China Follows Flawed Economic Model

In the midst of Asia’s economic woes, China seems to be moving in the wrong direction--and a recent, little-noticed CIA report shows why.

The essence of it is this: China is trying to imitate Japan and South Korea. Over the last couple of years, authorities in Beijing have begun to follow the same economic path blazed by Tokyo and Seoul many years ago. Yet this approach has been at the root of many problems Japan and South Korea are now confronting.

In recent decades, both Japan and South Korea have fostered the development of a handful of huge conglomerates, which obtain favored treatment from governments and banks. Each conglomerate includes many different kinds of businesses, which tend to get supplies and other services from others within the same network.

In Japan, these interlocking networks are called keiretsu. In South Korea, the chaebol. Now, as China moves toward a market economy, it has been attempting to create its own home-grown conglomerates.

Every year or so, the CIA publishes a study of China’s economy.

This year’s report demonstrates the extent to which China has been using Japan and South Korea as its models for economic development.

Many of China’s recent economic reforms “appear inspired by the Japanese keiretsu or Korean chaebol systems,” the CIA says. Its report notes that the Chinese regime has been encouraging mergers, the creation of holding companies and new, cooperative relationships between banks and large enterprises.

China has been trying to overhaul its state enterprises, which for decades were the backbone of its socialist system. One part of these reforms is China’s plan to close those state enterprises that are losing too much money.

Understandably, this idea of letting some companies fail is the aspect of the Chinese reforms that has gotten the most attention overseas. Closing down these enterprises means putting people out of work, and growing unemployment raises the specter of political instability.

However, China’s drive to get rid of “losers” is only one part of its economic program. The CIA report emphasizes that at the same time, the Chinese regime has also been “picking winners” by trying to transform some other state enterprises into “self-sufficient, profit-oriented, state-owned companies that have close links to individual state banks.”

For example, China set up a program under which 300 large state enterprises got preferential access to credit from individual state banks.

What’s wrong with setting up these conglomerates and giving them special favors? There are a number of difficulties with what China has been doing.

The crisis in Asia has shown the underside of these huge conglomerates. In South Korea, the chaebol became wasteful and corrupt, often venturing into inefficient and unprofitable ventures they knew nothing about.

Not everyone agrees that this way of doing business is so bad. Retired UC San Diego professor Chalmers Johnson--whose book about Japan’s Ministry of International Trade and Industry showed how the Asian style of development really works--believes that this model still makes sense for China.

He argues that the problems of South Korea’s chaebol have been overstated and are not the underlying cause of the Korean economic crisis. Rather, Johnson says, Asia’s problems stem from too many countries relying upon exports for economic growth.

Still, the bottom line is that over the last year, at least eight of South Korea’s 30 largest chaebol have declared bankruptcy. That should give pause to the Chinese.

China’s system of favoritism for conglomerates could lead to a rigged system that is unfair, humbling and unattractive to ordinary people. As the CIA delicately puts it, China may be creating a system “in which economic power is highly concentrated and a few interest groups have an inordinate effect on government policy.”

Over the long run, China’s policy of favoring a few could have an impact on trade too.

The Japanese keiretsu and the South Korean chaebol were vehicles for protectionism: Foreign companies had difficulty landing a deal because they weren’t part of the system. With the U.S. trade imbalance with China about $50 billion a year and growing, China’s policies could make life harder for American firms.

China may yet back away from this approach. Beijing seems to be moving slowly, reevaluating what happened in South Korea and taking some steps toward a more open economic system. The CIA report hedges, saying, “What type of market economy will result [in China] is still unclear.”

South Korea’s problems of the last few months have been scary enough. Imagine if China--with a larger economy and roughly 20 times as many people--copied South Korea’s model and, a few years from now, wound up in the same economic mess. That’s a prospect worth trying to avoid.

Jim Mann’s column appears in this space every Wednesday.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Trade Imbalance

America’s trade imbalance with China has grown steadily over the past decade as U.S. exports to China have remained at low levels, while sales of Chinese products in this country have shot upward.

The U.S. trade deficit with China . . .

. . . is largely attributable to Chinese gains in U.S. market.

Source: CIA: “China’s Economy in 1995-97”