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China's Crisis of Success

Bill Overholt
Feb 16, 2018

Bill Overholt and I recently had a discussion about the points he makes in his new book, China's Crisis of Success. Here are five key points, each corresponding to a section below.

The Rise of China: How Economic Reform Is Creating a New Superpower by Bill Overholt, published in 1993, was called 'nonsense' and 'too optimistic.' How did that work out for the reviewers? 

Now, almost three decades after The Rise of China, Bill believes that China's future has become 'much more uncertain.' And, he addresses his concerns in a new book, China's Crisis of Success.

Bill outlined some the key points from his book recently in an interview with me. And, I have conveyed these below. As you will see, I have let Bill speak for himself. 

Bill was right in 1993. 

1. Fear and simplicity.

A 'sense of terrible crisis [was] a prerequisite for an Asian economic take off,' Bill says. 

  • Fear. Following the events that befell Asian countries - such as, the Korean War and the Chinese civil war - each nation faced the real possibility that it might not recover. This made leaders more willing to take great risks and their peoples more willing to accept them.
  • Simplicity. 'These countries' economies, when they're getting started, are basically agriculture, infrastructure, and some very primitive manufacturing.' This makes the plan simple: 'stimulate growth, build infrastructure, and open and marketize the economy.'

2. Simplicity to complexity - and new crisis. 

With success comes more complex economies, politics, and societies. 'And, then you gradually get to a point of complexity, where there is an economic and political crisis of some kind.' Time for a transformation.

  • China's leaders realized this and reached consensus about the need for reform during Hu Jintao's 'lost decade,' 2002 to 2012.
  • The guide for reform: China 2030, jointly prepared by the World Bank and China and adopted by the Third Plenum in 2013.

3. Slower reform, bigger debt. 

The decision for leadership: quick reform and lower GDP, or slow reform, maintaining higher GDP but accumulating debt in support of inefficient industries.

  • China chose slower reform, higher GDP, and increasing debt.

4. China's leadership

China's leadership wanted Xi to centralize power. We often hear criticism that Xi Jinping is power hungry. But, in fact, Xi's centralizing of power was part of the consensus leadership plan, what they saw as the only way to push reforms through. 

5. But,

'Xi Jinping may have gone well beyond what the consensus originally intended, and the politicization of the reform may not be exactly what some of the designers of the reform intended.' 

You will find each of Bill's points developed below. Let me know what you think.

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1. 'A sense of terrible crisis was a prerequisite for an Asian economic take off'

Bill Overholt
Feb 16, 2018

China's Crisis of Success—1

'Why is this sense of terrible crisis a prerequisite for an Asian economic take off? Because it creates a certain political environment.'...'The counterpart, on the economic side, is an economic simplicity.' says Bill Overholt.

Political Fear. 

'The Asian Miracle countries are all countries that were scared out of their minds.'

  • 'Japan after World War II. South Korea after the Korean War. Taiwan after the Chinese Civil War. Singapore after a very traumatic separation from Malaysia. And, China, after what I call a "bad hair" century - a  terrible series of crises and wars, ending with the Cultural Revolution.'

'Why is this sense of terrible crisis a prerequisite for an Asian economic take off? Because it creates a certain political environment.'

  • 'The leaders are so scared that they're willing to take great political and economic risks. And, to do bigger things, more dangerous things than a normal leader would.'
  • 'The people are conditioned the same way. They're scared that society is going to collapse. That their kids won't have anything to eat. They're willing to accept more stressful change than people in a normal, unfrightened place would accept.'
  • 'The leaders offer policies and tell the people, "You need to know this is going to be terribly disruptive. And painful. But, it's going to save our society."'

Economic simplicity. 

'The counterpart, on the economic side, is an economic simplicity.'

  • 'These countries' economies, when they're getting started, are basic agriculture, weak infrastructure, and some very primitive manufacturing.'
  • 'Even the government can figure out what to do in that situation initially: stimulate growth, build infrastructure, and open and marketize the economy.'

