DEBATING TOP-NOTCH economists, especially a highly respected and knowledgeable one like Jonathan Anderson, apparently borders on intellectual masochism for a political scientist. But because most economists are handicapped by an intellectual tunnel-vision problem—they tend to use economic growth as the only mark of social progress and ignore the overall context in which economic development takes place—this contest is not only winnable, but also can be intellectually fulfilling.

Jonathan starts out by using what he calls “hard data” to argue two points. First, on the economic front, he points out that China’s economic growth for the past thirty years has been driven by productivity growth (hence, it is of high quality), and that its state-owned enterprises have become market oriented and more profitable, on average, than private-sector firms. Second, Jonathan sees the risk factors that could derail China’s growth as “moderate”; he believes that social tensions in China are driven primarily by economic factors that will be easily fixed with China’s continued growth (poor social services in cities and low income growth in the countryside); and, that the lack of democracy rather than being a real danger is instead “one of the best predictors of success” in Asia.

Unfortunately, Jonathan makes three mistakes that undermine his optimistic forecast of China’s rosy economic future. First, the data he cites as “hard” are actually quite subjective. At best, they paint an ambiguous picture of China’s economic performance. Second, he understates the degree to which the Chinese state is entrenched in the economy and overstates the level of performance by the SOEs. Finally, in typical economist fashion, he ignores the so-called elephant-in-the-room risk factors—environmental degradation, high socioeconomic inequality and corruption—and downplays the future impact of an aging population and the potential for social conflict. It is not just the economic fundamentals that he has misjudged but also, perhaps more importantly, China’s societal and political weaknesses.

MEASURING ECONOMIC performance is hard, even for economists. One of the best yardsticks is, as Jonathan points out, total-factor-productivity growth. Unfortunately, estimates of China’s TFP growth are highly contestable. Based on research by leading American and Chinese economists, China’s TFP growth rate has been declining in the past decade, so using the average TFP growth data for the past three decades is not a reliable way to forecast China’s future growth. It merely spreads the gains out over time, thereby masking the recent downturn.

Further, it is probably too generous and truly unrealistic to use TFP data alone to assess China’s economic performance. TFP marks productivity gains, but what if such gains do not accrue to the average Chinese citizen? What if rapid GDP growth is not accompanied by commensurate growth in household income and consumption? This is where China comes up short. While its GDP growth for the last three decades approached 10 percent a year, the growth of household income was lower (the weighted household income rose at about half of the per capita GDP growth rate in rural areas and at roughly 75 percent of the per capita GDP growth rate in the cities). Simply put, an average Chinese does not have the money to buy Chinese products (especially since he must also save for health care, education and retirement due to a tattered social safety net). This has led to a level of consumption that has shrunk to a historical low in recent years. Such evidence suggests that China may have a large economic output, but it has not been fully translated into increased individual welfare, hindering the growth of domestic demand and the overall health of the economy.

When it comes to Jonathan’s assertions about the state’s role in the economy, he again looks to data rather than nuance. The influence of the Chinese state in the economy vastly exceeds the direct output of SOEs. Jonathan argues this number runs to about 25 percent of GDP. In actuality, SOEs account for a much-higher percentage of the economy; my debating partner has not included many companies in which the state has a controlling interest. Even more so because the Chinese government controls the price of capital and land, and limits entry to strategic sectors of the economy, its influence in the marketplace is far more extensive and potent than most people realize. Chinese SOEs are also not as productive as Jonathan tries to show through his data. Their profitability comes from their monopoly status, not from their competitiveness. In fact, 80 percent of SOEs’ profits come from a handful of giant state monopolies, such as China Mobile, China National Petroleum Corporation (CNPC) and Sinopec. Research shows that, in terms of marginal capital output, SOEs are about half as efficient as private and foreign firms operating in China.

Finally, Jonathan should have taken into account the impact of environmental degradation and rising social injustice (compounded by inequality and official corruption) on China’s economic future. Given the extent of environmental pollution and the costs of mitigation and protection required to make China a country in which people can breathe, drink and eat without getting poisoned, no economic forecast of China’s future will be persuasive if it downplays or overlooks the environmental risk factor. And above all, while the normal ebbs and flows of an economic cycle may help explain social grievances, they are not the sole cause and it would be wrong to ignore other factors. In fact, in many recent large-scale riots, economic factors were conspicuously missing. What is important is that when a fast-growing society is perceived by its people as unjust, as China is today, its rulers are sitting on a ticking time bomb.

That is why Chinese leaders are calling for a “harmonious society.” Regrettably, even the best economists have missed the political warning signs.

Anderson Responds:

LET ME start by repeating my conclusion from the main article: to argue against China’s eventual rise it’s not enough to point to vaguely perceived imbalances or assert that the economy can’t go on exactly the way it was before. We need more than a little grit in the wheels to slow the country down—instead, we need a definitive, fundamental crisis that pushes China off the growth path for a long time to come. And we need it soon, ideally within five to ten years.

Now, as an avid follower of Minxin’s work, it’s a pleasure to have a chance to comment on his views, and he clearly provides an engaging review of long-term challenges for the mainland economy. But has he made the case for a looming crisis? Unfortunately, the answer is no—and on most counts the arguments fall very wide of the mark indeed.

One of Minxin’s main propositions is that the state’s role in the economy is unhealthy and out of proportion, that Beijing created a false sense of economic well-being and a flawed set of economic structures. He asserts that the government creates massive economic distortion by manipulating key input prices such as those of energy, capital and land. Yet to start, I must ask, what energy mispricing? For the past two decades Chinese fuel prices have been set more or less at world levels, with the exception of the short-lived 2007–08 subsidies as a response to global crude price spikes, and, as I write, Chinese consumers are paying more for fuel than their U.S. counterparts. There is no “world price” for electricity, which makes comparisons harder here, but while China regulates prices, it does not subsidize electricity production or distribution.

He talks too about the government’s heavy hand in the corporate sector. But here again, where are the chronic subsidies Minxin mentions? With the exception of the 2007–08 payments to oil refiners, China has not given cash handouts to industrial state firms for a very long time. As I noted, quite the opposite is true; SOEs today face a much-larger tax burden than the private sector and are the largest provider of funds to the government.

The government does provide an implicit subsidy to banks by putting a ceiling on deposit rates and a floor on lending rates. But while this artificially depresses the return to Chinese savers, it also imposes an artificially high cost of funds on corporate borrowers. In other words, China is not subsidizing capital; if anything, it is taxing it.

