A preview of Nick Lardy’s new book *The State Strikes Back*

A new Nick Lardy book comes along regularly every few years, and each one is an event for the China-watching community. Anyone who cares about the Chinese economy will find The State Strikes Back: The End of Economic Reform in China? interesting and provocative. This is a preview, not a review, since the book is not officially out until next week and so my Kindle pre-order hasn’t downloaded yet. But I saw his book talk in Seattle last night, where he gave a characteristically clear and concise summary of the argument (he also has an op-ed in the FT.)

The new book has to be understood in the context of Lardy’s previous book from 2014, Markets Over Mao: The Rise of Private Business in China. In that book he argued that it was the rise of increasingly efficient and productive private-sector companies that has driven China’s economic growth over the last four decades, not state-owned enterprises, government planning and industrial policy. In contrast to the view in some quarters that China remains a fundamentally state-controlled economy, he laid out all the ways in which markets have been liberalized and competition increased since 1978.

A lot of the key changes in the relationship between the state and private sector happened in the 1980s and 1990s, and are well explained in that book. But Lardy also engaged with the argument that, as he put it, “state-owned firms returned to prominence of the decade of leadership of President Hu Jintao and Premier Wen Jiabao (2003-12)”.

While acknowledging that the Hu-Wen government wanted to make state enterprises and industrial planning play a a bigger role in the economy, he argued that the data showed they had not succeeded. In fact, the private sector’s share of economic aggregates had continued to increase, not because of continued privatization but because private firms are more efficient and grow faster than SOEs. This process was aided by a substantial increase in private firms’ access to bank credit.

The main point of Lardy’s new book, based on his slides and talk, is that the positive trends he had emphasized in his last book are now going in reverse. The data now show that private firms’ access to bank credit has sharply declined, and that their share of various economic aggregates is also falling. He puts particular emphasis on the drop in lending to private firms:

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(Note: Lardy has a chart like this in his slides, but this is my chart not his. It is based on the same underlying data but my estimates come out slightly different.)

The big decline in bank lending to the private sector (the absolute volume of new loans to private companies shrank, not just the share) had major consequences. It forced private firms to rely even more on shadow finance. But in 2016 the government also decided (correctly) that the rapid expansion of shadow finance posed systemic risks. The tightening of regulation led to an outright decline of shadow financing in 2018, putting many private firms into dire financial straits. The financial pressure on private firms has allowed their state competitors to expand at their expense: SOEs in industry are growing faster than their private competitors. Lardy said this is the first time this has happened since 1978.

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(Again, this is a re-creation of one of Lardy’s charts using public data.)

Lardy thinks all this is bad for China. He is right! He also puts most of the blame on the policies of Xi Jinping–tolerating SOE inefficiency, encouraging the creation of larger SOEs, tightening Party control over private firms–since these trends in the data did not show up until a few years into his administration.

Essentially, both of Lardy’s recent books are about the use of economic data to support a narrative about the direction of reform in China. In Markets Over Mao, he argued that the data did not support a narrative of the resurgence of the state sector, and in fact supported a narrative of the rise of the private sector to new heights. I think it is fair to say that a number of people felt that Lardy in that book was too forceful in downplaying trends that were in fact important, but perhaps were difficult to tease out in the aggregate economic data. Now, Lardy is arguing that the data support a narrative that the state is resurgent and the private sector is losing out. Since this is a recent reversal of a positive long-term trend, he thinks that if China changes course it could significantly boost its economic growth rate, by as much as 2 percentage points.

My own view is more that economic policy under Xi Jinping represents an intensification of trends that were already playing out under Hu Jintao. I think this is pretty clear if you pay attention to China’s official rhetoric and try to understand the underlying political economy. Since I think the problems go back further than 2015, I am less optimistic than Lardy about China’s longer-term growth prospects (thanks to Greg Ip of the WSJ for including a summary of my views in his latest piece).

I also think that it is tricky to tell a clear story about the rise or fall of the state sector using the official economic data–having spent a lot of time and effort trying to do that myself. As someone who very much appreciates Lardy’s careful work with Chinese data, let me offer a couple of caveats to the charts above, in the spirit of seeking truth from facts.

