It seems that many so-called China experts try to enhance the value of their services by attributing a certain amount of “inscrutability” to the Chinese that only they can decipher. Besides being a patently offensive assertion, this is also grossly misleading.
At least in terms of economic issues, there is little mystery about the Chinese approach to doing business. It can be understood as being shaped by two decipherable and predictable realities. First, the system of authoritarian rule can be described as feudalism with Chinese characteristics. Second, much of the leadership continues to rely upon instincts guided by years of exposure to Marxism. In turn, the contrived notion of “market socialism” reflects the Chinese version of a Third Way so avidly sought by European social democrats like Tony Blair.
A good starting point is to remember that China’s ancient and modern history is marked by what is essentially imperial rule. With brief interludes that include flirtation with democracy under Chinese President Sun Yat-Sen and chaos under warlords, each successive Chinese leader has assumed power as the head of a highly centralized imperial government that perpetuated a feudal relationship with its citizens. In effect, the destiny of citizens depends upon how they serve the plans of their political masters.
This shapes the attitude toward contracts and explains the alien nature of the rule of law to the Chinese leadership. The presence of authoritarian rule results in contracts being one-sided agreements, subject to the whims of those with the most power. This requires a considerable amount of forbearance on the part of those who are aggrieved when breach occurs. In turn, those who govern China find legal rules and judicial independence to be inconvenient and intrusive.
When it comes to commercial and financial dealings, years of flirtation with Marxian doctrine have contributed to a misunderstanding about the nature of modern capital markets. This is further complicated by a long tradition among the Chinese whereby business relationships were based upon personal contacts. In such a setting, the deferral of repayment of debts and interest tends to be less of a serious transgression.
This approach to borrowing and lending suffers from two basic flaws. On the one hand, it overlooks the fact that capital is scarce. Appeals for delays in payments to creditors might be based upon assertions that liquidity problems will be resolved in the future. But this can only be known for certain with hindsight. In all events, illiquidity often leads to insolvency. In the meantime, capital funds are diverted from more productive uses. Not only does the capital owner lose opportunities for higher returns, the community is made worse off due to the inefficient use of scarce capital. The fluidity of modern capital markets raises the individual and community costs of the inefficient use of capital.
On the other hand, market economies treat payment of interest and repayment of principal as valid and necessary as payments to other factors of production. Capital owners should not be arbitrarily expected to wait until conditions improve while debtors find funds for such disbursals. But then in China, even workers might be forced to wait until some unspecified future moment to receive their compensation. While Chinese workers in state-owned enterprises might be captive to such arrangements, international lenders are not. The global capital market allows creditors to seek more reliable borrowers.
Closures of financial institutions provide mixed signals on China’s willingness and capacity to play by global rules of transparency and accountability. It might be encouraging that financial institutions weakened by wobbly operating practices have been closed or are being restructured. In June 1998, the Hainan Development Bank was closed along with about 30 credit cooperatives. Then the Guangdong International Trust and Investment Corp. was closed in November with foreign banks left holding most of the $4 billion of GITIC’s outstanding debt, much of it “unregistered” and thus not guaranteed by the Chinese government.
After missing an interest payment on a $200 million international bond in October 1998, Guangdong Enterprises (Holdings) Ltd. has been declared insolvent. Proceedings are now under way to settle over $5.6 billion in debts and other liabilities owed to a wide range of foreign creditors.
Without a transparent method for clearing debt, uncertainties over the outcome may either inhibit future capital lending or raise the risk premium charged to Chinese borrowers. It is not that creditors should not expect to absorb losses when projects fail. The real issue is that most of the lending was based upon the presumption that some arm of the Chinese government was the ultimate guarantor. This provided a false sense of confidence on the part of lenders who might otherwise charged higher interest rates or who might have opted out altogether.
One of the most important lessons of the East Asian financial crises is that political connections should not be a substitute for prudential risk analysis. Hopefully creditors with exposure in China will finally learn their lessons in the school of hard knocks.
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