Minxin is correct that there was a time when SOEs were not expected to repay loans, but as a macroeconomic phenomenon this era effectively ended in the mid-1990s when the government began to shut down debtors and impose hard budget constraints on banks and firms. As a result, the vast majority of China’s “massive” nonperforming loans (NPLs) were extended before 1997—and, following a subsequent extensive cleanup, mainland state banks now have very low NPL ratios by emerging-market standards.

As for the argument that China is getting a decreasing return on investment, Minxin is not so much wrong as misguided. One of the very definitions of long-term economic development is the accumulation of capital, which in turn automatically means falling returns on new investment; if RMB 100 of new capital spending yields less new output than before, this is more likely a measure of success than failure in a rapidly growing economy.

How can we know for sure? For serious economists, the answer is to look at the returns to labor as well. If labor efficiency is rising faster than capital returns are falling, the economy is healthy; if not, then there is a stronger case that growth is imbalanced and distorted. The one numerical indicator that captures both capital and labor efficiency—and thus the single best measure of long-term economic success—is total factor productivity, and as I discussed earlier nearly every available study done on this basis finds very high rates of TFP growth in China.

Most important of all, if we look at bottom-up measures of corporate returns for any given sector, it’s difficult to find even one industry where net margins, return on equity or return on invested capital failed to rise on average over the past decade, i.e., precisely the period during which Minxin claims China should have been careening into hopeless overcapacity.

Minxin also cites demographics as a potential source of economic stress. However, although there’s no question that China faces an eventual decline in labor-force availability, this is a profoundly long-term process, particularly when we consider that China still has another 75 million or so underemployed rural workers waiting to come into industry and services. And remember that labor growth contributed only around two percentage points to trend growth in the first place; the majority was explained by capital investment and rising efficiency. So while demographics can slow the mainland down at the margins, this is hardly a revolutionary turning point.

Minxin is also correct that aging societies generally save less, and I have little argument with his estimate of 5 percent of GDP for eventual household-savings losses—but this can hardly matter for China today, which exports a full 10 percent of GDP in excess savings to the rest of the world. By any reasonable calculation the economy could lose three times Minxin’s figure in terms of lower savings and still grow very comfortably at 8 percent or above.

In addition to economic factors, Minxin also addresses what he sees as deep societal fissures, from inequality to the environment. As a long-term resident of China, I have no interest in downplaying the considerable environmental problems plaguing the country. However, it’s one thing to point to bad air and bad water and quite another to argue that this will lead to economic crisis. If we accept that water availability is the most serious potential issue, then the math becomes surprisingly simple: by far the biggest user in China is the agricultural sector, and we will know that water is becoming a meaningful economic constraint when we see food production under pressure. And it may surprise many readers to discover that China is still a sizable net agricultural exporter, with no sign whatsoever to date of this trend reversing.

And now we come to what I believe are the most serious issues, where I agree with Minxin that the trends of the last decade—falling social expenditures and rising inequality—if left unchecked, could lead to grave trouble. And the figures he quotes are a broadly accurate reflection of reality . . . up to, say, 2003. As I discussed in the main article, these two problems were not failings of governance so much as adverse economic shocks (the late-twentieth-century collapse in government revenue and falling rural incomes). Over the past five years the underlying momentum has already changed dramatically. Again, Chinese government revenues have skyrocketed since the near-starvation days of the late 1990s and are now back on a par with most emerging markets, allowing for a significant ongoing expansion in social spending and transfer payments. And rural income growth between 2004 and 2008 was the best in nearly fifteen years, reflecting the economic impact of demographic changes and urbanization as well as greater government support. If the present renaissance continues, then what looked like an intractable dilemma five years ago could well become a distant memory in another five years’ time.

In sum, China is a good deal more market oriented than Minxin assumes in his writings—and the market is already sorting out China’s most pressing remaining problems.

Beijing’s Exceptionalism by Jonathan Anderson

IS CHINA’S rise inevitable? Well, as we’ve learned to our great chagrin over the past twelve months, there’s nothing inevitable about continued rapid economic expansion or the near-term success of any economic model, and past performance is most emphatically not a guarantee of future returns. And, as with any lower-income developing country, there are plenty of visible and unforeseen pitfalls that could hurt China’s growth prospects over the coming years and decades.

However, as author and newspaperman Damon Runyon famously remarked, “The race is not always to the swift nor the battle to the strong—but that’s the way to bet.” And when taking odds on the potential of today’s emerging markets to mature into wealthier and more powerful states, you had best be betting on China.

The mainland is already getting there faster than any major economy before it. And, the risks of an outright economic derailing over the next ten to twenty years are much lower than commonly believed.

IN A debate often dominated by conjecture and assertion it helps to focus on hard data, and at the macroeconomic level, here are the hardest numbers we have: in the three decades between 1978 and 2007 the official Chinese GDP grew at an average real pace of 9.9 percent. Of course, the quality of historical growth figures has generated an intense academic debate, and many researchers conclude that real growth has been overstated for a variety of reasons (such as under-measurement of inflation and other distortions in the traditional socialist statistical system); however, even the most skeptical analysts still come out with numbers of 9 percent year over year (y/y) or above for the postreform era.

How does an average growth rate of 9 or 9.9 percent compare with other major historical cases? As it turns out, whether we take the top or the bottom end of the range, China is a world-record holder. Over its peak thirty-year growth period Japan grew “only” at an average real rate of nearly 8 percent, and between 1960 and 1995 the high-growth Asian “tigers” expanded at paces of 7.8 percent in Hong Kong, 8.3 percent in South Korea, 8.4 percent in Singapore and 8.9 percent (the previous record) in Taiwan. This is not all; with the sharp slowdown in mainland birthrates since the 1970s, China’s outperformance in terms of per capita income growth is higher still.

The next set of figures concerns the sources of that growth. Remember from first-year economics that in the most basic formulation there are three ways for countries to grow: (i) by adding more labor, (ii) by adding more capital, and (iii) by combining capital and labor in better and more productive ways. The latter is so-called “total factor productivity” (TFP) growth, and is in many ways the best single measure of long-term economic success because it gauges the “quality” rather than just the quantity of growth.¹ Here, as well, researchers have carried out detailed studies of China’s growth composition. Estimates of historical-factor-productivity growth tend to run from 2 percent y/y to 4 percent y/y, with the broad bulk centered around 3 percent. That is, as best we can measure, just under one-third of China’s growth is coming from rising productivity.