First, on the bank lending data. Lardy is right to highlight the sharp downturn in lending to private companies in 2015-16. But it is not clear to me that this is a result of government policy to favor SOEs. Recall that there was a pretty serious economic downturn in 2014-15. It would make sense for banks to respond to that by trying to reduce the risk in their loan books, and one obvious way to do that would be to curtail lending to smaller and riskier companies, i.e. private ones. (The fact that SOEs are seen as less risky than private companies is a structural problem, but it’s nonetheless true that banks are correct to make this judgment given the realities of China’s political economy.) In other words, the change may have been more cyclical than structural.

There is some preliminary evidence that supports this interpretation. The data that Lardy and I use to calculate lending to state and private firms is released with a long lag, and recent figures aren’t out yet. But banking officials disclosed last year that lending to private firms totaled 30.4 trillion renminbi as of September 2018. This is equivalent to 38% of outstanding corporate loans–which is roughly the same level as in 2013, and a big increase from the 32% in 2016 (again, this is the share of outstanding loans; the chart above is the share of new loans made each year). This suggests that new loans to private firms rebounded in 2017-18 (probably more in 2017) as the economy recovered.

Second, on the industrial data. The fact that industrial SOEs are increasing their value-added faster than private companies is certainly notable. But SOEs and private companies tend to operate in different industries, so it can be hard to tease out the difference between sector effects and ownership effects. Industrial SOEs are concentrated in upstream, commodity-producing sectors, while private firms are more in downstream manufacturing sectors. It seems quite likely to me that the big decline in SOE value-added in 2015-16, and its rebound in 2017-18, have the same source: swings in commodity prices that had big effects on their profitability (value-added is basically profits plus labor compensation). The chart below uses monthly rather than year-to-date data, and we can see that the growth in SOE value-added has recently fallen back below that of private firms as steel and oil prices have come down.

iva-ppi

Lardy is right that the fact that in these charts the red line (SOEs) is above the blue line (private firms) is significant and concerning. But if this year or next the blue line moves back above the red line, will that mean China’s private sector is out of the woods, and all is fine? I suspect not.

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Xi vs. Stalin: What drives the reversal of economic reforms?

In the parlor game of finding historical analogies for present leaders, Chinese leader Xi Jinping is often compared to Mao Zedong. This is not very apt: Xi is an organization man, whose overriding desire for order is quite different from Mao’s love of chaos. After spending some time with Stephen Kotkin’s Stalin biography, StalinParadoxes of Power 1878-1928, I am surprised more people do not compare Xi to Stalin (though of course some have). Both men rose in an authoritarian system formally run by a collective leadership, and shifted it in the direction of more personalized rule for themselves and tighter political controls on everyone else.

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Stalin, of course, also unleashed a historic economic catastrophe upon the Soviet Union, when he abandoned the market-tolerating New Economic Policy and embarked on a crash course of agricultural collectivization and forced industrialization. Xi has not done that! His endorsement of industrial policy and favoring of state enterprises has disappointed many liberal economists. He wants a strong state, has re-emphasized Marxist ideology and clamped down on public policy debate. But it is also worth remembering that he has allowed technocrats to liberalize the exchange-rate regime and tighten up financial regulation, two long-needed reforms.

Nonetheless, the slowing economy has recently led to more public discontent with Xi’s policies. Xiang Songzuo, the former chief economist of Agricultural Bank of China, is one of those arguing that there is a connection between Xi’s aggressively Marxist rhetoric and weaker growth: he thinks a loss of confidence and fear of expropriation among private entrepreneurs is aggravating problems caused by the buildup of debt and misallocation of investment (see this translation of a speech he gave in December). Some foreign commentators are also warning that there is a “big danger that China will re-nationalize much of its economy.”

So it seems worth posing this question: what caused Stalin to abandon pro-market policies, and could similar factors be at play in Xi’s China?

Continue reading →

The origins of the Communist party-state dual structure

One of the many fascinating tidbits scattered through Stephen Kotkin’s Stalin: Paradoxes of Power 1878-1928the excellent first volume of his Stalin biography, is an explanation of where the unique “party-state” Communist political structure comes from.

