by Robert M. Liu 

China’s Socialist Market Economy

(June 7, 2005)  The Chinese government in Beijing says that the Chinese economy is a market economy, but both the United States and the European Union disagree. In fact, the official name of China’s economy is “Socialist Market Economy”. So, as you can see, there have to be some differences between a truly free-market economy like the U.S. and China’s “Socialist Market Economy”. 

For starters, the term “Socialist” in China refers to state control, government control, regulatory control, bureaucratic control, and, last but not least, Communist Party control. Along with the term “Socialist”, come numerous restrictions for businesses.  

In order to get around such controls and restrictions and survive, a business operator needs to have special connections (“guan-xi” in the Chinese language) with government officials, bureaucrats and Communist Party cadres -- one of the main reasons why there is rampant bureaucratic corruption in China. 

Secondly, despite the economic reforms which began in the late 1970s and which have enabled the private sector of the Chinese economy to grow, the state continues to control a disproportionately large chunk of China’s resources.  

For instance, the state owns all of China’s land. A state-owned Chinese enterprise may use a piece of land but may not own it. What the enterprise holds is the so-called “Land Use Rights”, which may remain valid for a certain period of time and which can be used as “Contributed Capital” from the Chinese side if the state-owned enterprise forms a joint venture with a foreign company. 

The state also controls the banking industry, the import and export business, the transportation industry, the railway systems, the mining industry, and many inefficient factories (dubbed as China’s “Socialist Dinosaurs”). With so much of the economy under the control of the state, its bureaucrats, and the Communist Party’s officials at various levels, “Guan-xi” and Graft have inevitably become twin brothers.  

Yet, when China claims to be a market economy and asks both the United States and the European Union to accept its claim, the term “Socialist” magically disappears as if China had already evolved into a free-market economy. Of course, this can’t fool the U.S. and the EU.  

China’s currency peg to the U.S. dollar

In a free-market economy, the prices of commodities are supposed to be determined by the forces of the marketplace: supply and demand. And one of such commodities is the currency, the printed paper issued by the central bank that circulates in the market as legal tender or a store of value. 

The Chinese currency, the Renminbi (which means the People’s Currency) or the yuan, is not convertible. Although the yuan is pegged to the U.S. dollar at US$1.00 to 8.27 yuan, a Chinese citizen is only allowed to sell his U.S. dollars to a state-run bank at the aforesaid exchange rate. He cannot convert his savings in the Renminbi into U.S. dollars and then transfer his U.S.-dollar assets to an overseas bank. However, the Chinese government allows Chinese citizens to convert a limited amount of money into U.S. dollars if they need to travel overseas. 

This fact shows that the Chinese economy is not a free-market economy at all. It also shows that the Chinese government is concerned about capital flight. Perhaps, it knows that if it allows Chinese citizens to convert their savings in the Chinese currency into U.S. dollars, many of them, especially the rich ones, would do so and then transfer their U.S.-dollar assets to the United States or to certain Swiss banks. 

Now the talk is that the Renminbi is “undervalued” and therefore should be revalued upward by at least 20%. That may be the dream of American manufacturers who want a weak U.S. dollar and a strong yuan to help stem the flood of Chinese imports. They should know that the root cause of China’s huge trade surplus with the U.S. is the fact that labor costs in China are much lower than in the U.S. If a 20% currency appreciation led to a 20% decrease in Chinese wages, cheap Chinese imports would remain as cheap as if no currency appreciation had occurred. 

China’s banking system and Intellectual Property protection

The Chinese government may not have a lot of credibility with Chinese citizens. Consequently, the actual demand for U.S. dollars in China may be greater than we know. That means that if the yuan became freely convertible, it might fall rather than rise -- probably one of the reasons why the Chinese government dare not make the yuan convertible. 

By now, it is well-known that, loaded with bad loans, China’s state-run banks are insolvent by Western standards. Over the years, China’s state bank officials have lent money to loss-making state-owned enterprises without security. Such a state of affairs is unlikely to induce depositor confidence in the state-run banking system. 

It is also well-known that while China runs a huge trade surplus with the U.S. -- US$162 billion in 2004, it spends littlle money to purchase U.S. copyright products, because Intellectual Property protection in China is inadequate. With a lack of enforcement of Intellectual Property regulations, Chinese users reportedly steal billions of dollars’ worth of U.S. copyright products each year. This can hardly induce confidence in the Chinese system of “Socialist Market Economy”. 

The factions of the ruling Communist Party

On the political front, there are various factions in the ruling Communist Party of China: the moderates who are currently in control; the hardliners who are anti-U.S.; the liberals who are mostly well-educated intellectuals and may be even pro-U.S. but who are apparently too weak to be considered a formidable force in Chinese politics. 