'The Asian Miracles have a succession of models, starting with Japan, each asking: How we can create a great economic take off? The common answer:'

  • 'Gradually open the economy to foreign trade and foreign investment'. 
  • 'Gradually marketize the economy by allowing market prices and other market phenomena to work.'
  • And, build infrastructure like crazy.'

'This works for quite a while because politically it's relatively simple.'

  • 'That doesn't mean there aren't terrible political struggles, that doesn't mean there isn't a resistance, but it's not the way it would be in Britain, or the  US, or China in normal times when people would push back against these tremendous, rapid changes.' 

'So, all this works for a while. And then, success comes.'

  • 'And, then you gradually get to a point of complexity, where there is an economic and political crisis of some kind.'

'Successful economic modernization has eliminated the fear that once energized the  Asia's Miracle Economies.'

  • 'Simple economies and politics have been replaced with immensely complex ones.'

'Economic and political complexity are two sides of the same coin.'

  • 'The rise of large, rich, efficiently organized economic sectors is the same as the rise of large, rich, powerful interest groups with conflicting interests of immense complexity.'
  • And, this creates the crisis of success.
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2. China 2030: 'It's hard to find a more impressive economic plan anywhere else in economic history.'

Bill Overholt
Feb 16, 2018

China's Crisis of Success—2

'Simple economies and politics have been replaced with immensely complex ones. And you gradually get to a point of complexity, where there is an economic and political crisis of some kind.'

Bill Overholt says, 'China's situation today is a little like that of an entrepreneur, who has invented a good widget, done well in marketing it, the company is taking off, and it's gotten to a certain point where they have to do the IPO.'

  • 'Now, it needs professional accounting and professional human resources and so on. It needs a transformation in order to keep going. If it succeeds at that transformation, take off continues, and if it doesn't, it flops.'
  • 'The core issue for China is dealing with the social complexity that comes with economic success.'

From simple to complex. 'China doesn's have simple infrastructure, agriculture, and government manufacturing anymore. There are thousands of sectors.'

  • 'In the power sector, you have all kinds of different power production systems: coal, solar, wind, hydro. You have conflicts between the producers and the distributors, who are no longer the same companies.'
  • 'There are thousands of software firms in conflicts between the users and the owner, inventors. And, so on.'
  • 'These sectors are big and powerful and assert their interests.'
  • 'China's economy just got too complicated to be managed from a few offices in Beijing anymore.'

'China's leadership recognized the issue; they saw it coming; and they addressed it.'

  • 'They decided, "Instead of trying to make all the major decisions in the NDRC, the National and Development Reform Commission, we're going to have market allocation of resources. It's going to be done automatically by the market, and it’s going to be more efficient."'

'From that premise, like somebody developing a system of mathematical theorems, they deduced hundreds of individual policies to implement that market allocation of resources. They consulted Nobel Prize winners, they consulted all kinds of private sector actors, as well as government officials.'

'The end result was China 2030: Building a Modern, Harmonious, and Creative High-Income Society prepared jointly by the World Bank and the Development Research Center of the State Council.'

  • 'It's hard to find a more impressive economic plan anywhere else in economic history.'

'China 2030 was announced as a report of the Third Plenum, with great detail about what they planned to do after Xi Jinping took power.'

  • But, 'in the politics and implementation, it's gotten complicated.'
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3. The slower the reforms, the bigger the debt

Bill Overholt
Feb 16, 2018

China's Crisis of Success—3

'What the Chinese have effectively chosen is much slower reform in order to keep the economic growth rate up around 6.7%.'

Bill Overholt says, 'When they started to implement the China 2030 reforms, first, the leadership had a choice:

  • 'Rapid reform, which would mean much slower economic growth', or 
  • 'High economic growth, which would mean accumulating a lot of debt and slowing the reform process.'                                   

'What the Chinese have effectively chosen is much slower reform in order to keep the economic growth rate up around 6.7%.'

  • 'So, they've acquired a substantial problem of debt as they're trying to keep this engine moving really fast.'

