has seen the rise of multinational corporations that integrate production, capital and finance across many different countries. During that time the most polluting and the processing industries have moved from the developed to the developing countries.

Competitive Pressures Will Change China, WTO or Not

China's entry into the WTO is a legal question, said Yang. Whether China enters the WTO or not, China will still feel great pressure from international competition. Even during China's decades of isolation China felt international pressure. For example for many years the U.S.-controlled UN would not allow China to take its place in the United Nations. China's decades of isolation still affects the way China feels pressures today. Take the Taiwan issue as an example. Why does the U.S. Congress support Taiwan? Most of the many Chinese in the United States support Taiwan. They are the people who left China in 1949, did not find a place in Taiwan - and so ended up in the United States as people without a country. Many Taiwanese went to the United States, but the PRC was cut off from the United States until twenty years ago. The U.S. Congress invited Lee Tenghui because over 300 U.S. members of Congress responded to the wishes of their constituents.

Isolation, Lack of Pressure Made PRC Industry Backward

This story shows that no country can cut itself off from international pressure by isolating itself. As a result of the years of isolation, many people around the world do not understand China. There have been other consequences as well. Why are the State Owned Enterprises (SOEs) in such bad shape? They were closed to the outside world for forty years and made no improvements. Naturally, they are in desperate shape today. Pressures from international competition are very strong today.

Chinese Economy Up But Military Competitiveness Down

Chinese devoted much effort to aerospace and other national defense technologies and industries when it was still a very poor country, said Yang. China built atomic bombs and satellites. Although the Chinese economy has grown rapidly over the past two decades, China has actually lost ground in military technology compared with foreign countries. Today China doesn't even have the capacity to build 150 jet planes a year. China stopped advancing in the aerospace field as a consequence of its decision to buy large numbers of foreign aircraft. During the 1990s China bought 800 foreign aircraft. Over the past seventeen years, China has bought over 1000 foreign aircraft. Yang mentioned that the Chinese military had asked him to give them a lecture on China's economic security.

Today producing modern aircraft is essential to the national defense and to maintaining national sovereignty. The U.S. DoD orders a large proportion of the planes made by the U.S. aerospace industry. The European Union countries pool resources to pay the USD 2-3 billion needed to develop a modern aircraft. Government arranges mergers and pay subsidies to support a healthy aerospace industry. The aerospace industry is too important to the national defense to be left on a simple profit and loss basis.

Ideology is Obsolete: What Matters Are Standards and Technology

When we talk about international competition, said Yang, we should be talking about technologies and standards. We shouldn't be talking about the system of ownership anymore. That debate is obsolete. The developed countries are dumping processing and asserting themselves by setting technical standards. The WTO provisions on finance and telecommunications opens up world trade for the developed countries in those areas. The entry of multinational companies is good for China, which benefits from the foreign investment, but tough on the Chinese companies that must compete with foreign multinationals.

Why Are Chinese Companies Treated Worse than Foreign Ones?

Foreign companies get better treatment than Chinese companies since they benefit from a reduction in the 17 percent VAT. The result is that PRC companies can't afford to invest. What kind of "national treatment" is this? Government policy encourages Chinese to go off and work with the foreigners. This puts the SOEs and Chinese companies at a serious disadvantage. There is a pathological triangular relationship at work here. The Chinese people fear officials, officials fear foreigners, and foreigners fear the Chinese people, said Yang. Some Chinese move money overseas and then bring it back to China as "foreign capital". The Chinese government prefers to ask foreigners rather than Chinese PhDs to be consultants. You'll probably see much more foreign investment in the SOEs as a way to get the SOEs out of trouble.

International Competition Tough, Law, Environment and Quality Standards Are Important

International Standards Organization (ISO) quality standards require production to a certain quality standard, said Yang. Chinese companies are working for foreigners and making parts for them. It has become a buyers market -- Chinese companies look for foreign companies and not the other way around. In some emerging technologies foreign companies have the first mover advantage and Chinese companies now have to play catch-up: cellular telephones are an example. If the quality standards can be met, then foreigners will come to invest. Good law enforcement and a good environment also encourage foreign investment. China's success in meeting international competition will depend in large part on the ability of the Chinese government to marshal resources and mobilize people in confronting China's very serious domestic problems such as water, population and the environment. The ineffectiveness of government in China is a very serious problem.

More Water Needed to Feed China's Growing Population

Yang said that in thirty years China will need to feed more people. How many? Nobody knows for certain -- perhaps as many as 1.8 billion. [See Embassy Beijing reports PRC Family Planning Rules in Rural Henan County, China's One Child Policy, Two Child Reality and PRC Family Planning: The Market Weakens Controls But Strengthens Voluntary Limits ] China now plans to open up and develop the West. But water is a big problem. Perhaps water from glaciers in Tibet can be channeled to Xinjiang. The Yellow River flows fewer and fewer days each year. The Yellow River deposits so much silt on its bed that it is higher than the surrounding countryside as it flows from eastern Henan through Shandong Province to the sea. Excessive use of underground water along China's east coast is bringing salt water into the acquifers in some areas.