The moderates certainly know that a good relationship with the U.S. benefits the Chinese economy, which today depends heavily on Western investments, Western technology, and Western markets -- the U.S. market in particular. It must be clear to them that China cannot afford a war at the Taiwan Straits. Who’s going to buy Chinese toys, Chinese sneakers, Chinese garments in the event of war? 

Yet, in the meantime, Beijing has apparently used quite a bit of the money it has made in the U.S. market to fund its military buildup in recent years. The number of missiles stationed in Fujian Province across from Taiwan has increased in an attempt to intimidate Taiwan’s leadership. This fact shows that the hardliners in the CPC continue to have strong influences in Chinese politics.  

Not long ago, China’s former foreign minister Qian Qichen managed to have an article published in the China Daily, the country’s official English-language newspaper, severely criticizing U.S. foreign policy. This may be an indication that the anti-U.S. hardliners in the CPC are unhappy with the moderates’ policy of cooperation with the Bush administration on a series of issues. It may also be a signal that they retain the ability to stage a comeback. 

Strangely, almost at the same time, the European Union, under the urging of France, declared that it wanted to sell weapons to Beijing. What for? Is China under threat from Russia or Japan or India or the United States? Does the European Union want to help Beijing deploy more missiles against Taiwan? But French president Jacques Chirac may not care. His interest is in tweaking Uncle Sam’s nose once in a while. 

Changes in Chinese society

Anyway, the fact that the Communist Party of China has a strong anti-U.S. faction in its ranks makes it hard for the U.S. to treat Beijing as an ally. It certainly is not an ally, though it is not an enemy, either. But the economic reforms have caused the Chinese society to change rapidly. The middle class is growing. Its demands for more political relaxation and transparency are increasing as well. As a result, the CPC has been under pressure for change. 

In the meantime, well-educated, better-off people have joined the ruling Communist Party of China since the late 1970s. This phenomenon may have already changed its class nature. The CPC used to be a proletarian revolutionary political organization focused on class struggle (or Class Warfare as Americans would say) under its late chairman Mao Zedong.  

But today, the CPC looks more like a Confucianist party seeking to maintain stability and the status quo of one-party rule. Even as the CPC claims to be Marxist, China’s ancient scholastic Confucian traditions may have quietly staged a comeback, enabling only well-educated and better-qualified folks to move up the party hierarchy. At least in theory, this should strengthen the moderate faction and to some extent the liberal faction. Hopefully, such developments are conducive to a better U.S.-China relationship. 

North Korea’s nuclear weapons program

Three years ago, I had hopes that Beijing might be willing to pressurize North Korea to give up its nuclear weapons program. In fact, the Chinese leadership did use its influence to persuade North Korea to participate in the six-party talks in Beijing on how to resolve the North Korean nuclear issue. 

The problem is that North Korean dictator Kim Jong-il is determined to acquire nuclear weapons. A few words of persuasion from Beijing cannot make him change his mind. If the international community is to make Kim Jong-il behave, it will have to place him under much stronger pressures.  

Judging from what has happened on the Korean Peninsula since three years ago, Beijing does not seem ready to cut off its economic assistance to North Korea. The anti-U.S. hardline faction in the CPC may not want the Chinese government to exert strong pressures on North Korea, though Kim Jong-il’s nuclear weapons program is not in China’s interest. Whereas the moderates may not want to be seen as being closely aligned with the U.S., which is ideologically inconvenient in a country with a Communist brand name. 

So, Kim Jong-il does not believe that he must give up his nuclear weapons program. In 2004, he was waiting to see who would win the presidential election in the U.S. Now that George W. Bush has won, Kim Jong-il (in some sense like the Democrats) wants to see when Bush will become a quacking lame duck. Deeply engaged in delaying tactics, Kim Jong-il is busy conjuring up various shenanigans to shield his nuclear weapons program. 

The Democrats say that the Bush Administration should begin direct talks with North Korea. But for what purpose? Direct talks or no direct talks, Kim Jong-il wants nuclear weapons. Direct talks would not generate adequate pressure to make him give up his nuclear ambitions. If direct talks could produce magic solutions with tyrants, British prime minister Arthur Neville Chamberlain’s direct talks with Adolf Hitler should have prevented World War II from breaking out.  

Tough options for the U.S.

One option for the U.S. is to refer the North Korean nuclear weapons issue to the U.N. Security Council and call for U.N. sanctions against North Korea. Will Beijing block such U.N. sanctions? If it does, Washington may have to reassess its policy toward China. As things stand now, the six-party talks in Beijing are unlikely to produce results unless China is ready to cut off its economic assistance to North Korea. 

What will happen if North Korea tests its nuclear weapons? One possibility is that the U.S. may react militarily in the event of a North Korean nuclear weapons test and an international naval blockade may be established to shut North Korea’s sea lanes so as to stop it shipping dangerous cargos to the world’s dangerous spots. Such a turn of events could lead to a second Korea War. Sounds like a very unpalatable prospect. But if Kim Jong-il makes that fatal choice, what should we do?

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