How this works. 'Fast reform would, for instance, involve very rapid reduction of over capacity. Now, the Chinese are reducing over capacity, but not as fast as they might.'

  • 'These inefficient concrete and aluminum factories, and other things, accumulate more debt as they wait the reform process.'
  • 'Also, and very important politically, local governments have become incredibly indebted, and you can crack down on that quickly, or you can not allow them to work at all for a considerable period of time.'
  • 'It's all happening more slowly than it might have otherwise.' 

'The other political decision that has slowed reform is that in effect politics has been given priority over a lot of economic reform.'

  • For example, 'The government talks about putting these big State Owned Enterprises on a level playing field with others. It talks about putting them on completely market basis.'
  • 'Then they say, "we're going to strengthen the role of the party committee inside these enterprises." They make sure the party committee has control over corporate strategy.'
  • 'Well, is it really on a market basis if the party controls the strategy has been strengthened?'

Another example. 'We're going to have the rule of law. It's going to be one of the major things of reform.'

  • 'But we're going to strengthen the role of the party commission that oversees the courts’ decisions.'
  • 'Well, is it really rule of law if a political commission is ultimately making the decisions?'

'There's a whole series of such things I talk about in China's Crisis of Success as the "Ten Key Contradictions"' (page 248).

'Reform is going forward, but it's going forward at a considerably slower pace than it might have, and with much higher priority for political considerations than was expected when China 2030 was drafted.'

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4. Enter Xi Jinping. The reformer?

Bill Overholt
Feb 16, 2018

China's Crisis of Success—4

'Second, they realized that these reforms are painful, and so there's going to be a lot of pushback from all the important power groups of Chinese society. So, they used the Anti-Corruption Campaign as a hammer to push aside these groups who were resisting reform.

Hu Jintao, Xi Jinping's predecessor, presided over China from 2002 to 2012 or, what some call, China's 'Lost Decade.'

'Under Hu, China's top decision making body, the then nine-person Standing Committee of the Politburo worked a little bit like the U.S. Supreme Court - one man, one vote,' says Bill Overholt.

  • 'It wasn't even like the U.S. Federal Reserve, where the Chairman of the Federal Reserve really has tremendous power to drive the outcomes.'
  • 'So, reform just wasn't happening, and China's leaders (those with power, whether in or out of office) decided they needed to centralize power to a much greater degree.'

First, 'the leaders chose a much more charismatic, forceful top leader than Hu - Xi Jinping. And, they:

  • 'Reduced the Standing Committee to seven members from nine.'
  • 'Lobbed off the more extreme political views in order to have an easier consensus. For example, they jailed Bo Xilai, who represented one part of the end of the spectrum.'
  • 'Put the, so-called, extreme reformers in a second tier, in the Politburo, not in the top Standing Committee.' And,
  • 'Created all these small "Leading Groups," as they're called, to handle the most important problems, with Xi Jinping in charge of them all.'
  • 'A tremendous centralization in order to get reform going. That's one part of that consensus decision.'

'Second, they realized that these reforms are painful, and so there's going to be a lot of pushback from all the important power groups of Chinese society. So, they used the Anti-Corruption Campaign as a hammer to push aside these groups who were resisting reform.'

  • 'The most dramatic and the first was going after Politburo Standing Committee member Zhou Yongkang who also ran something called the Petroleum Faction. The Petroleum Faction oversaw controlled energy prices and therefore, hundreds of billions of dollars, which they could extract a share of for themselves.'

'The final piece was Xi Jinping himself. 'Xi had a fairly limited personal political base. He's been very concerned that doing painful reforms in the face of tremendous opposition would not work, or maybe not work and get him unseated.'

  • 'So, he's spent the first five years using his more centralized powers to eliminate all possible rivals and to try to get all the interest groups as much under control as possible.'
  • 'The story has been that the first 5-year term, which just finished recently, is about consolidating power, and the second five years is about implementing the reform process successfully.'
  • 'We’ll have to see.'
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