How does this compare with other parts of the world? Once again China posted a record performance. For much of the postwar era, the industrialized West saw annual TFP growth rates of up to 2 percent; the average for Japan and other high-growth Asian countries was around 2.5 percent—with no other region coming even close to these numbers. So productivity growth of 3 percent or thereabouts puts the mainland economy at the very high end of global experience.

And this brings us to our final set of hard numbers. In 1990, average Chinese national income in prevailing U.S.-dollar terms was $350 per head. By 2000, that figure had risen threefold to $1,000 per head, and, as of the end of 2008, per capita income had tripled again to $3,000. If China continues to grow at 8 percent y/y or above in real terms for the next two decades, then in present-dollar terms, per capita income could easily reach $8,500 by 2020 and $20,000 by 2030. This puts average mainland incomes above where Taiwan and Korea are now—i.e., solidly middle class and eligible for OECD membership—and also puts the total size of the Chinese economy above the combined level of the United States and the European Union today.

Let me summarize here for emphasis: in strict macroeconomic terms, so far China is unambiguously the most successful emerging economy of the postwar era. And at the current pace of development, China’s “rise” is not some hazy prospect shimmering on the distant horizon, but a concrete reality only twenty years down the road. Most important of all, as laid out above, the mainland doesn’t need to grow at a breakneck pace of 10 percent per year to attain developed-country status by 2030; 8 percent will do nicely, and even if trend growth drops to 6 percent or 7 percent, this simply pushes back the arrival date by a few years.

In other words, if you want to argue for China’s failure, it’s not enough to say that the economy will slow. Instead, you need a massive disturbance or outright crisis that derails growth for a long, long spell—and you need it fairly soon.

In today’s public debate there are plenty of potential hazards to point to, including bubbles bursting, global depression, social tensions, loss-making state enterprises, an inefficient socialist model and the lack of political freedom. And as I stated at the outset, there’s no guarantee whatsoever that one or more of these elements won’t suddenly overwhelm China’s growth prospects and drag the economy down. However, an objective look at risk factors shows that they are moderate, with little to suggest that the economy faces a looming crisis anytime soon. With apologies for the brevity imposed by space constraints, let me at least give a broad outline of the main arguments here.

FIRST UP is perhaps the most obvious and pressing concern, which is China’s fate in the current global recession. Export volume contracted outright in the fourth quarter of 2008, and the turnaround in local stock and property markets has sent domestic construction and industrial spending down sharply as well. With the prospect of much-slower growth and rising unemployment this year, it’s natural to wonder if this is the shock that could send the mainland over the edge.

However, by any measure China is one of the least export-exposed economies in the Asian region; only around 8 percent of the mainland workforce is employed in export industries, and light-export manufacturing, such as toys, textiles and electronics processing, accounts for a smaller share still of total Chinese investment spending. Even at the very peak of the recent trade expansion, net exports drove no more than one-sixth of overall GDP growth. This helps explain why China was able to keep right on growing during previous sharp export recessions, such as the global IT bust in 2001–02, and why it will take much more than falling exports to seriously impair medium-term-growth prospects today.

Turning to the domestic economy, China’s local stock market shot up nearly sixfold between 2005 and 2007 before suffering an equally dizzying fall in the past fifteen months, raising concerns of a Japan-style “postbubble malaise.” On the other hand, this is nothing new; for the past two decades Chinese stock prices have inflated wildly every five years or so followed by equally abrupt declines. The important fact is that even today equities account for a very small part of household and corporate balance sheets, that is to say, in real economic terms China’s stock market is still little more than a sideshow.

Housing and property markets are a different issue. As we have seen in the United States, property recessions can wreak significant havoc—but the key here is that China looks nothing like the United States. Consumer mortgage debt is tiny, average loan-to-value ratios are extremely low as well, nationwide home prices have actually declined relative to incomes for the past decade and absolute inventory levels haven’t budged since 2004. So while Chinese sales and construction volumes fell sharply last year and home prices are now contracting on a nationwide basis, there’s little in the data to suggest that the current property woes are anything more than a painful cyclical correction.

NEXT TO address in the debate over China’s rise is the persistent idea that since the country is nominally socialist, the economy must have muddled through so far due to the efforts of central planners who ignore free-market principles and allocate resources against all economic rationality—and just like the Soviet Union before it, China is threatened with a nasty shock if and when market forces finally prevail. A lighter version is that China is overdependent on the “extensive” growth model, i.e., planners are good at throwing capital and labor at a problem but bad at getting returns on investment; once the economy starts to run out of resources the entire system could falter.

According to the data, however, neither of these is a real concern. The single-best indicator of the quality of overall resource allocation in any economy is one already discussed—total-factor-productivity growth. For the Soviet Union, the figures were simply awful. On standard measures, the Soviet economy actually saw TFP levels fall by nearly 1 percent per year in the final two decades of its existence, the worst performance of any major region in the world and an accurate reflection of the hugely distorted nature of the economy.

Meanwhile, as we saw above, China not only had positive TFP growth for the last three decades, but one of the absolute-best productivity performances on record. This is mirrored in financial data such as industrial profitability, corporate returns on equity or returns on invested capital. Regardless of the measure you choose, China has seen consistent improvements over the past fifteen years, and, even in today’s global slump, margins and capital returns have remained near record-high levels.

Nor is there any indication that the “extensive” part of mainland growth is in danger anytime soon. Much has been made of the looming demographic downturn, but this almost completely misses the point; if we look at China’s historical growth pattern, only perhaps one-sixth came from labor expansion, with another third from factor productivity—and the rest was due to new capital creation. In other words, just as in China’s Asian neighbors, the real heavy lifting in trend growth was done by savings and investment.

How likely is it that China will run out of savings to invest, or profitable destinations for its capital? Rising productivity and respectable corporate returns tell us that the latter issue is not a concern, as China still has plenty of areas for profitable investment at home. And on the former front, remember that the mainland currently exports around 10 percent of its GDP in excess savings to the rest of the world, by far the highest level of any major economy.

ACCORDING TO current statistics, roughly 25 percent of Chinese GDP is generated by state-owned enterprises, or SOEs. To most readers this brings up a specific set of connotations: state enterprises generally do not run on market principles, depend on government for resource allocation and economic decision making, suck resources and subsidies from the “good” part of the economy, hide behind protectionist walls and often destroy value outright—causing outputs to be worth less than the cost of producing them. So even if the private sector is buoyant and profitable, having a “dead weight” of this magnitude risks pulling the rest of the economy down with it.

