China: Is High Growth-High Risk Liberalization the Only Alternative?


China’s drive toward economic superpower status in the world economy has accelerated in recent years. As China’s economy becomes globalized, fundamental changes in its financial markets have opened opportunities for overseas expansion as well as increasing risks of financial crisis. Dynamic growth, large-scale financial speculation and overseas expansion are accompanied by deeper and more pervasive social and economic problems, which can undermine sustained growth and political stability.

China’s Dynamic Economic and Financial Growth

By now the world is aware of China’s unprecedented prolonged double-digit growth rates in GDP, exports, manufacturing and other economic sectors. Economists and Central Bankers have taken notice of China’s $1.5 trillion dollar reserves, $3 trillion dollar savings and the rapid growth of millionaires and billionaires. Moreover, despite US and European financial market turbulence in mid 2007, China’s trade balance for July 2007 was a near record $24.4 billion dollars, its exports grew by 34% despite rising oil imports and reductions in rebates to exporters and interest rate increases. China’s GDP is expected to grow at nearly 11% for 2007 (Financial Times July 20, 2007), the highest rate of growth in the new millennium.

While US politicians, pundits and trade union bosses continue to fume about China’s low wage advantages (cheap labor) and ‘unfair trade’, Beijing is moving on to a new advanced stage of capitalism — large-scale, long-term investment in research and development (R&D), large-scale private and public overseas investments in Africa, Asia and the United States and big investments in high tech industries linked to manufacturing. China’s major banks and corporations are ‘going public’ — offering shares to private investors and raising $52 billion dollars in the first 6 months of 2007 — making China the world’s leading center for share offering (Financial Times, July 5, 2007). Over $1,300 billion dollars of Chinese savings are about to flow into global bond and equity markets as liberalization spreads (Financial Times, August 28, 2007). Today the Chinese stock market (including Hong Kong) is bigger than Japan (FT, August 29, 2007). China’s capital markets are moving toward integration with the world market and its multinationals and investors are prepared to challenge US-EU domination in the commodities sector. Over the next decades, Chinese companies will compete with Boeing and Airbus in the production of commercial aircraft. Despite the protectionist bombast emanating from the leading Democratic Presidential candidates, Chinese imports grew from $512 billion dollars in 2004 to $792 billion dollars in 2006 and will reach $1 trillion dollars by 2007/2008. China is second only to the US in investments in technology, allocating $134 billion dollars in 2006. As a percentage of GDP (4.9%) China leads the US several times over.

Clearly China’s macro-economic successes and its ability to reduce the gap separating it from the older imperial powers like the US and European Union, has aroused hostility, anxiety and efforts to undermine its competitive advantages. By raising complaints which apply equally or more to the West and Japan, concerning the environment, product safety and trade union rights (over 91% of US private sector workers are non-unionized and most public-sector workers have highly restricted or no right to strike), both the US and EU are attempting to block China’s emergence as a world economic power. China’s sustained growth, despite stiff competition from low wage areas and high tech countries, political pressure from the outside and social tensions on the inside, has raised issues which thus far have not been addressed by its outside critics (predicting unsustainable catastrophic consequences) and internal celebrants of the current economic model.

The new challenges are precisely due to the economic successes of the regime as it climbs up the economic ladder from labor intensive, low value-added production to high tech, skilled and semi-skilled production and services. As China moves from assembly plants and high dependence on industrial inputs to fully integrated manufacturing based on endogenous technology, its unskilled, migrant surplus work force becomes redundant at the same time that the scarcity of skilled workers increases their bargaining power.

As China diversifies its trade, it becomes less dependent (and vulnerable) on the US and more integrated into the Russian-Asian-African-Latin American-Middle Eastern economies. As China’s financial sector expands domestically and globally and it shifts from being a capital importing to a capital exporting country, it faces new challenges and risks. Volatile stock markets, high-risk overseas investments can lead to big gains or steep losses, which can have serious consequences on China’s ‘real economy’. These risks grow as the Chinese government’s liberalization program accelerates and embraces all sectors of the economy.

China’s financial Liberalization and US Foreign Economic Strategy

There is no question that the impetus for China’s liberalization policies from the late 1970s to the present are a product of internal political decisions taken at the highest spheres of the government. Nevertheless, outside forces, principally the US government, have exerted pressure on China’s economic polity especially since the 1980s. US policy has pushed, pressured, threatened, cajoled and secured incremental but cumulative changes in China’s economic policies and structures over the last quarter century.

