Charles Hugh Smith on China

Do We Have What It Takes To Get From Here To There? Part 2: China

Charles Hugh Smith

Of Two Minds,

9 November, 2012

Pull aside the curtain and what you find is a China crippled by corruption and debt.

Does China have what it takes to get from here (industrialized export economy) to there (sustainable growth, widespread prosperity)? The same can be asked of every nation: do they have what it takes to move beyond their current limitations to the next level?

Let's start with the fundamentals, what every nation must have to establish a stable, sustainable, widely shared prosperity. These are not just ethical niceties--these are the foundation of economic security.

Consider corruption. Corruption isn't just a "values" issue: corrupt societies have corrupt economies, and these economies are severely limited by that corruption. A deeply, pervasively corrupt economy cannot get from here to there.

Corruption acts as a "tax" on the economy, siphoning money from the productive to the parasitic unproductive Elites skimming the bribes, payoffs, protection money, unofficial "fees," etc. By definition, the money skimmed by corruption reduces the disposable income of households and enterprises, reducing their consumption and investment.

"Income" derived from corruption is the classic example of "unearned" feudal rights being imposed on serfs, a broad-based "tax" that keeps them impoverished.

The other side of the corruption coin is transparency: thus it is no surprise thatTransparency International is the organization that monitors corruption globally and that issues its annual The Corruption Perceptions Index that ranks countries/territories based on how corrupt their public sector is perceived to be.

The top of the least--most transparent, least corrupt--are Denmark, New Zealand, Singapore, Finland and Sweden, with Canada, Netherlands, Australia, Switzerland and Norway close behind.

Germany ranks 15, Japan 17, Chile 21, the U.S. 22, France 25, Spain 30, Souyth Korea 39, Italy 67, Brazil 69, China 78, India 87, Egypt and Mexico, tied at 98, Indonesia 110, Vietnam 116, Syria and Uganda, tied at 127, Azerbaijan 134, Iran 146, Russia 154, and at the bottom of the list (or the top if we are measuring corruption), Iraq, Afghanistan, Myanmar and Somalia at 175 - 178.

There is no way for a deeply corrupt society to get from here (their current level of development) to there (a higher level of development) because corruption limits two essential components of sustainable growth and widespread prosperity: social mobility and innovation.

In corrupt societies, potentially profitable innovations are quickly stolen, copied, pirated or appropriated by corrupt officials and/or criminal cartels. The innovator cannot reap the fruits of his innovation. His only choice is to move to a nation that offers him the freedom to develop his ideas and drive and keep the yield for himself and his family.

If we were to remove every immigrant and their children from the list of influential innovators, entrepreneurs and inventors who have expanded the wealth of the U.S., the list would likely be cut in half.

Since we have many friends in China and India, the two giant economies that many expect to dominate the global economy in the 21st century, we are intimately aware of the pervasive nature of corruption in these societies and economies. If you want to go to dental college in India, for example, you do not need to be a good student; a bribe will do the trick.

This means someone who would have qualified for a slot based on merit is denied the chance in favor of the incompetent who can pay the bribe. Not only does this limit social mobility of the talented and motivated--the very people you want to succeed--it seeds your entire economy with incompetence, laziness and abuse of power.

In China, the way to get a driver's license is not to learn how to drive--what a bother that is! You get the license by paying a bribe. That may be one reason why the death toll from traffic accidents is horrendous in China.

If you work in an upper-level position in an SOE--state-owned enterprise, still the heart of the Chinese economy--much of your salary may be paid as a lump-sum "bonus" that is issued at the whim of your boss. If you alienate your boss, you may not get a bonus or it will not reflect the value you added to the organization that year. This is why young Chinese workers must spend their hard-earned money on Coach-brand handbags to be given to the boss's wife whenever they go abroad, even if they know the wife already has five overpriced "luxury brand" handbags.

Though the luxury item is likely made in China, and the knock-off available on the street corner is identical in look and feel, they have to buy the "name brand," for it is the high cost that matters. In effect, lower-rank employees are paying $800 for the store bag that says "this is the real deal."

The boss, meanwhile, skims enormous sums in "fees" from the enterprises' contracts. His official salary might be $30,000 a year, and he collects 10 or 20 times that in "fees"--or if he is especially enterprising, 100 times his official salary.

You will never hear the truth about the way things really work in China unless the person trusts you--something that takes years to develop. No wonder Westerners who fly in for swank briefings based on lies are so clueless about the Chinese economy.

This is why $300 billion is leaving China every year and flowing to more transparent nations such as Canada, Australia and the U.S. Those who have done the skimming know their wealth--and maybe their lives--are increasingly at risk. So they're getting out while the getting is good, and buying houses and visas for their offspring overseas. China's in big trouble - should U.S. worry?

Reliable estimates from journalists and economists published in October place the amount leaving the country at between $225 billion and $300 billion over the last year - 3 to 4 percent of China's economic output for the period. That is so even though moving significant amounts out of the country is strictly illegal. The outflow is growing larger every year, just as the GDP continues to fall - not a coincidence.

Anecdotally, this probably grossly underestimates the real sums being transferred abroad: if insiders are guessing $300 billion, the true total may be much higher.

This is the other cost of a lack of transparency: all the critical information and data is opaque. How can anyone operate a business when the true nature of conditions is unknowable? You can't, or you make decisions based on dodgy data that ends up crippling your enterprise.

As noted here before in In a Dysfunctional Status Quo, Reform Triggers Collapse: corruption isn't a feature of the economy of China: corruption is the economy. I recommend reading these recent news reports to fully understand the hopelessness of "reforming" corruption in China.

Reform unlikely, says China expert Roderick MacFarquhar (via Maoxian)

MacFarquhar, a professor of history and political science at Harvard University, said the vested interests of the political elite were so entrenched in a corrupt system that an overhaul would amount to dismantling the regime.

Despite hopes the regime can peacefully transform itself into a democracy with rule of law, MacFarquhar said he could not see such a transition, which would require the ruling elite to give up its power and privileges.

Although a political system's inertia often meant a fragile regime could exist for years, MacFarquhar said unpredictable circumstances could trigger its collapse. "You don't know what can unseat a fragile system," he said.

Growing Concerns in China about Inequality, Corruption (Pew Research Center)

Wary of Future, Professionals Leave China in Record Numbers (NY Times)

China's economic destiny in doubt after leadership shock (Telegraph)

The Chinese Credit Bubble (Zero Hedge)

It is here that we get the first glimpse of the true sheer extent of the Chinese credit bubble, which as the chart below shows, is already the largest in the entire world.

Pull aside the curtain and what you find is a China crippled by corruption and debt.