The trouble is that none of those characteristics really hold true in China. Industrial statistics show that mainland SOEs are more profitable on average than the private sector, and even when we adjust for sectoral differences there is almost no visible difference between state-owned and private profit performance. With the exception of recent short-lived fuel subsidies, the government does not hand cash to state companies; quite the opposite, SOEs pay far more in net taxes to the government than their private counterparts. And sectoral data suggest that overall productivity and margin growth have been a good bit faster in heavy-industrial state sectors than, say, in foreign-funded light-manufacturing export firms over the past fifteen years.

Many may ask how this is possible. The answer is that there’s not much “state” left in China’s state-owned enterprises. In most emerging markets you will find, say, one large, state-owned telecom company, one automaker, one airline and so on down the line—usually companies that are heavily protected and often loss making. By contrast, the mainland has dozens of major automakers and airlines, hundreds of steel companies, a good handful of major telcos, power producers and the rest. Most of these firms may be state owned, but they compete aggressively with one another; entry barriers are very low even by Asian standards, with many sectors highly open to private and foreign investment.

Moreover, only the very largest SOEs have any guarantee of existence at all, as they discovered in the late 1990s when then-Premier Zhu Rongji mercilessly shut down tens of thousands of state-run companies because they were neither profitable enough nor large enough to be worth saving, thereby putting more than 25 million state workers on the street. Major SOEs still enjoy preferred access to commercial-bank resources, but this access is fading rapidly as banks are under strong pressure to hone their focus on profits and cash flow. And the state now has almost no direct say in corporate investment and production decisions, having dismantled the (largely rubber-stamp) government-investment-approvals process a number of years back.

THEN THERE is the question of how China can grow without democracy. The idea that economic success puts the rising aspirations of the middle class on a collision course with China’s authoritarian regime is a cherished tenet, and the recent wave of rising social unrest is often touted as proof that a painful clash is imminent. However, while there’s little doubt that China will face growing political frictions and some painful choices over the next decades, there’s also little to suggest that the country faces a looming crisis.

In fact, when it comes to Asia, the better question may be: how can you grow with democracy? After all, every one of the region’s economic success stories over the past thirty years—Japan, South Korea, Taiwan, Hong Kong, Singapore, Malaysia—happened in what was effectively a one-party state, and some had governments as authoritarian as China’s. By contrast, countries with consistent or intermittent periods of democratic rule, such as the Philippines, India, Bangladesh, Pakistan and Thailand, came in toward the bottom of the growth list. Clearly the lack of contested elections was not a hindrance to growth in Asia; indeed, it was one of the best predictors of success.

This is because Asia’s economic winners may not have had democracy but they did have capitalism. All of the high-growth countries had a strong market orientation and a commitment to globalization; they generally also had strong governance institutions with some measure of social accountability. In effect, there was an unwritten contract with the populace that as long as governments delivered the goods in terms of growth, the citizenry would hold off on democratic aspirations until the economy reached a stable, middle-class income plateau.

Is China different, and could the political order fall apart well before incomes reach more developed levels? To make this claim, there are two possible lines of argument. The first is that the mainland simply isn’t as “capitalist” as the Asian tigers were, with less market orientation and more state distortions and problems. I’ve already disputed this idea for China itself, but I should also stress how well the mainland holds up in a comparative sense.

At one-quarter of GDP, China’s state-owned economy today is largely comparable in size to the historical role of Japan’s keiretsu and South Korea’s chaebol in their own economies, with the crucial difference that mainland SOEs are a good bit more exposed to market forces. Foreign direct investment plays a far bigger role in nearly every industrial sector in China than in Japan and South Korea even today, not to mention in the 1970s and 1980s. By any measure, China has much greater domestic competition within industries than its north-Asian neighbors, and large Japanese and South Korean firms arguably received more effective support and subsidization from their “main bank” relationships than mainland SOEs do from Chinese state banks today.

The second argument is that the Chinese state is more rigid and less responsive—and that a rising wave of social unrest is already threatening political stability. Even by the government’s own statistics there has been a marked increase in public or “mass” disturbances since the beginning of the decade, and reports of unruly demonstrations and violence are common in the foreign press.

But, there’s just one caveat. Very few of these disturbances involve higher-income urban residents, or for that matter urbanites at all; instead, the vast majority come from farmers and rural migrants. In other words, this is not the aspiring middle class “rising up” against authoritarian rule, but rather the poorest segments of the population chafing against their plight. And, as it turns out, their gripes are founded in economic issues, not political ones.

Let me explain what I mean. As China pursued enterprise reforms during the 1990s, one of the consequences was a collapse of budgetary finances; at the lowest point, general government revenue had dropped to less than 10 percent of GDP, more reminiscent of an African nation than a nominally socialist state. This left the authorities with barely enough funds to maintain civil-service employment, forcing sharp cutbacks in education, housing and medical services. And by far the worst affected were county and village governments, which were left to fend for themselves by exploiting their own base: levying taxes on farmers and expropriating land.

The other problem was rural incomes. Local farm prices were flat or falling from the mid-1990s through the early part of this decade, and Chinese farmers saw very little income growth at a time when their urban counterparts were gaining wealth at a record pace. With flat earnings, rising taxes and fees, village governments selling off farmland at minimal compensation and migrant wages stagnant as well, it’s little wonder the mainland saw growing rural disturbances.

But now look what has happened over the past half-decade. To begin with, budgetary revenue has rebounded steadily as a share of GDP, reaching 20 percent in 2007, and suddenly the center is flush with cash. This has meant rising transfers to local governments, increased spending on health and education, and the removal of all agricultural taxes in the last few years. Second, the authorities have undertaken significant changes in land-tenure policy, including better guarantees of a farmer’s claim to a specific piece of land, a more transparent sales and transfer regime, and more avenues for legal recourse. These leave less scope for local corruption and more gains to farmers from future land transactions.

Third, since 2004 there has been a large trend rise in domestic food prices, driven by rising urban consumption and the natural decrease in supply due to past land sales. And over the past three years real farm-income growth at last caught up with and even exceeded the urban pace of wage increases. Finally, rural migrant wages have also jumped over the same period as a result of tighter labor markets caused by fewer young, mobile workers.