To summarize US policy goals and relative successes and failures:

1. Opening China to large-scale, long-term foreign investments and majority ownership.
2. Large-scale comprehensive lowering of trade barriers.
3. Patent and licensing agreements and defense of ‘intellectual’ property rights and their enforcement.
4. Restrictions on Chinese investments in specific lucrative US economic sectors.
5. Labor legislation to increase wages and the costs of production.
6. Efforts to restrict China’s economic expansion in Africa (Sudan), Southwest Asia (Iran), Middle East (Gulf States) by selectively raising human rights issues.
7. Sustained massive pressure to lower barriers to the US penetration of China’s financial markets, banks, savings, loans and investment houses.

US financial entry and expansion is the long-term and strategic goal of Washington’s foreign economic policy to China. In fact, most of the other US complaints and demands on China can be seen as bargaining chips in securing a decisive opening of China’s financial sector. Summarizing US imperial financial strategy, the first step is to secure China’s acquiescence in an ‘opening’ for financial groups to buy shares and secure a ‘beach head’ in each sub-sector: banks, financial houses and investor consultancies among others. This would be accompanied by further ‘liberalization’ of offshore investments as well as ‘in shore’ investments (buy-outs) by big US private equity funds. The third step would involve US financial giants exploiting their access to hundreds of billions of local savings (public and private) to invest in local manufacturing, commercial, technological and financial enterprises — leading to control over China’s strategic economic sectors. Finally having secured financial leverage over the economy through buy-outs and mergers and acquisitions to exert direct pressure on the political regime to serve US imperial interests.

The financial sector is the dominant economic sector in the US economy and the most politically influential. It is no surprise that the former CEO of Goldman Sachs, US Treasury Secretary Paulson, serves as the point man and the leading economic strategist of the US Empire in the Far East. Paulson’s tactic is to raise the protectionist demands of US manufacturers and demagogic politicians as a bargaining tool to secure Chinese concessions with regard to ‘opening up’ its financial and banking sectors to US penetration and eventual control. Today leading members of financial, banking and related ‘services’ have replaced manufacturers as the dominant group in the US ruling class. Paulson’s entire career is linked to Wall Street, and he has demonstrated his loyalties (and self-interest) by pursuing greater liberalization of China’s financial markets both as a CEO for Goldman Sachs and as the economic czar of US economic policy. Wall Street and the US imperial policy-makers all agree that the strategic goal is to liberalize China’s financial sector in order to gain access and eventual control over China’s foreign reserves, savings and investment capital via a direct institutional presence in China and via indirect influence by managing funds held by Chinese overseas investment agencies.

China’s Liberalization of Financial Markets

China’s economic policy makers have taken numerous gradual small steps toward opening its financial markets to US and foreign capital. The liberalization of the financial sector has been fraught with debate and opposition, but over time and more recently, the ideologues of liberalization have been gaining ground. The progress in liberalization has been incremental but accelerating despite the high risks involved. The highly negative results of financial liberalization evidenced by the Japanese crisis of the 1990s, the huge Asian crisis of 1997 and the open-ended US-EU crisis which began in July 2007 has failed to deter Chinese liberalizers who believe that China is immune to crises. China was not affected by the previous financial crises precisely because of capital controls, limits on foreign financial ownership and prohibitions on hot (speculative) funds. Despite the salutary effects of state-regulated financial controls, the Chinese liberalizing elites promote financial liberalization by arguing that:

1. Foreign bank entry will increase financial efficiency, lessen corruption, integrate China into international financial networks and, in general, upgrade China’s financial practices and organization.
2. Foreign ownership of Banks will be in partnership and under supervision of the state and thus will have to comply with Chinese laws and serve the national interest.
3. Investing Chinese foreign reserves overseas in private equity will earn more for the Chinese state than by holding US Treasury bonds. In any case ‘only’ $200 billion of the $1.3 trillion dollars in savings is allocated for equity investment.
4. By investing overseas China can secure its supply chain of vital energy, raw materials and food stuffs as well as reducing its trade surplus and negative political pressure from the US and EU.
5. By opening up the financial sector China can secure the support of Wall Street and the City of London against the protectionists, especially in the US, pitting Paulson and Bernake (Central Bank Head) against Senators Clinton and Schumer and other Democratic Presidential demagogues.

