What lies ahead for World Bank's proposals for China

According to a Wall Street Journal Report dated August 2, the World Bank, at the request of PRC State Council Premier Li Keqiang, and Development Research Center of the State Council are working together to set a reform agenda. The report revealed that the World Bank are gathering a wide variety of proposals and suggestions for China to privatize a major bank and allow farmers to sell their land. The author of that report commented that these are “Changes that could upend decades-old Communist Party ideology if implemented”.
In fact, if these reforms are really to be implemented, what would be upended is not ideology but the existing pattern of interests in China. The so-called “ideology” is nothing more than a legitimate semblance of that pattern. It should be said that Li Keqiang understands pretty accurately the lesions on the Chinese economy and, by inviting the World Bank to hammer out reform proposals with the Development Research Center, he intends to make a breakthrough.

This intention arose because if the status quo of the financial system is maintained, banks would become Automatic Teller Machines from which local governments of all levels could freely withdraw as much cash as they would like to, and inflation would devour the Chinese economy; and if land is not privatized, farmers would continue to be plundered, the situation that the Chinese economy being hijacked by the real estate bubble and real estate interest groups would continue.

However, there are two risks with this scheme.

Firstly, financial privatization pose a likely risk of the Chinese economy being hijacked by Red families.

Once the door to financial privatization is open, who would stand the best chance of becoming the biggest buyers of bank shares? It would be the Red families, of course.

To begin with, many members of Red families have already earned prestigious statuses in various financial businesses. According to a Financial Times story published on March 29, 2010, “China: To the money born: Senior officials’ children increasingly dominate private equity”, those sons and daughters of top Chinese government officials who entered the private equity business included George and Jeffery Li, both sons of Li Ruihuan; Li Tong, daughter of Li Changchun; Jeffrey Zeng, son of former deputy Premier Zeng Peiyan; Wilson Feng, son-in-law of Wu Bangguo; Liu Lefei, son of Liu Yunshan, and others. Wen Jiabao’s son Winston Wen, who reportedly had left the private equity business, was also mentioned in that article.

And WSJ reported in an article on July 3 this year disclosed details about how Alvin Jiang, grandson of Jiang Zemin, became a partner of Boyu Capital; also reported in the article was that Chen Yuan, son of CPC elder Chen Yun, served previously as Chairman of the board of the National Development Bank.

It can be said that whether viewed from their strength, experience, connections, or their routes to equity participation, upstarts in the financial industry who were born to Red families stand a better chance to becoming prioritized buyers of stock of privatized bank(s).

Even if the government stipulates that a single shareholding individual or corporation could not hold more than say 20% of the bank’s shares, those upstarts could easily achieve their objective with their sophisticated techniques of setting up shell companies, indirect shareholding and cross-shareholding.

Once the nouveaux riches manage to dominate the financial sector by taking control of major banks, the Chinese economy that has been run by the Party would turn into one that is controlled by dignitary groups.

The impacts this type of privatization has on the people aside, it obviously would affect local governments which, having long enjoyed the convenience of borrowing through Local Government Financing Vehicles (LGFVs) to develop the economy without having to repay the debt, would see that the means become viable no more.

Which among the Red financial upstarts would feel okay to see their own money gone for nothing?

Local forces would probably not like this reform package. In order to have the support from the parties concerned, the Central government could of course allow the provincial branches of that major bank be privatized on location and permit family of provincial and regional chief executives to purchase those stocks so that all connected could have equal opportunity. However, this is technically very difficult: in the past decade or so, local branches of banks have accumulated vast amount of debts, which is a burden that no bigwigs would want to carry personally.

Back in those years when Zhu Rongji implemented reform to State-owned enterprises, he did so by privatizing industries that were strongly competitive in the market and designated those industries relating to the people’s livelihood to be monopolized by State-owned enterprises. Such industries like petrochemicals, railways, Grain and oil and so on.

The survival of these economic oligarchies, which provided the basis of taxation and material guarantee that facilitated economic development during the decade under Hu-Wen leadership, rely heavily on the favorable tilt of state-owned banks. Once banks are privatized, State-owned enterprises would have difficulties getting from banks the sort of extremely concessionary policy loans that they used to obtain in the past. Therefore, this reform package would very likely be objected by major State-owned enterprises.