The bottom line is that China has seen considerable structural and largely market-driven changes that are already fundamentally altering the rural income balance, and should go a long way toward addressing the economic problems leading to the recent unrest. This year and the next will be tough, to be sure, as weak export markets and, especially, falling construction demand take a toll on migrant employment—but as I argued above, these are cyclical issues that are unlikely to prevent a return to trend growth in the near future and over the long term.

Continued

National Interest
March/April 2009

by Minxin Pei and Jonathan Anderson

Minxin Pei is a senior associate in the China Program at the Carnegie Endowment for International Peace. His most recent book is China’s Trapped Transition: The Limits of Developmental Autocracy (Harvard University Press, 2006).

Jonathan Anderson is a senior global emerging economist at UBS.

Looming Stagnation by Minxin Pei

FORECASTERS OF the fortunes of nations are no different from Wall Street analysts: they all rely on the past to predict the future. So it is no surprise that China’s rapid economic growth in the last thirty years has led many to believe that the country will be able to continue to grow at this astounding rate for another two to three decades. Optimism about China’s future is justified by the state’s apparently strong economic fundamentals—such as a high savings rate, a large and increasingly integrated domestic market, urbanization and deep integration into the global trading system. More important, China has achieved its stunning performance in spite of the many daunting economic, social and political difficulties that doomsayers have pointed to as insurmountable obstacles to sustainable growth in the past. With such a record of effective problem solving, it is hard to believe that China will not continue its economic rise.

Yet, while China may sustain its growth for another two to three decades and vindicate the optimists, there are equally strong odds that its growth will fizzle. China’s economic performance could be undermined by the persistent flaws in its economic institutions and structure that are the result of half-finished and misguided government policies. A vicious circle exists in which the Communist Party’s survival is predicated on the neglect of fundamental aspects of society’s welfare in favor of short-term economic growth. And many of the same social, economic and political risk factors the government has thus far sidestepped—heavily subsidized industries, growing inequality, poor use of labor—remain. Some are becoming worse.

Because the party relies on growth for legitimacy, Beijing invests in tangible signs of progress—factories, industrial parks and the like. This emphasis on “visible” gains has in turn led to huge social deficits. By focusing on short-term growth instead of long-term sustainability, health care, education and environmental protection have all been neglected. Not a cause for optimism.

The end result is a state built on weak political, economic and societal foundations with a potentially unhappy and restless people. Reducing these economic and social deficits will require both additional financial resources and politically difficult institutional changes. Allowing such deficits to accumulate is simply not viable.

Worse, China’s difficulties will be compounded by the future deterioration of some of what have thus far been structural and political strengths—a large, young population; underpriced natural and environmental resources; and a public consensus in support of economic growth. With fewer people entering the workforce, a rapidly aging population and ongoing environmental damage, China faces the choice between stagnation, even disaster, or fundamental change. The fact that all of these risk factors have not derailed China’s growth in the past does not preclude the possibility that they could do so in the future, especially if the Chinese government fails to make major policy adjustments.

Of course, these challenges—rebalancing China’s economic growth, addressing social deficits and rebuilding a political consensus that supports growth—are manageable if the Chinese government can implement effective economic and political reforms and remove the underlying causes. But will Beijing do so? Does the Chinese political system possess the flexibility and inner strength to overcome the opposition of entrenched interests? Is the ruling Communist Party willing to take the risks of adopting reforms and disrupting a carefully balanced coalition of political and economic interests?

As the world is engulfed in a global economic crisis and China’s growth engine starts to lose steam, it is time to reexamine the risk factors that lie ahead and rethink our complacent assumptions about China’s future.

HIGH RATES of economic growth tend to conceal serious structural, institutional and policy flaws because, as the Chinese saying goes, “one mark of beauty can hide a hundred spots of ugliness.” All too often, high growth rates themselves are taken as prima facie evidence of superior institutions and wise policies. Our obsessive focus on the speed of economic development often blinds us to the underlying weaknesses of the country. Over time, such myopia leads to complacency and, worse, a dismissive attitude toward warning signs of trouble.

In China, four factors were crucial to the state’s economic performance over the past thirty years: high domestic savings (which allowed for investment in industry), the demographic dividend (which provided a large potential workforce), the globalization dividend (which enabled integration into the world market) and considerable efficiency gains from the liberalization of an enormously inefficient planned economy. However, while these fundamentals have contributed to rapid economic growth since the 1980s, they unfortunately also allowed the Chinese government to avoid undertaking effective measures that would further liberalize the economy, establish robust regulatory institutions and dramatically reduce the role of the state in the economy. This does not mean that Beijing has not taken important reform measures. It has—but it did so, almost without exception, only when compelled by a serious economic crisis (as was the case with mass bankruptcies of state-owned enterprises at the end of the 1990s).

Such behavior is costly because it ignores the fact that benefits from investment in capital, demographic advantages and growing trade neither solve all problems nor remain static. Today, as China’s export growth plummets and domestic consumption remains anemic, it is quite evident that economic and societal imbalances have not only undermined China’s sustainable growth but also have weakened its ability to weather the current economic crisis. To be sure, these imbalances have been building up since the early 1990s. Their principal symptoms consist of excessively high investment in fixed assets (i.e., capital-intensive industries) and low household consumption, rising dependence on exports as a growth driver and the underdevelopment of the service sector. For example, from 1992 to 2005, investment rose from 36.6 to 42.6 percent of GDP while household consumption declined from 47.2 to 38 percent of GDP. In 2007, household consumption fell to 35 percent of GDP, a historical low. Consequently, export growth assumed increasing importance as a key driver of GDP growth. By 2007, export growth contributed roughly 25 percent of GDP growth.

Because the bulk of China’s investment goes into the manufacturing sector, particularly capital-intensive heavy industries, persistently high investment has exacerbated the imbalance between too much manufacturing and too little growth in the service sector. Compared with its developing-country peers, China stands out for having an underdeveloped service sector.

Besides creating excessive dependence on exports and industry, too much investment in fixed assets has begun to yield decreasing economic benefits. Between 1991 and 1995, RMB 100 million in additional investment yielded RMB 66.2 million in additional GDP, 400 new jobs and RMB 10.4 million in additional wages. Between 2001 and 2005, the same amount of extra investment yielded only RMB 28.6 million in additional GDP, 170 new jobs and RMB 3.7 million in additional wages.

Such structural imbalances threaten growth sustainability because they create massive economic distortions, subjecting the Chinese economy to chronic excess capacity, low consumer welfare, rising trade frictions and poor utilization of its comparative advantage—people—because these imbalances lead to growing capital intensity and decreasing labor intensity.