These arguments in favor of liberalization of the financial sector have deeply influenced Chinese policy-makers. China has increased foreign access to China’s booming stock market. In May 2007, Beijing agreed to allow new securities joint ventures and increased the range of activities these firms can participate in (Financial Times, May 25, 2007). Foreign banks are now allowed to issue credit and debit cards. Foreign financiers are now allowed to invest up to $30 billion dollars in domestic financial markets, triple its previous ceiling. For now China is resisting US pressure to lift ownership caps on foreign investment in domestic banks and to permit foreign companies to buy into domestic brokerages. However given the growing US and EU presence, experts expect China’s liberals to lift these restrictions in the near future.

China has given the green light to worldwide expansion, mergers and acquisitions and investments in minority shares of foreign equity companies (FT, May 31, 2007). China has recently opened its corporate bond market by eliminating quotas, and allowing bond prices and interest rates to be set by the market (FT, June 15, 2007). In 2006 the Chinese investment banking sector was opened to Morgan Stanley, Goldman Sachs and UBS they have benefited from a 10 fold increase in the stock market in 2007 (FT, June 6, 2007).

China’s promotion of private equity investments has led to a doubling of investments in mainland companies to $7.3 billion dollars in 2006, over 2005. However, the private equity investment sector has been dominated by giant US-owned funds, such as the Carlyle Group and Texas Pacific Group. In June 2007, Beijing opened the door to foreign buy-outs (FT, June 7, 2007).

China’s banks have pushed into wealth management, attracting more high net worth clients — while ignoring micro credit, low-income farmers and small producers.

China has virtually lifted all restrictions on foreign investment in Chinese private companies — leading to foreign penetration of several key sectors. During the first 5 months of 2007 overseas banks profits grew by an annualized 43% — $400 million dollars (FT, July 7, 2007).

The opening to private equity firms in China has been subject to continuing restraints — limiting purchases to minority shares. The US Carlyle Group has established an $800 million dollar toehold in financial services, media and manufacturing. Once established as minority shareholders, the big Western financial houses can move toward greater controls. Some equity funds and bankers have taken majority shares in small provincial banks — avoiding the political opposition, which results in attempts to grab majority shares in larger coastal banks. The key tactic is to establish firm economic and political links and leverage initial ties into wider spaces and larger profits over time (August 27, 2007). The key concern of the entire Anglo-American financial elite is to secure a clear path to capturing savings from retail banking customers. Barclay Bank has taken another route to entry into the Chinese financial market by selling 3.1% stock to the China Development Bank. Barclays now has an influential Chinese financial partner to facilitate buyouts in the China market.

China’s liberalization is leading to the export of capital via three state channels, which have loosened overseas investment restrictions. Starting with $90 billion dollars in one agency and $200 billion in another, Chinese capital provides an extremely lucrative field for international advisers to ‘create’ investment products to attract the nearly $300 billion dollars coming into the global market. The US and Europeans have already indicated they will block Chinese investment in what they will choose to describe as ‘strategic sectors’, as occurred in 2006 when Washington vetoed China’s purchase of UNOCAL Oil Company.

Western and Japanese finance capital enter China’s market via a two-step liberalization process. First the state privatizes energy, telecoms, manufacturing, and banking sectors. Under the new liberalization process, this is followed by initial private offerings (IPOs), where stocks are sold to investors, via listings in overseas stock markets. Big US banks and investment advisory groups, like Morgan Stanley, reap hundreds of millions in fees organizing IPOs. All the major IS investment banks including Merrill Lynch, Goldman Sachs and others are set for lucrative fees assisting the financing needs of China’s private sector. The rapid growth of China’s private sector provides a major breakthrough for Western finance capital especially investment banks. If and when the big state companies decide to list in overseas stock markers, mega-billion fees are in the offering for Wall Street and the City of London.
Liberalization: The Risks

The financial opening in China increases its risks to international financial and market volatility: the risks of investor contagion resulting from sudden downturns in overseas markets will affect Chinese overseas listings. Within China, liberalization has led to a growing speculative bubble as stocks have gone up nearly 200% over two years, without any commensurate growth in the earning power of the firms targeted. The stock price-earnings ratio is four times what is considered reasonable. Sooner rather than later the bubble will burst and scores of millions of retail investors will lose their savings and likely express their losses via public protest.

