The Independent

9 October 1998

The Chinese illusion

It is a pity that Western leaders like Mr Blair have not learned from the Asian crisis. By Gerald Segal 

AT FIRST glance, Tony Blair looks as if he has enjoyed an excellent spot of strategic tourism in China this week. The Chinese, as they can do so well, made Blair look good, upstaging the hapless William Hague in Bournemouth. Blair made sure he said just enough about human rights to muffle most of the critics on the left of his party. In comparison to France's Prime Minister Jospin, who visited China in September and barely mentioned human rights, Blair could bask in the comments by Peking's spin doctors that this was the most important foreign visit in 1998, apart from President Clinton's in June. 

But blink again and you see a visit in an early Eighties time-warp, when Western leaders flocked to Peking to praise China's great reform experiment and add to the hype about China as the next superpower. Blair, like Clinton, justifies mealy-mouthedness about China's domestic and external behaviour on the false premise that China is a great power that is helping to keep the Asian economies from further chaos and maintain regional security.

Sadly, this is merely the new version of a 200-year-old illusion about Chinese power. As usual, the leading inflators of China are in a business community that dreams of a massive Chinese market. In reality, China is a fragile country with a lethal combination of Japanese and Russian failures. Like Japan, China has a bubble economy compounded by weak political leadership. Chinese officials in Shanghai proudly showed Tony Blair acres of shiny new buildings, with plans laid for the world's largest office tower. No mention was made of the fact that 70 per cent of the new buildings were empty and the skyline was littered with abandoned building sites. Money is pumped into this system at a time when bad bank loans stand at 40 per cent of GDP.

Chinese entrepreneurs know, even while Chinese officials try to persuade foreigners otherwise, that money is better invested outside China. Hence the fact that more money has fled China than entered since 1992; and in 1998, the outflow of hot money is nearly twice the rate of inflow. Such capital flight is the clearest possible sign to foreigners that the Chinese economy is in trouble, and was a warning sign that many missed before the collapse of other Asian currencies in 1997.

To be fair to the Chinese leadership, they understand these problems, even if the distinguished British visitor is told otherwise. Prime Minister Zhu Rongji's reform plans announced earlier this year, and now mostly shelved, are testimony to the vastness of the challenge and the weakness of Chinese leadership. To some extent China, like Japan, has leaders who know they need to undertake difficult and dangerous reforms, but are too indecisive to keep moving forward nevertheless. Precisely because so many states in Pacific Asia are in such deep economic trouble, China is now wondering whether it learned the correct lesson in opening up to the outside world. It is a pity that senior Western leaders like Mr Blair have not learned from the Asian crisis and become more sceptical when seeing capital flight, empty buildings and optimistic rhetoric.

A Chinese economist, He Qinglian, has published in China a daring analysis of why her country's reforms are merely "the marketisation of power". Like the dominance of Russian "oligarchs", power in China is concentrated in the hands of a tiny elite of "red princes and princesses" and well connected officials. Income inequality has grown rapidly in China and, since 1994, has been higher than in the US. The 70 per cent of the Chinese population that lives in the countryside have even seen a real (not just relative) decrease in wealth in recent years. Under these circumstances, China, like Russia, suffers what Ms He calls a "collapse of ethics".

The analogy with Russia also includes the failure to collect taxes, regional power-brokers thumbing their noses at central authorities and, most disturbingly, growing capital flight. In Russia, as in China, despite the massive outpouring of money by local elites, Westerners are exhorted to pour money into their country. 

What is most remarkable is that Tony Blair brings UK investors who contemplate investments where locals no longer dare. More encouraging is the fact that the British delegation is returning with far fewer deals than expected. The risk of entering enthusiastically into business deals with China (especially those supported by UK government export guarantees) is that the British money will be lost just as surely as it has been lost in Indonesia and elsewhere in the region in recent months.

The most obvious parallel with Russia is in the failure to reform rusting state-owned industries (SOEs). Chinese officials know they cannot deal with their bankrupt banking system unless they stop providing drip-feed loans to long-dead SOEs. Some 4 per cent of China's supposed 7 per cent annual GDP growth is the unsaleable product of the SOEs. Amazingly, bank lending has increased by 24 per cent in the first half of 1998, but in a rapidly deflating economy the government fears that closing SOEs will cause mass unemployment and social unrest. In the absence of a welfare system there seems to be no choice but to sustain SOEs as a proto-welfare net. Nevertheless, unemployment is at 10 per cent and rising.

Of course, there are also important differences with Russia. China's political system remains far less pluralist; there is no equivalent to an independent Duma or a freeish press. China's currency has a fixed exchange rate and convertibility is constrained, thereby limiting the ability of international markets to impose "market discipline". The Russian economy depends far more on the export of natural resources, while China has been successful in developing a light industrial export sector. China has also benefited from large inflows of capital from ethnic Chinese.

An optimist about China will claim that Taiwan is the future, where a once-Leninist ruling party transformed itself and the surrounding political system into effective pluralism. But as Chris Patten astutely notes in his recent book, East and West, a more likely future for China may be a version of Indonesia. Crony capitalism, politically powerful armed forces, regional tensions, income inequality and some encouraging signs of the emergence of a civil society are all present in modern China. No wonder that China turned off CNN's satellite feed when student demonstrators on the streets of Jakarta toppled President Suharto.

In the final analysis, clarity about China's fate will not be achieved until we understand that China and its foreign apologists have not truly broken with the past. China is burdened both by its failure to understand that it cannot defeat or even remake the Western system that dominates our world, and by its failure to reject the Leninist solution. As China approaches the 50th anniversary of its Communist revolution, it becomes all the more alarming that, unlike Russia, it has not admitted that its revolution was a huge mistake. What is more astounding is that supposedly innovative Western leaders cannot distinguish dying Communist rhetoric from stark reality.

A truly innovative British approach to China would be one based on a more honest appreciation of China's flaws: speak plainly to China, not only about its abysmal human rights record but also about the fact that it will be taken less seriously by the outside world unless it changes its economic and foreign policies. Offer China help in reforming its banking system, but do not feed its sense of self- importance by minimising the risks of economic failure. Speak plainly to China about its risky behaviour in the South China Sea, threats to Taiwan, and destabilising exports of military systems. If you come in awe of China, you tend to go away with a more dangerous China.

The writer is director of studies at the International Institute for Strategic Studies in London