OF COURSE, these structural imbalances are symptoms of both unreformed economic institutions and the continuation of bad policies. Despite thirty years of reform, the Chinese state maintains a decisive influence on the economy through both its direct presence (state-owned or -controlled enterprises) and its policies. For example, state-owned enterprises (SOEs) account for about 35 percent of GDP today, but the government’s role in the economy is much more substantial than even this figure indicates. The state maintains a monopoly or near monopoly on the so-called strategic sectors, such as banking, financial services, natural resources, energy production, telecom services and most heavy industries. Nearly all of China’s largest companies are owned or controlled by the state.

In addition, key input prices, such as those of energy, land and capital, are set by the government. Because of the government’s bias in favor of investment and manufacturing, such key prices are set at artificially low levels as subsidies. For example, the primary market for land is almost nonexistent. Local governments often seize land from powerless and voiceless peasants and sell the land-use rights to developers and/or use it for infrastructure projects—all for a fraction of its market value. As for the cost of capital, the Chinese government has been skillfully wielding financial repression to use household savings as a way to subsidize the investment of Chinese state-owned firms. Until recently, SOEs could borrow from banks without worrying about repayment. Even though household deposits are nominally protected by the state, Chinese taxpayers are responsible for bailing out banks that are drowning in massive nonperforming loans.

Obviously, such wasteful use of China’s scarcest resources—energy, land and capital—to maintain an unbalanced growth model cannot be sustained indefinitely. For the past three decades, China’s strong economic fundamentals enabled its government to continue these distortions with impunity. But many of these fundamentals are either weakening or expected to disappear within the next two decades, thus making it impossible to achieve high growth with the same flawed policies.

Of the deteriorating fundamentals, two deserve special mention—demographics and savings—because they have in the past been among the principal drivers of China’s growth. China is expected to lose its demographic dividend in the middle of the next decade. The median age of the population will rise from 32.5 years in 2005 to 37.9 years in 2020. The percentage of the population 60 and over will increase from 11 percent in 2005 to 17.1 percent in 2020. By 2030, according to the Chinese minister of labor and social welfare, 351 million Chinese, or 23 percent of the population, will be over 60, and the elderly-dependency ratio will increase from 5.2 to 1 in 2006 to 2.2 to 1 in 2030. The worker-to-retiree ratio will fall from 3 to 1 in 2006 to 2 to 1 in 2030. The rapid aging of the Chinese population will unavoidably increase health-care, pension and labor costs, eroding China’s competitive advantage. More important, this will also cause China’s savings rate to fall. One World Bank estimate suggests that old-age dependency could depress private savings by six percentage points of GDP by 2025. Another study of demographic change, without population-policy adjustment, estimates that per capita income growth would fall from 5.3 percent a year in 2000 to 2.9 percent a year by 2020.

This means the government will be unable to continue its practice of subsidizing industrial growth with private wealth. When coupled with an aging, increasingly dependent society and poor social services, stagnation and, eventually, abysmal failure loom.

IF SEVERAL years ago few would concede that China’s rapid economic growth was achieved at very high social cost, such as deteriorating social services, potentially catastrophic environmental degradation and rising income inequality, today this is no longer a disputed fact. Even the Chinese government has admitted that its economic growth is socially costly.

The accumulation of social deficits since the early 1990s was the unavoidable outcome of government policies that deliberately shift resources away from providing socially beneficial services (education, health care and environmental protection) to projects and activities that could produce immediate and visible signs of progress (infrastructure, commercial development in cities and industrial parks). Such policies were perfectly aligned with the imperative of regime survival and the incentives of individual government officials. For the Communist Party, policies that could generate rapid short-term economic growth even at the expense of long-term social costs were preferable because of the party’s dependency on growth as a source of legitimacy. For government officials whose promotion critically depends on their ability to deliver visible and measurable signs of growth, diverting scarce resources away from social services to investment projects offers a guaranteed ticket to higher offices and greater power.

As a result, these policies have worked wonders for both the party and its members, but their social costs have been horrific.

Official data indicate that the government’s relative share of health-care and education spending began to decline in the 1990s. In 1986, for example, the state paid close to 39 percent of all health-care expenditures while individuals paid 26 percent. By 2005, the state’s share of health-care spending fell to 18 percent, and the share of individuals’ spending rose to 52 percent. This dramatic shift in cost has placed significant burden on household budgets and consequently reduced access to health care. Per capita health-care expenditures as a share of consumption more than tripled in urban areas from 1990 to 2006 (from 2 percent to 7.1 percent) and increased 30 percent in the countryside. Unable to pay for health care, about half of the people who are sick choose not to see a doctor, based on a survey conducted by the Ministry of Health in 2003. The same shift has occurred in education spending. In 1991, the government paid 84.5 percent of total education spending. In 2004, it paid only 61.7 percent. During the same period, tuition and fees (costs borne by individuals) rose significantly. In 1991, they accounted for 4.4 percent of spending. By 2004, they contributed about 19 percent. One key indicator that reduced government spending has restricted access to education is the percentage of middle-school graduates who go on to enroll in high school (since students have to pay for high-school education). In 1980, almost 25 percent of the middle-school graduates in the countryside went on to high school. In 2003, only 9 percent did. In the cities, the percentage of middle-school graduates who enrolled in high school fell from 86 to 56 percent in the same period.

On the natural-resources front, the extent of China’s environmental degradation is now fairly well-known. Although estimates of the cost of pollution vary, they all suggest that environmental degradation is exacting a huge toll on Chinese society. The most recent study, a joint effort by the World Bank and the Chinese government, shows that the aggregate cost of pollution in China in 2004 was roughly 5.8 percent of GDP. Another study undertaken by two Chinese government agencies and released in 2004 estimates that the amount of underinvestment in environmental protection is roughly 1.8 percent of GDP a year. To fully treat all pollutants discharged in 2004 alone, China would need a one-time expenditure of 6.8 percent of its 2004 GDP—RMB 1.086 trillion, or $158 billion. The Chinese government’s poor stewardship of the environment has added huge stresses to the country’s fragile ecological system. Although a continental-sized country, China is resource scarce on a per capita basis. In particular, it suffers from serious water scarcity and uneven distribution of water resources: the per capita water availability is only 30 percent of the world average, and the area north of the Yangtze River, which accounts for 64 percent of China’s land surface, has only 19 percent of the country’s water resources. Truly alarming is the Chinese government’s growth-at-all-costs strategy that has devastated the country’s already-scarce water resources. The 2004 joint study reports, “About 25,000 kilometers of Chinese rivers failed to meet the water quality standards for aquatic life and about 90 percent of the sections of rivers around urban areas were seriously polluted.” Without prompt and effective measures, environmental degradation will not only pose an insurmountable hurdle for future economic growth, but also precipitate large-scale social unrest and political conflict.