The incremental quantitative openings to foreign financial investors can lead to cumulative qualitative changes over time. There is a high probability that loosening quotas on foreign investments will lead to greater leverage for foreign capital to move through local Chinese proxies or ‘straw men’ toward dominant positions. While that is in not the picture today, it could easily become so if current liberalization policies deepen and extend over sectors with time. The fact is that foreign finance capital has the funds, organizational power and market command to out-compete local Chinese banks and bankers in any ‘open market’.

Similar serious risks exist with regard to Chinese overseas investments: Decisions by US and British investment banks and advisory units, apart from receiving lucrative fees, have already cost China’s Investment Corporation (CCIA) a $400 million investment loss in one month in one of its earliest overseas ventures: Blackstone’s IPO attracted $3 billion from CIC at $31 dollars a share. Its top CEOs, Steve Schwartzmann and Peter Peterson, cashed in their stocks capping over a half billion in profits. With the insiders’ sell-off, Blackstone’s stock dropped to less than $25 dollars a share ($23 by the end of August 2007) and the Chinese state lost in a very big way from what was deemed a legal but questionable operation by Blackstone’s top leadership. China’s short career in foreign equity ownership has resulted in a 22% loss. This CIC exercise in high-risk-big loss investing at the hands of US financial moguls is only the tip of the iceberg. The entire liberalization process both with regard to inflows and outflows of capital puts in jeopardy the entire edifice of China’s industrial growth. As Chinese finance capital speculates on funds from China’s export surplus and buys into risky financial instruments, millions face greater economic insecurity. Meanwhile hundreds of millions excluded from the inner financial circles continue to suffer the consequences of low-wages and the high cost of privatized education and health care. While middle and upper class Chinese can afford the luxury of winning or losing their discretionary earning on the stock market or converting their savings to offshore accounts, most Chinese workers and peasants — the backbone of China’s high growth — suffer the consequences of high volatility from the irrational behavior of the market gamblers.

Alternatives to Greater Liberalization

Liberalization of China’s financial sector is the strategic goal of US economic Czar, Hank Paulson. As the Financial Times emphasized, “The prize of access to the world’s fastest growing economy for US financial service groups has been one of the US Treasury Secretary’s most visible single pursuits, sparking criticism that he was beholden to the industry’s ambition to reach China’s 1.3 billion consumers.” (April 24, 2007) Leading US financial analysts agree. Robert Nichols of the Financial Services Forum underlined this point: “Secretary Paulson has put financial services on the agenda in our economic relations with China in a big way.” (Ibid) As we have mentioned in our text, Paulson has successfully pushed liberalization on a number of fronts: China has removed constraints on new foreign companies investing in brokerages and raised the quota for what foreign investors can invest directly in the Renminbi-denominated domestic market from $10 billion dollars to $30 billion dollars.

China has facilitated the licensing for foreign insurance companies — opening up a multi-billion personal insurance market to big western insurers. Beijing has also allowed foreign securities firms to expand operations to include property trading and fund management (FT April 24, 2007). China has opened the multi-billion dollar credit card sector to foreign banking by allowing foreign invested banks to open their own brand of Renminbi-denominated credit and debit cards.

As financial liberalization moves Wall Street and the City of London closer to achieving their ‘prize’ — massive entry and control of China’s financial markets — the Chinese financial sector runs a multiplicity of growing risks. The risks from deepening liberalization include: loss of control of economic policy via the growth of foreign control over financial levers; risks from making overseas investments based on inexperience, lack of information and collusion between investment advisory agencies and corporate enterprises.

China’s risks of big losses by investing overseas in ‘highly rated’ securities, bonds and stocks is illustrated in the current world financial crisis ignited by the sale of ‘sub-prime’ mortgages and now extending throughout the prime mortgage and other securities markets.

The general truism that political power follows economic penetration is applicable to China. As the US and European financial sector enters in ‘partnership’ with Chinese banks, they will likely use their leverage over their counterparts to co-opt, bribe and pressure local and state officials to further liberalize and extend foreign access to Chinese stocks, bonds, securities, savings and eventually full ownership of strategic financial sectors.

In contrast to the high risks of losing political and economic control and investment losses — evidenced by the $400 million dollar loss in the CIC investment in Blackstone — China has sound, low-risk investment opportunities in the domestic economy which will enhance long-term, large-scale growth.