In China today, as in the Soviet Union in the past, the Communist Party and the government exist as parallel, intertwined institutions, with Party clearly politically superior even as government bodies do most of the practical work. In the Soviet case, this resulted from the fact that the Bolsheviks had seized power as a minority party but were nonetheless attempting to exercise absolute control over the entire country:

Party thinking equated Bolshevism with the movement of history and thereby made all critics into counterrevolutionaries, even if they were fellow socialists. Meanwhile, in trying to manage industry, transport, fuel, food, housing, education, culture, all at the same time, during a time of war and ruin, the revolutionaries came face to face with their own lack of expertise, and yet the solution to their woes struck them with ideological horror: They had to engage the class enemy—“bourgeois specialists”—inherited from tsarist times, who often detested socialism but were willing to help rebuild the devastated country. …

But the cooperative tsarist experts were not trusted even if they were loyal, because they were “bourgeois.” Dependency on people perceived as class enemies shaped, indeed warped, Soviet politics and institutions. The technically skilled, who were distrusted politically, were paired with the politically loyal, who lacked technical competence, first in the army and then in every institution, from railroads to schools. The unintentional upshot—a Communist watchdog shadowing every “bourgeois expert”—would persist even after the Reds were trained and became experts, creating a permanent dualist “party-state.” …

“The institution of commissars” in the Red Army, Trotsky had explained of the political watchdogs, was “to serve as a scaffolding. . . . Little by little we shall be able to remove this scaffolding.” That dismantling never happened, however, no matter how often commissars themselves called for their own removal.

China went through a similar dynamic as the Communist Party took over government and nationalized companies after 1949: Party figures were installed to oversee managers and technical experts. As in the USSR, this dual party-state structure persisted long after its immediate justification had passed, even when the majority of government officials and company leaders had become Party members. In other words, the Communist Party has continued to treat its own country as a hostile environment that could not be trusted.

The fact that the dual Party-state structure is, essentially, institutionalized mistrust, is one reason why this system is hard to defend on principle. Chinese scholars have been discussing the need for the Communist Party to adapt from being a “revolutionary” party to a “governing” party for decades. In the liberalizing 1980s, there was the beginning of a movement to formally separate the Party and government, but this was reversed in the post-1989 return to conservative politics. Xi Jinping also seems to want to clarify the relationship between the role of the Party and government. But he has taken the opposite approach: formalizing the Party’s leadership over the government (see my previous post on this topic).

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The best books I read in 2018

My nonfiction reading this year was heavy on specialized works of Chinese history, which were useful to me but not easy to recommend to others, so I’m putting fiction first this time. It’s more fun. As with previous lists, these are just my favorites of books I read in 2018, not limited to books released in 2018.

Fiction

  • Varlam Shalamov, Kolyma Stories. Unquestionably the best thing I read all year, utterly compelling. If there is any justice, the publication of this new translation will reorder the established hierarchy of twentieth-century Russian and world literature.
  • Keith Gessen, A Terrible Country. A charming and moving account of a young American’s complicated relationship with Russia.
  • Madeline Miller, Circe. The witch who entrapped Odysseus and his sailors tells her side of the story; a vivid reimagining that retains the weirdness and force of myth.
  • Caitriona Lally, Eggshells. A mentally disturbed woman rides the bus in Dublin. Often hilarious, sometimes infuriating, with wonderful wordplay throughout.
  • Eric Ambler, The Light of Day. A top-notch thriller from 1962 whose focus on people stuck in between national borders feels very contemporary. Check out Ethan Iverson’s guide to all 18 of Ambler’s novels.
  • Jim Harrison, Legends of the Fall. In this collection of three novellas, the title piece  and “Revenge” are both brilliant, “Westerns” in the widest and best sense of the term (you can skip the middle one though).

Nonfiction

The world’s most unproductive entrepreneur

The new book by Wall Street Journal reporters Tom Wright & Bradley Hope, Billion Dollar Whale: The Man Who Fooled Wall Street, Hollywood, and the Worldis amazing. It must be one of the most detailed accounts of high-level corruption ever produced. I had followed their reporting on Malaysia’s 1MDB scandal, and generally understood that the financier Jho Low had colluded with former prime minister Najib Razak to embezzle ungodly amounts of money from the state development fund.