Then there is rising inequality—a mainstay of many countries experiencing rapid economic development and social change. Although the causes are complex, government policies that fail to ameliorate the effects of economic-growth inequality can further exacerbate the trends. In China, the government has consistently undercut social services to the general public, and left the poor bearing the brunt of the deterioration in the provision of public goods. Additionally but inexplicably, Beijing has failed to counter rising inequality by instituting a relatively progressive tax system. China has no capital-gains tax, property tax or inheritance tax. Its income tax is so ineffectively enforced that it generates only a very small portion of government revenues. At present, income inequality in China has reached a level close to that of Latin America. The overall level of income inequality from 1985 to 2006 rose 39 percent (averaging a 1.8 percent increase per year). Although “within” (intraurban and intrarural) income inequality remains lower than national inequality, it has also risen significantly. In fact, the rate of increase in urban income inequality from 1985 to 2006 was twice that of rural income inequality (63 percent compared with 27 percent). The distribution of wealth in China is even more unequal than income. Household surveys and academic research show that the Gini coefficient of wealth rose from 0.40 in 1995 to 0.55 in 2002 (the higher the Gini coefficient, the more unequal the distribution of wealth or income). The distribution of financial assets is particularly skewed. In 1995, the Gini coefficient for financial assets was 0.67; it rose to 0.74 in 2002. These trends do not bode well for China. If they are not reversed by effective policy, China will likely suffer a rising crime rate and increasing social conflict closely associated with frustrations and tensions generated by inequality and high perceptions of social injustice.

THE COMBINATION of accumulated economic imbalances, misguided growth strategies, deteriorating fundamentals and social deficits makes it difficult to imagine that China will be able to maintain its current rate of economic growth without significant policy changes and reforms. Even with effective policy adjustments, China is unlikely to keep growing at a high single-digit rate for the next two decades. As we have seen, such high growth in the past has been obtained through artificial means. It is inflated, not just by creative accounting, but by discounting and excluding consumer welfare, social costs and environmental damage.

If China does not make the necessary changes, it will face something far worse than low single-digit growth—the delicate coalition among the ruling elites will unravel, the legitimacy of the Communist Party will erode and social unrest will rise. If it does make adjustments, we will merely see lower rates of growth.

But neither Beijing nor the outside world should worry about China’s reduced rate of growth in the coming decades because, to the extent that the Chinese government has improved the quality of growth at the cost of speed, it will be able to sustain a respectable rate of growth while addressing the economic and social problems caused by past policy mistakes.

Incidentally, this is what the current Hu Jintao government has pledged to do. However, based on the modest achievements of Beijing’s efforts to rebalance its growth strategy so far, it is becoming increasingly clear that the current growth strategy is rooted in the existing political system. It would take much more than rhetorical exhortation to reverse course. As long as Chinese government officials are assessed and promoted based on their ability to deliver economic growth, often within the two-and-a-half-year tenure of a party chief, the short-term obsession with the rate of growth will continue. In addition, so long as Chinese officials are accountable to their superiors, but not to the general public, they will have little incentive to pursue policies that would benefit their constituents. State monopolies on key sectors and the distortion of factor prices (such as energy, land and capital) will continue as long as the Communist Party believes that further withdrawal from these sectors and price liberalization will undermine its ability to influence the economy and maintain an expansive patronage system which benefits its supporters. Finally, good governance, measured in terms of adequate delivery of public goods and sound environmental stewardship, will be difficult to achieve without greater participation by China’s embryonic civil society and major social groups.

So a major course change would suspiciously lead to something akin to political liberalization—something the Communist Party has tried very hard to prevent since 1989. It is doubtful whether Beijing has the political courage to gamble the party’s future on it.

Continued

NO STRINGS ATTACHED

In 2006, the National Land Authority got $615,000 from Japan to buy a computer system — one of the many donations that are helping bankroll the Cambodian government today, with uncertain results. About 2,000 nongovernmental organizations (NGOs) and donor groups are registered to work in Cambodia — more per capita, some of them have said, than in any other country. Aid groups run projects in health, education, the environment, and governance. Every year, they hold a meeting to discuss priorities for the coming year. Invariably, some admonish their peers not to give any money until the government ends the land seizures, puts a stop to the contract killings, and passes the anticorruption law. Year after year, Hun Sen and other senior officials exuberantly espouse the donors’ goals — and then return to business as usual. The exercise is “little more than a studied attempt to tell donors what they want to hear,” a 2007 UN report lamented. “The government has learned that they are not serious,” said Chhith Sam Ath, of the NGO Forum on Cambodia, an umbrella group for about 85 donor organizations. “They do not stand behind what they say.”

Once, just once, a major donor held back money because of government skimming. Charging “misprocurement on 42 contracts and declared non-eligible expenditures” of $12.2 million in 2006, the World Bank withheld funds until the government started returning what had been diverted. Stéphane Guimbert, the World Bank’s senior economist in Phnom Penh, says that the bank has set up more stringent financial monitoring. In December, the bank also started a new program called Demand for Good Governance, a $20 million grant to help “NGOs, grass roots groups, independent media, trade unions, etc., to support transparency and accountability programs in Cambodia” — with the funds, however, to be disbursed to the government.

In Samrithy, of the Cooperation Committee for Cambodia, says donors rationalize giving money even though they know a share of it will be stolen. “Some money goes this way or that way, but it’s useful if some of it reaches the poor. Not all of it does, but some does,” he said. And so, as the Cambodian government continues to ask for funds, donors continue to disburse them. In 2007, they gave $550 million after the government promised to pass the anticorruption law, and in 2008 they pledged another $689 million. Although the law had still not been passed by the end of 2008, donors pledged almost $1 billion for 2009. On average, donors supply about half of Cambodia’s annual budget.

