Why Privatization Won't Work

Robert Dujarric is a research fellow in the national security studies department at the Hudson Institute's Washington office

As the just-concluded 15th national congress of the Chinese Communist Party shows, Chinese leaders are keen to sell off state-owned enterprises, though to avoid losing face they prefer euphemisms like "public ownership" to "privatization." Regardless of the decisions taken at the congress, however, the reforms will almost certainly fail to bring modern capitalism to China.

First, private property is a simple concept but one that requires detailed and well-enforced laws to work well. Communist nations, where the state owns everything, can do without tax regulations, contract law, civil courts, commercial codes and competent judges, but market economies cannot. Without these institutions, which Americans take for granted, societies are doomed to anarchy (at worse) or to poverty (at best).

The legal and enforcement mechanisms needed to manage a capitalist system are complex and take many decades to develop. China lacks this legal and institutional infrastructure. Its leaders are against the rule of law and there is an enormous shortage of personnel who understand the legal and institutional foundations of capitalism. Because China has never experienced modern capitalism, it is wishful thinking to expect that government reforms can rapidly establish a well-functioning market economy.

Second, privatization in China is likely to become "nomenklatura privatization," i.e. the transfer of assets to powerful industrial managers and political figures. These individuals will manage the "privatized" firms in their interest rather than accept the need to serve outside investors. (I once heard a Central Asian official proudly say that he had privatized a local hotel. He meant that he now owned it.) Therefore, as has happened in several post-communist states, privatization will fail to institute one of the key elements of capitalism, namely the power of shareholders to control and fire managers and to sell their holdings to whomever they want.

A related aspect of this problem is that Chinese privatization will provide ample opportunities for bureaucrats, party officials and their families to enrich themselves by taking over state property at no cost. Using their political connections, they are likely to get the government to grant their businesses monopolies and subsidies, thus hurting the economy and consumers. This will make the masses think that capitalism is nothing but a get-rich scheme for the elite and will fuel resentment.

Third, privatization will not prevent at least some corporations from losing money. In market economies, companies go bankrupt every day. If privatization is taken to its logical conclusion, many people will lose their jobs. Even if the economy is doing well, not all workers who are fired will find employment elsewhere, especially older employees from state-owned factories who are not attractive hires for new businesses. Given the communist regime's fear of social unrest, the government is likely to go on subsidizing money-losing firms to avoid layoffs, which would negate the advantages of privatization.

Fourth, it is not possible to separate politics from economics. By abolishing private property, communist parties ensured their monopoly on power. Private ownership puts economic resources in the hands of individuals who are not under the party's control. Because the communist rulers have shown little inclination to tolerate an opposition, they will find it impossible to implement a true privatization drive because that would make individuals who might oppose them rich and influential. Therefore, the Chinese leadership will opt for a system that only puts money in the pockets of men beholden to the party and their cronies.

China will change over the coming years. Unless there is real political revolution, however, it will not become a market economy based on the rule of law and private property. Its communist system will decay into some form of administered economy, where the boundaries of private and state ownership are ill-defined and corruption is the norm. It is not communism, but neither is it capitalism as we understand it. This is why China is not likely to develop a modern economy as South Korea and Taiwan have.

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