But what I had not really grasped before reading this book is that Low did not just steal money that belonged to the Malaysian state and people–he actually organized the creation of the 1MDB fund, and effectively controlled it. The 1MDB fund in fact never had any other purpose or rationale than as a vehicle for corruption.  The scheme got its start when Low approached the sultan of Terengganu, cleverly exploiting the opportunities for corruption in Malaysia’s system of hereditary monarchies:

He’d built a quick reputation in Malaysia as a deal maker, but, as always, Low was keenly aware of how his success stacked up on a global stage. Low had observed the power and status of Khaldoon Al Mubarak of Mubadala, who ran the Emirati sovereign wealth fund. A fund like that had billions of dollars in investments, not mere millions.

Why, Jho Low wondered, couldn’t he put together a sovereign wealth fund of his own—one based in Malaysia? But where could he find the initial funds? Traditional sovereign wealth funds invest oil profits, and so Low honed in on the Malaysian state of Terengganu, which was rich in offshore oil and gas fields.

But it didn’t take long for that local fund to become a national initiative. In August 2009, Najib announced the launch of the 1MDB fund at a dinner with the crown prince of Abu Dhabi:

The 1MDB fund was simply the Terengganu Investment Authority, which had recently raised $1.4 billion in Islamic bonds, transformed into a federal entity. The 1MDB fund would be responsible for repaying the bonds. Once Najib came to power, Low convinced him to take over the fund, broaden its remit, and look for Middle East backing.

Low’s pitch for the 1MDB fund was basically that it would be a completely unaccountable vehicle for the prime minister to dish out development projects and political patronage to benefit himself and his supporters:

The 1MDB fund was supposed to invest in green energy and tourism to create high-quality jobs for all Malaysians, whether of Malay, Indian, or Chinese heritage, hence the slogan “1Malaysia.” The fund, Low promised the prime minister, would suck in money from the Middle East and borrow more from global markets. But he had another selling point, one which Najib, who was ambitious, found extremely attractive: Why not also use the fund as a political-financing vehicle? Profits from 1MDB would fill a war chest that Najib could use to pay off political supporters and voters, restoring UMNO’s popularity, Low promised.

Over the next few years, Low and his conspirators would use 1MDB to borrow billions of dollars from global capital markets, and would simply take much of the proceeds for themselves. To achieve all this required Low to do constant networking, set up immensely complicated financial and legal arrangements, and splash out tens of millions of dollars along the way to win friends and influence people. Low in fact worked hard at his corruption, and displayed unmistakable entrepreneurial flair–a huge amount of effort deployed to make his country poorer not richer.

Previously I had thought of corruption as mostly acting like a drag or tax on the economy: the extraction of bribes to approve a construction permit or dismiss traffic fines. My imagination had not quite encompassed the idea that corruption could be a motivating force for huge economic initiatives that would be entirely wasteful. So one lesson from the book seems to be that I have been insufficiently cynical about human frailty.

Low’s tale also made me recall the distinction that William Baumol made between productive and unproductive entrepreneurs, in a famous 1990 article:

The basic hypothesis is that, while the total supply of entrepreneurs varies among societies, the productive contribution of the society’s entrepreneurial activities varies much more because of their allocation between productive activities such as innovation and largely unproductive activities such as rent seeking or organized crime. This allocation is heavily influenced by the relative payoffs society offers to such activities. …

If entrepreneurs are defined, simply, to be persons who are ingenious and creative in finding ways that add to their own wealth, power, and prestige, then it is to be expected that not all of them will be overly concerned with whether an activity that achieves these goals adds much or little to the social product or, for that matter, even whether it is an actual impediment to production (this notion goes back, at least, to Veblen). …

There are a variety of roles among which the entrepreneur’s efforts can be reallocated, and some of those roles do not follow the constructive and innovative script that is conventionally attributed to that person. Indeed, at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy.

Baumol’s article cited many interesting historical examples of unproductive entrepreneurship, but his contemporary examples were all a bit dull: he mentions tax evasion and corporate lawsuits. Low’s audacious scheme to create a sovereign wealth fund in order to plunder it surely makes him the paragon of twenty-first-century unproductive entrepreneurship.

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Gessen on Shalamov: “It was nothing personal. Just the twentieth century.”

I really enjoyed Keith Gessen’s new novel A Terrible Countrya charming, convincing and moving account of a young American’s complicated relationship with Russia. The narrator is a struggling low-level academic specializing in Slavic literature, who must return to Moscow to care for his aging grandmother. He gets by teaching an online course in Russian literature, but generally seems more passionate about playing pick-up hockey than the great Russian books.