China each year suffers serious economic losses due to the dismantling of its public health system. One of the biggest casualties of the transition to capitalism has been the privatization of health care and the loss of all medical coverage of China’s hundreds of millions of poorest peasants and rural migrants. (Financial Times, August 30, 2007). A fifty billion dollar investment in free rural public health program, staffed by professional doctors and nurses, low-cost drugs and basic medical technology would increase productivity and consumer spending (currently saved for medical emergencies), reduce troublesome trade surpluses by increasing imports and increase living standards. (OECD China 2005, page 12). This would also lead to a decrease in female infanticide, because the insecurity of access to medical care after retirement is one of the main reasons rural families prefer to have only sons.

China’s primary and secondary school system has been privatized — as local and state governments have introduced fees. The result is a growing dropout rate among tens of millions of poor Chinese children. “Over the last five years, the number of Chinese who cannot read and write grew by 30 million to 116 million, wiping out years of gain,” (China Daily, April 2, 2007). China’s move from a low skill, labor intensive economy to a more advanced technological society will be hampered by lack of basic educational skills. Public investment of at least $20 billion (from the $200 billion investment funds) is low risk, highly productive and employment generating. Investment in universal free public education will employ millions of teachers, principals, school workers and construction workers in building and maintaining schools and related facilities, expand the domestic demand for manufacture of books, computers and school materials.

Every major environmentalist group, national and international political leaders, tens of millions of Chinese workers and residents have pointed to the high cost of pollution both in terms of unhealthy population, loss of productivity and losses of cultivated land, drinkable water and safe air. China could invest $100 billion dollars in alternative energy usages, energy efficient buildings and the regulation and closure of industrial and chemical polluters. According to the World Health Organization, 705,000 people die prematurely every year in China because of filthy air and water (World Book Report March 2007, quoted in Financial Times July 3, 2007). For every early death, we can assume at least several hundreds of thousands who are temporarily or partially incapacitated by pollutants. While top leaders have urged local officials to act and even established environmental criteria in their performance evaluations, pollution continues to grow. China’s decentralized political structure allows local official to violate national directives and encourages them to continue to promote local polluters. Only national directives and funding administered by local democratically elected environmental committees, which include independent consumer and environment specialists with police powers, can break the power of the alliance of local/state officials with the public/private polluters.

China’s dependence on foreign markets and offshore investments is a result of the weakness of the domestic market, largely the product of the low salaries, wages and dismal consumer power of workers and peasants. The weakness of the domestic market for mass produced goods is the result of the great concentration of wealth and income in the upper 10% of the population, China has (with Nepal) the worst inequalities of any Asian country. Inequalities in China are greater than Japan and 50% greater than in Taiwan or South Korea (FT August 9, 2007). Enforcing minimum wage, limiting working hours and occupational safely legislation will increase the purchasing power and available shopping time for hundreds of millions of consumers who are marginalized from the domestic economy. China will become less dependent on exports, social unrest will decline and potential political upheavals will decrease. Investing in raising income will reduce profits, conspicuous consumption by the economic elite and stock market speculation. Wage increases will also reduce the trade surplus and the search for risky overseas investments.

China is at the turning point: Continued liberalization leads to high risk overseas investments, loss of domestic market control, greater inequalities and pollution, leading to greater political and social unrest.

Political and social reforms re-orienting investments to the domestic market and rebuilding the entire public educational and health system is central to ‘constructing socialism with Chinese characters.” Intervening through locally elected community based environmental assemblies to liquidate polluters is necessary to modernizing China and preparing it for a more advanced economy.

Raising income and corporate taxes on the emerging foreign and domestic corporate elite is necessary to lessening inequalities and controlling luxury imports. Lessening the power of the state and private ruling class avoids high-risk foreign takeovers of strategic economic sectors via ‘joint ventures’.

China’s giant economic leap forward via public-private investments has opened a vast, far-reaching internal debate over its future direction: The choice is between accelerated liberalization and open doors for foreign financial capital, as US Treasury Secretary Paulson argues, or profound rectification and re-orientation toward low-risk, large-scale investment in the domestic market, as many Chinese workers demand. Will China follow a path of neo-liberal reform with Western characters or a socialist model with Chinese characters?