Even though the CPC is now in control of everything in China, Xi Jinping has to put in tremendous effort in dealing with political pressure form the Red families. Tackling one Bo Xilai was already quite difficult. It would be even harder to have things under control if a couple more full-fledged, financially strong Red financial groups emerge. Such a consequence can ill afford not to be taken into account.

Secondly, local governments may resist this reform package.

Even though the issue of farmers’ employment has always been troubling China, it is already the least of the worries for the government and can be put aside.

Premier Li Keqiang may intend to terminate land finance of local governments through privatization, and also putting an end to the risky situation of the Chinese economy being hijacked by real estate.

However, for land finance to end, the local governments would have to be provided with possible route of economic transformation first. And the current state of the Chinese economy does not look good.

Based on headline stories collected from newspapers, a person by the name of Jin Yu wrote an article summarizing the nine industries that are about to go bankrupt in China. Mentioned in that article are crises in photovoltaic enterprises, shipbuilding, and steel industry.

In addition, as a result of overcapacity and the collapse of giant Junduoli Enterprise, the LED industry underwent an intensified reshuffle process.

Besides, home stores have been disappearing due to the impacts from electricity suppliers and rising costs; small- and medium-sized enterprises are being squeezed to bankruptcy.

The Shipping industry is in bleak business conditions; the Ponzi scheme of trust companies is on the verge of collapse and 600 third-party financial institutions would fold.

In another article that entitled “China’s top ten resource-depleted cities that are heading for their demise”, it included Erdos, the coal capital in Inner Mongolia and the coal enterprise of Shenmu in Shaanxi. The decline of both reflected the current situation of the coal industry.

Also in the list were Yumen, Gansu, where oil resource had been depleted; the two cities of Huangshi, Hubei and the “copper capital” of Dongchuan, Yunnan had seen their mining resources used up and both are declining. These three cities showed that the sun is setting on resource-based industries.

It is most shocking that Guangzhou and Wenzhou, both had once been very wealthy cities, were actually included in that list as well.

Since Reform and Opening Up, Guangzhou, the political and economic center of the Pearl River Delta, had been in a favorable position. First it was its close proximity to Hong Kong that gave it a leg up, and then Guangdong became an important production base of the world's factory. With these Guangzhou became the wealthiest city across the country.

In recent years, Guangzhou actively attempted industrial transformation when the processing business in the Pearl River Delta declined and cultivated a “strategic leading industry”, the automotive industry. Quite a number of Japanese automotive brands picked Guangzhou as their production base.

But since the dispute over the Diaoyu Islands arose, the city's automotive industry suffered considerable impacts. Zhu Xiaodan, former Governor of Guangdong, actually had to go to the Ministry of Finance to say that the city has been in need of money and asked for financial support.

As for Wenzhou, a city that put together much effort in developing such labor-intensive light industries as manufacture of footwear, garment, leather, glasses, pens, lighters, sees the impending failure of the economic model it adopted.

Before the advent of new industries, local governments would still count on land finance (some provinces have already begun to implement a 10-year plan of “new urbanization”). The privatization of land would put an end to the path of selling (appropriated) land, which enabled local governments to earn big from the difference between acquisition and selling prices. Their great resistance to this would be quite understandable.

Pressure from local governments would eventually congregate around Xi Jinping, the Party's General Secretary.

So far, it should be said that Li Keqiang's economic reform has the full support from Xin Jinping—the time that changes must be made to mainain the Party's rule has come, after all. But when pressure mounts, whether or not Xi could withstand that is a different matter.

At the end of the day, local governance relies on local governments. And most of the local governments are now immersed in debt and are under huge financial pressure. Some places can't even pay wages, and have long been unable to take care of the people's livelihood.

And to say the least, it takes money to keep the civil servants' enthusiasm for work or to maintain stability. Without money, there is no stability.

The World Bank’s reform blueprint set forth the direction of market-oriented reform. The direction is correct. However, this proposal studiedly overlooked the institutional environment of China: what affects market-oriented reforms is not the logic of market economy, but instead the unspoken rules of dividing of interests through political deals. How great an extent a reform under the work of this rule would deviate from its objectives is an important factor that must be considered in advance.