One of the only exceptions, to my surprise and delight, is a digression on Varlam Shalamov’s Kolyma Stories, which I just read this year and immediately recognized as an indisputable masterpiece. Here is the narrator’s appreciation of Shalamov:

Shalamov saw things differently from Solzhenitsyn. He saw them doubly, ambivalently. He thought Solzhenitsyn was a windbag. Physical pain, hunger, and bitter cold: these could not be “overcome” by the spirit. Nor did the world divide neatly, as it did for Solzhenitsyn, between friends and enemies of the regime.

For Shalamov, in the camps there were people who helped him and there were people who brought him harm (who beat him, stole his food, ratted him out), but the majority of the people he encountered did neither. They were just, like him, trying to survive. There was great brutality in the camps, and very little heroism.

In his memoirs he told a remarkable story about learning, at one of the darkest moments of his camp life, that his sister-in-law, Asya, with whom he was close, was in a nearby camp. Shalamov was in the hospital with dysentery, and one of the doctors wanted to know if he wished to send Asya a message. Only half alive, Shalamov scribbled her a short and unsentimental note. “Asya,” it said, “I’m very sick. Send some tobacco.” That was all.

Shalamov clearly remembered this with shame, but also with understanding: he was weak, on the edge of death, and had been reduced to a bare animal existence. There was no great lesson in this, except that in certain conditions a man quickly ceases to be a man.

It was nothing personal, as the saying goes. Just the twentieth century.

This is very well put, far better than I managed when trying to express what is so great about Kolyma Stories (here is my previous post on Shalamov).

For more on Gessen’s novel, Francise Prose’s review is on the mark, and gives a good flavor of what the book is like.

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A novelist’s view of China’s rise, from 1983

Walter Tevis’ 1983 science-fiction novel The Steps of the Sun is mostly not a very good book; unlike some of his other books (the excellent chess novel The Queen’s Gambit, or The Color of Money) it has not aged well. The one thing about the book that does seem ahead of its time is the worldbuilding: it is set in a future world in which China has unquestionably risen. Here is one background passage:

Half the people on the street were Chinese. By midsummer New York always seems to be a Chinese city, a kind of cultural suburb of Peking. The Russians are ahead of everybody else at heavy industry; the art comes from Buenos Aires and Rio de Janeiro; the political life in Aberdeen and Hangchow is far more lively than New York’s; and if you want to make a really big business arrangement you go to Peking, the world’s richest city.

But New York is still New York, even with its elevators not working and a total of one hundred fifty taxis permitted to operate (Peking has thousands, they are electric powered and have leather upholstery). But Peking is still a stodgy businessman’s city, with all the old China erased from its neoclassical architecture. The Chinese come to New York for the civilized life.

New York is the major city of a second-rank power, of a country whose time is slipping away; but it still has a bounce you don’t find anywhere else. There are restaurants with white tablecloths, with waiters in tuxedos that look like they came from the last century, and, however they beer-feed and hand-rub their fat old steers in Japan, the Kansas City steak served in a New York restaurant, with the dim lights and the polished wooden bar and the tuxedoed waiters, is still one of the delights of the world. And New York theater is the only theater to hold anybody’s interest for long; American music is the most sophisticated in the world.

The Chinese are still, behind those stuffy facades, the greatest gamblers on earth and the trickiest businessmen; they’ve accommodated their ideology and their asceticism of the last century to their present wealth with the ease of the Renaissance Popes; they are Communists the way Cesare Borgia was a Christian. And they love New York.

Some of these details are remarkably prescient: the Chinese tourists crowding the streets of New York, and the way the city serves as a kind of living museum of a certain type and period of culture. The bit about China being ahead of the US in electric vehicles also has a ripped-from-the-headlines feel. In another passage, a billionaire shows off his ability to speak Chinese (remind you of anyone?).

This is pretty unusual stuff for 1983, when Americans were obsessed with the rise of Japan and had barely begun to notice China. William Gibson’s much more famous Neuromancer, from 1984, chose Japan as the natural setting for its hyper-technological fantasies. So I am curious what might have inspired this aspect of the book; there is little in Tevis’ biography to suggest a particular interest in or knowledge of Asia.

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