By Valentin Schmid
Another book written in 2012 that too few people paid attention to. If they had, they could have easily predicted and avoided the current troubles in China. From the inevitable overinvestment, to environmental destruction, to the futility of monetary policy and the chronic lack of innovation, Mark DeWeaver covers it all - in history, in theory, and in modern-day (mal)practice.
The biggest myth he dispels about the Chinese economy is that it's socialist in name only and run by private enterprises big and small alike.
"Perverse incentives at the local government level continue to be the underlying drivers. Neither extinct nor even endangered, the animal spirits of the Maoist era are still thriving more than thirty years after the introduction of China's 'reform and opening' policy in 1978."
The local governments in very ordinary terms do whatever they want until Beijing throws the baby out with the bathtub and restricts all investment activity everywhere.
"Booms are led neither by Beijing nor by the private sector, but by local government officials motivated by interests all their own," DeWeaver writes.
So what are the local government's, or the local government official's, interests? No, it's not like it says in the CCP's constitution, that a party member should always put the party ahead of personal interests.
In fact, it's these very personal interests that drove overinvestment in industrial capacity and real estate. The CCP rewards local officials through a tournament system where they compete against other local officials to get the best numbers, be it GDP or otherwise, with devastating results for capital allocation and the natural environment.
"When 'numbers produce officials and officials produce numbers,' as the Chinese say, outright fraud will be an issue as well."
Mark A. DeWeaver
A good example is China's goal to have non-hydro alternative energy cover 8 percent of installed capacity by 2020. Because the emphasis is on capacity and investment expenditure, 26 percent of China's wind-power capacity was not connected to the power grid at the end 2010. Many of the wind farms are continuously blasted by sand from the desert, leading to mechanical failures and defects.
This is also the reason why every province and second-tier city in China needs its own airport, regardless of economic viability. "Some 'image projects' have no discernible rationale at all aside from creating the impression that officials are getting things done."
Investment in infrastructure and real estate generates GDP growth, the stick local officials measure each other against. They use tax breaks, cheap land, low-cost credit (channeled via locally-controlled banks) as well as waivers on centrally imposed labor and environmental regulations to attract private and public sector investment.
Because there was no downside for the local officials, at least not until Xi Jinping unleashed his anti-corruption campaign in 2013, capital was misallocated, the natural environment destroyed, and arable farmland converted into unused real estate.
Of course, there is plenty of upside in terms of corruption for the average local official. "Bid rigging is exceptionally easy to get away with because the same officials are often in charge both of inviting bids, in their capacity of transportation department employees, and submitting bids, in their capacity as managers of department-owned construction companies."
No Central Control
DeWeaver then shows that the much-touted central government control and foresight only has very crude mechanisms to rein in wasteful local government spending.
First of all, most banks, whether central or local, are ultimately controlled by the CCP. And it's CCP officials who benefit most from corruption. "The bankers, whose primary allegiance is to the Party rather than to their institutions, still have little choice but to support local government projects."
As for the central bank's ability to manage credit, DeWeaver was way ahead of the curve in noting that the impossible trinity renders the efforts of the People's Bank of China [PBOC] to control bank lending futile, and describes the process in great detail.
"The PBOC has many of the same tools as the developed country central banks, but it uses them differently and they generally are less effective as instruments of countercyclical policy."
Innovation: We've Been Here Before
The icing on the cake of this book, however, is how DeWeaver deals with the claim that China will one day become a leading source of innovation, a narrative much espoused by consulting firm McKinsey, for example.
Proponents of the China innovation story often cite the amount of money spent on research and development as well as the number of patents filed. But, like everything in China, and much like the local government GDP growth targets, these figures are given by the regime.
So the national "Medium- And Long-Term Plan for the Development of Science and Technology" targets R&D expenditure of 2.5 percent of GDP by 2020. Lo and behold, China spent 2 percent of GDP on R&D in 2013 producing little, if any, countable results. The same target goes for patent filings, where China is supposed to be number five globally in 2020. In 2014, it was number one already, without anybody in the world noticing.
"This way of thinking substitutes quantity for quality, just as [with] the targets for steel tonnage during the Great Leap Forward," writes Weaver.
So it comes as a small surprise that more than half of China's science and technology R&D funding is wasted on non-research activities like business trips, meetings, and entertainment, according to a recent report by Huanqui.com.
DeWeaver also notes that this push for innovation is not a new idea. In fact, the sixth five-year plan of 1982 has much the same content as the 11th and 12th five-year plan, other than the specific mention of scientific development.
Much like the Soviets in the 1980s, DeWeaver notes that you can plan to innovate as much as you like; as long as you get the incentives wrong, all you are going to get are minor modifications to existing products. "While China's leaders continue to claim that they are in the midst of engineering an economic transition, there is little sign that this is happening."
As for reform and rebalancing, DeWeaver has a crushing verdict: "As long as the 'leadership of the Party' cannot be challenged, such a transformation is highly unlikely."
The verdict for "Animal Spirits with Chinese Characteristics:" For any serious student of the Chinese economy, the historical context, the great technical detail, flawless theory, and countless examples for modern day (mal)practice make this book essential reading.