Water-Short China Wastes Water Extravagantly

Two routes for the South to North Water Transfer Project are planned. Yet waste of water resources is a large part of China's water problem, said Yang.[See PRC South to North Water Transfer Project and PRC Water: Waste A Lot, Have Not -- The Problem Is Policy, Not Technology ] Capital Steel in Beijing consumes one-third of Beijing's water supply. Capital Steel was certainly placed in a place with bad fengshui. The plant is on the western side of a big city so that prevailing westerly winds blow pollution from the steel plant over central Beijing. Capital Steel should be closed. Land values would rise afterwards and all those rich people who worry about their kids being kidnapped if they stay in small towns can move into apartments there. Yet if Capital Steel were to close, Beijing Municipality would lose important tax income and 200,000 workers who would lose their jobs. So Capital Steel stays open.

Tree-Short China Should Not Be in the Paper Business

The Chinese paper industry is the third largest in the world but production is scattered among many different producers and so efficiencies of scale are not realized. China is short of wood. It should not be in the papermaking business. Imported paper is cheap. China should invest in forests overseas in places like Australia and Africa.

Will the Government Act? Or Will Food Security Suffer?

Will China have solved its food problem in another thirty years? Will China be dependent upon the U.S. for food imports? Importing food is like importing the water and the soil of a foreign country. Is the Chinese government capable of solving this problem? Can China open up land upon which farmers can grow more food? If two hundred million farmers can be put to work planting trees and restoring land, China will be able to feed itself, said Yang. If China doesn't do that it will lose part of its independence. This is a matter of food security and economic independence.

But The Chinese Government is Corrupt and Ineffective

Yet the Chinese government is bloated [Note: Chinese central government ministries reduced their workforce by 40 percent in Spring 1998. Provincial and lower levels of government are doing the same over the next few years. End note], corrupt and ineffective. The organization of 200 million farmers to plant trees and restore the environment is not something that the market can do. It is a task for government, said Yang. [Comment: The Chinese government will subsidize farmers in 272 counties with grain in exchange for planting rice. In some areas former timber workers are being put to work planting trees. It is too early to judge the effectiveness of these measures. End comment.]

A few years ago farmers in Gansu tore up the grasslands when the price of some grasses went up. [See PRC Desertification: Inner Mongolian Range Wars and the Ningxia Population Boom ] The government did nothing, said Yang. Yang mentioned some recent positive government measures. Beginning this Spring, the numbered bank account system ended. Now all bank accounts must list both a name and national ID card number will help reduce grey income and help fight corruption. With greater transparency individual Chinese will become less dependent upon their local governments. They are becoming citizens (shimin).

Urban Villages: Save Land, Remove Obstacles to Modernity

China's 480,000 villages take up a lot of farmland. Farmers should be moved into urban villages in which they can have a more city-like life. This will restore much arable land to cultivation. The Chinese economy is stuck in the doldrums now because of the lack of domestic demand. Yet many farmers can afford to have televisions and telephones but don't get them. Why? One day, said Yang, as he peered at a barely discernible picture on a black and white TV one day, a farmer explained to me that if he were to get a color TV, the whole village would come to his house to watch TV. The same thing would happen if he had a telephone. It would be too embarrassing to charge neighbors for making telephone calls, said the farmer.

If the government were to arrange a change in farmer housing patterns, farmers would buy many more consumer goods. China will move from 30 percent urbanization today to 70 percent urbanization over the next several decades. Biotechnology will make it possible to produce much more food in a small space.

The Internet Will Boost China's Education and Economy

Europe and Japan have made the mistake of being very passive about the Internet. China should be more active! Telecommunications charges in China are higher and service is much poorer than in the United States. [Note: Internet access charges have fallen by about 50 percent over the past year in China. End note] People are afraid to use the telephone. Internet access charges should be cut by 90 percent. Cheaper internet service will be very important for education and news services. The net is revolutionary. The net economy will help China use its scarce resources more efficiently and to reduce pollution. Distance education via the Internet will greatly improve education in China. China's critical infrastructure for the Twenty-First Century is the Internet. Chinese businesspeople need to get on the net. If you are not on the net, your company may fail within three years, Yang told the assembled businesspeople.

Speaking Frankly and Democracy Will Help Solve China's Problems

China has many difficult problems, said Yang. There are water shortages. There are minority problems in Xinjiang where some separatists throw bombs and say "Kill one ethnic Han Chinese and Scare a hundred". But all these problems can be solved. Chinese reform is blocked by many interest groups (see Yang's essay translated in the appendix). Competitive pressure from foreign countries will force China to reform. Our responsibility as intellectuals, concluded Yang, is to speak out and say frankly what we are thinking. This is important for the development of democracy in China.

Appendix: Yang Fan Analyzes Corruption in Government

Yang Fan has analyzed how corruption has come to be so pervasive in Chinese government. Here is an informal translation an article Yang wrote for the nationally circulated Southern Weekend (Nanfang Zhoumo) newspaper. A translation of another Yang Fan article  The Causes of the Pathological Expansion of the Interests of Government Departments is also available.

