Can State-Run Capitalism Absorb the Shocks of ‘Creative Destruction’?

There is little doubt that state capitalism has been a key part of China’s super-charged growth over the past decade, and I agree with Bremmer that, over the long term, “state capitalism is not equipped to create the lasting and broadly shared prosperity on which construction of an innovative economy depends.”  So what happens?  Experience tells us these companies don’t just blow up: instead they gradually exert increasing drag on the economy, sucking in resources and producing fewer benefits for society.

There’s evidence that this is already happening in China.  Although central state enterprises continue to grow, their profits as a share of GDP peaked in 2007.  The two most profitable state firms have been wracked by corruption scandals. China Mobile has been grappling with a long slow-bleed scandal, while also struggling to adapt to new types of competition in its core markets (China Mobile’s profits declined in the third quarter 2013 for the first time ever).  Even more critical is the explosive scandal at China National Petroleum Company that implicates former Standing Committee member Zhou Yongkang, and poses the question of how high Xi Jinping’s anti-corruption campaign will reach.

So what’s going to happen?  Nothing.  Right now, the state firms are too powerful, and too embedded in the Communist Party system to change.  But here’s the question:  Can a new round of economic reforms reduce the privileged position of state firms, and create a more level playing field?  Financial reforms, if successful, will create more equal opportunities and higher costs of capital for SOEs; resource pricing reforms would take away some of the windfall profits and opportunities for manipulation that central SOEs currently enjoy.  If these reforms are successful, state firm paper profits (still large) will begin to erode.  If, and only if, that happens, we might begin to see Chinese leaders rethinking the role of SOEs, and making some tough choices about the future.

Observers have been predicting the inevitable demise of China’s state-owned enterprise for decades. And yet, here we are again debating their ability to survive despite the clearly demonstrated fact that they have not only survived by thrived.

That’s impressive and depressing. Impressive, because it’s a demonstration of the amazing human resources machine that is the Communist Party. Lumbering, money-losing behemoths were able to shed millions of workers and cut back benefits to turn into relatively efficient and even profitable corporations. There was social unrest and worker protest but most were managed away with careful infusions of cash and selective knocking of heads.

Depressing because these strengthened state-owned enterprises do, as Bremmer suggests, suck the air out of the economy and make it tougher for more creative private corporations to blossom. In effect, it looks like China has decided it would rather plod along with slower growth and suppress the incredible talent and innovation of its people.

Why? Because the state-owned enterprises represent the Communists Party’s core constituency. To make a slightly poor comparison, the state-owned sector is the party’s biggest campaign donor. Why would they reduce them? And what happens when private enterprises get really large? They start asking all sorts of pesky questions about rule of law and level playing fields that chip away at party authority.

So, bottom line: don’t bet against the survival of the state sector. Just don’t expect it to be too interesting.

Basically, there is nothing in China that resembles capitalism, so the question itself makes no sense. China is a typical example of a socialist planned economy. The economists Mises and Hayek have already made it clear that the socialist planned economy cannot survive in the long run. China will no doubt be an example of that. If not, then we will have to reconsider all of our basic notions about how economic systems work. However, nothing going on in China today suggests that will be necessary.

Can China’s state-run capitalism survive “creative destruction”? No, because entrenched interests will defeat change. The No. 1 enemy of the Chinese economy is political paralysis. Apart from the “leftists,” just about everyone in China knows what to do, but the political system is not capable of implementing meaningful restructuring.

When the economy was growing at a double-digit pace, political stagnation was not a big deal. But now independent data—corporate results, private surveys, and employment-creation statistics, for instance—reveal growth only in the low single digits. And if it weren’t for state investment—think “ghost cities” and high-speed rail lines to nowhere— the economy would probably be contracting. So China needs a new path. Premier Li Keqiang has promised significant reforms reducing state involvement in the economy, but so far there has been disappointment with his initial moves, even the much-discussed free-trade zone in Shanghai, with its surprisingly restrictive rules.

Li means what he says, but he works inside a collective political system and, for all his power, does not make decisions on his own. Everyone hopes there will be announcements of reform at the Third Plenum next month. Promises of change then may sound ambitious, but it’s unlikely they’ll be implemented in the foreseeable future. The entrenched interests that both Ian Bremmer and Barry Naughton refer to have captured the Chinese political system and will block urgently needed reforms.

Yet the entrenched interests are not the only roadblocks to change. China has progressed about as far as it can within its existing political framework. Further reform would threaten the Communist Party’s hold on power, so it will not sponsor change of that sort. A market economy, for instance, requires the rule of law, which in turn requires “institutional curbs” on government. Because these two limitations on power are incompatible with the Party’s ambitions to continue to dominate society, China cannot make much progress toward them within the current system.

Today, there is a growing recognition that fundamental economic restructuring in China cannot occur unless there is far-reaching political reform, reform certainly more ambitious than the “inner Party democracy” that leaders like to talk about. Yet meaningful political reform is completely off the table, as new supremo Xi Jinping has made clear.

China, for the moment, is trapped in various self-reinforcing—and self-defeating—feedback loops. In one of these loops, a slumping economy is creating a crisis of legitimacy, the legitimacy crisis, in turn, is causing a wide-ranging political crackdown, the crackdown makes reform unlikely, and the lack of reform prevents long-term economic growth. Just when China needs fundamental reform the most, its political system is least able to deliver it.

And one more thing. Xi Jinping is talking like a Maoist and Marxist these days. He may not actually believe his ludicrous-sounding ideologically tinged statements, but his words are nonetheless energizing leftists and disheartening reformers.

Reform in China, unfortunately, is dead in the water.