The Pathological Expansion of the Selfish Interests of Government Departments

South China Weekend [Nanfang Zhoumo] February 13, 1998 on p. 5 Nanfang Zhoumou is published by the Guangzhou Municipality Committee of the Communist Party of China. This article appeared beneath a regular column entitled "An Expert’s Perspective"

by Yang Fan
 

Using the Legislative Process to Write the Interests of the Department Into Law

The most serious interference with the rule of law by administrative power and in law enforcement is seen in local protectionism. In the legislative process we see another kind of protectionism, department (agency) protectionism. This makes law-making in China particularly complex. The administrative department concerned with the law drafts the laws passed by the National People's Congress. A great many regulations need to be written to give concrete expression to the laws. Therefore the administrative departments charged with regulating various fields can use this process to write their economic interests into the laws and regulations.
 

Many Ways to Maintain Department Monopolies and Oppose the Entry of Others Into a Market

Certain departments, in the name of "making things more orderly, strengthening management and protecting Chinese national enterprises" promulgate strict regulations governing entry into the market in the fields of foreign trade, wholesale business, telecommunications, finance and insurance, construction and other industries. These regulations are aimed at preventing the free business operations of non-state enterprises and enterprises not related to the ministry in the market. In many areas such as directives on the management of state-owned lands, management of permits for foreign trade, household registration system management, initial issuance of stock, and issuance of loans departments refuse to adopt the open bidding practices of the market economy. They instead insist on a confidential internal approval process. They get bids from only a small circle of bidders and so allocate contracts administratively rather than through open bidding.
 

Using New Methods to Maintain the "Identity of Business and Government"

The central authorities have time and time again ordered that the administrative departments divest themselves of their affiliated companies. In fact these companies were not fully divested, they are merely affiliated in a new, hidden way. The administrative departments with regulatory responsibilities and some departments, which have special powers, use their authority to operate businesses in fields where approval is very difficult to obtain. Some departments go so far as to get special permission to operate businesses, to operate in the financial sector, in the telecommunications sector, to get involved in real estate, operate "high class entertainment establishments" such as saunas and massage parlors or operate businesses involved in bullet-proof vests or weapons. The regulatory department uses its powers to set up commercial networks, to buy materials cheaply and to make a good profit. The regulatory department ensures that its affiliated company gets written into the plan, gets the appropriate permit, and block inspections in order to ensure that the company gets an abnormally high profit. The regulatory department gets its pay-off.

This situation is an even worse than existed before the formal relationship between the department concerned and the affiliated company was formally dissolved. This is because there is no formal relationship between the leadership of the department concerned and the managers of the company. Instead these are even stronger personal relationships among certain powerful people. These relationships are even more exclusively focused on private profit than before. Moreover, the regulatory department can say, since the relationship with the affiliated company has been officially dissolved, that the "company is no longer affiliated" with the department, and so absolve itself of responsibility. Now relations between the regulatory department and the enterprise are conducted in the shadows.
 

Establishing Rents to Make Big Profits

There is an economic theory called "seeking rents" which describes how a social interest group can, through lobbying, by influencing the enactment of legislation, and through government policy obtain special privileges. As the interest groups in the country become more diverse, "rent collecting" activities of interest groups becomes steadily more serious and more open. Moreover, the regulatory departments start "establishing rents". Regulatory departments do this by expanding the scope of their regulatory activities and by selling scarce resources controlled by the regulatory department in order to collect big profits.
 

Enterprise Corruption is Getting Worse

Corruption in the enterprises has become much more serious that just snatching at nearby targets of opportunity or trading favors between work units. Corruption has developed to the stage of regulatory departments supporting, tolerating, or even organizing "systematized corruption" and corruption in education, corruption in scientific research work, corruption in the selection of cadres, corruption in journalists accepting payments for making news reports, and other forms of corruption. Despite shortages, we can see high priced black market in things like high priced supplementary tickets for train berths, for performances, for medical exams by specialists. If there wasn’t a set up between the inside and the outside, how could such high prices be maintained?
 

Helping the Enterprises With "Rent-Seeking" From the Government

The regulatory departments, in a planned economy, sets the functions of each level of government below it and directly organizes economic activity in each field. The macroscopic management function and the function of owner of a state enterprise are combined in one organization. During the transition to the market economy, the law has already made a distinction between the regulatory department and the state enterprise. Now ownership in the state enterprise is vested in the Property Management Bureau. However, the regulatory department still retains control over the right of the enterprise to conduct business in its field. Even more important is the regulatory department’s right to appoint the managers of the enterprise. In policymaking, the regulatory department favors "family".

Moreover, when helping non-state enterprises to obtain favorable policies from the government, some of the cadres of the regulatory department privately act as "the manager" of these companies to reap a rich recompense. The regulatory departments, because they have too much contact with the enterprises and their interests are tied too tightly to the enterprises, in the name of "strengthening management" issue innumerable management regulations. These management regulations assist the enterprises to "succeed by getting around things" to reap an incommensurably large profit. Although these departments are called regulatory departments, they are really more like the corporate headquarters of some of the enterprises they regulate!