THE VIRTUES OF DEPENDENCE

International donors, in other words, are effectively bankrolling the Cambodian state, and that despite economic growth rates that until recently exceeded ten percent. Former U.S. Ambassador Mussomeli said these figures were less impressive than they seemed because Cambodia’s recent growth started “from a very low base.” At the same time, Cambodia’s economy relies on three principal sources of income: textiles, tourism, and agriculture. Its reliance on textiles is so extreme, in fact, that Cambodia has become beholden to U.S. retailers. As Mussomeli put it, “Levi Strauss or the Gap could destroy this country on a whim.”

Another outsider, Chevron, discovered oil offshore several years ago. The company is still trying to determine the size and marketability of the field, but the Cambodian government says it hopes to begin pumping oil in 2011. The International Monetary Fund estimated last year that the country could earn as much as $1.7 billion from oil within ten years of the date pumping begins.

This worries diplomats and donors: Will oil wealth not simply sluice down the corruption sewer? And with all that new money, will the government still need the NGOs? Without the involvement of international groups, “a lot of services would suffer, maybe collapse,” said Suomi Sakai, who headed UNICEF’s Cambodian office until last August. For the time being, the government officers who want to attract outside funds — the better to skim them — make sure that at least some things are done so that Cambodia shows a good face to international organizations. Kek Galabru, the head of Licadho, whose Web site regularly documents government abuses, says the government largely leaves her alone because it can point to her organization to secure money from the international community. As she put it, “The government can say, ‘Look at Licadho. They are free.’”

If the government no longer needed donor money because of oil revenues, would it shut down Licadho’s Web site, take over the newspapers, and crack down in other ways? “The little that has come out now suggests that the pockets of oil are more scattered and may be less commercially viable” than was once thought, said Guimbert, of the World Bank. “That could be a blessing in disguise. But I don’t want to discount the black scenario. It could still happen.” Hence the need, he said, to bring transparency to government spending. “There is a sense of urgency here.

The End

CORRUPTION RULES

One afternoon last May, a few months before the election, a convoy of motorcycles and rickshaws pulled up in front of the National Assembly to deliver a petition. The documents, which had been signed by 1.1 million Cambodians — eight percent of the population — and filled dozens of boxes, urged the assembly to pass an anticorruption bill that has been languishing for more than a decade. The United States had paid for the initiative. “Our assessment was that there was not the political will to pass the anticorruption law,” Erin Soto, who heads the Cambodian office of the U.S. Agency for International Development, told me. “When political will does not exist, it must be built.”

The U.S. embassy in Cambodia has made anticorruption a priority in its relationship with the Hun Sen government. It funded two comprehensive studies that were published in 2004 and 2005. They showed in stunning detail that Cambodian government officials steal between $300 million and $500 million a year (most years, the state’s annual budget is about $1 billion). In September, after working in Cambodia for several months on a World Bank project, Antonia Corinthia Naz returned home, disgusted by the graft. Naz, an environmental economist from the Philippines, complained that every step along the way, one Cambodian government official or another had demanded a kickback, sometimes asking for 20 percent of Naz’s daily salary.

For Cambodians, this is to be expected. “Everyone is corrupt,” said Ok Serei Sopheak, a prominent political consultant who became a senior adviser to the prime minister last fall. “It’s a way of life here. Everything is done under the table.” Thus, last spring, it came as no surprise to the motorcycle and rickshaw drivers delivering the boxes filled with the anticorruption petitions that the National Assembly official who greeted them refused to accept the documents.

TU CASA ES MI CASA

Corruption and impunity play directly into Cambodia’s policy of evicting thousands of poor families from their homes. In 2001, the government enacted a land law that was supposed to establish rules for mediating property disputes. Eight years later, it has yet to write the regulations that would implement the law. In the meantime, the government and its favored developers have simply seized the land they wanted. Phnom Penh is booming, and when a developer spots a choice piece of land, he pays off the relevant official to get a newly minted title and rid the property of its residents, who are almost always poor, uneducated people. When residents resist, the government often charges them with trespassing and throws them in jail.

Three years ago, soldiers and police officers showed up in the middle of the night outside of Un Phea’s crude home in central Phnom Penh. They threw her family and hundreds of her neighbors into the street and torched their homes. The residents were then herded onto buses, ferried 15 miles out of town, and dumped in a rice paddy without so much as a bottle of water or a tarp. This also created a problem for the owner of that paddy. “He had not been told,” Yeng Virak, executive director of the Community Legal Education Center, said, recalling that night. “Suddenly, there were 1,000 people on his land.”

Chum Bon Rong, deputy director of the National Land Authority, which is supposed to arbitrate such disputes, told me last summer that his agency had received more than 3,000 land-seizure appeals in the previous two and a half years. Of those, only about 50 cases had been adjudicated in favor of the evicted residents. And some of those cases had subsequently “disappeared,” Chum Bon Rong said, after they were referred to another agency tasked with implementing the National Land Authority’s findings.

After people like Un Phea are evicted, they are forgotten. Licadho, a local human rights group, noted in a report published last year that these people routinely suffer from malnutrition and various infectious diseases, as well as stress-related problems and depression. One day in August, Un Phea sat in the mud outside her shanty in what used to be the rice paddy, peeling bamboo shoots — and seething. “Before, I sold water and some eggs in front of the royal palace and made a good living. Here, it is hard to work,” she explained. She is 25 but already looks decades older. “They dumped us here and gave us no money, no land title, nothing.” The community has no water, not even a pump. “We have to buy water from the water seller,” she said, nodding toward a cistern beside the house. Mosquito larvae roiled the water. Tacked to her shelter’s front wall, a poster warned of dengue fever.

Continued

BAD EDUCATION

Every day, just before Chhith Sam Ath’s two young sons head out the door for elementary school in Phnom Penh, he gives them a small wad of cash. And every day, they hand it to their teacher as they enter the classroom. So do all the other students. Children who do not make the daily payments are likely to get bad grades. In the upper classes, teachers sell students the answers to final examinations — an expected practice, especially in urban schools. “You go to school and learn how to bribe people,” said Chhith Sam Ath, who is executive director of the NGO Forum on Cambodia. As in many developing countries, school attendance is not compulsory. And education officials say that some Cambodian families do not send their children to school simply because they cannot afford the daily bribes.

Im Sethy, the education minister, told me in August that the ministry’s policy is to “cut down on these irregularities.” But he also expressed sympathy for the teachers, who are paid $40 a month. “We have to increase the salaries,” he said. In the meantime, the ministry has given teachers permission to hold other jobs to supplement their incomes. Im Sethy said that his staff had sent a circular to the schools warning of suspensions and lost promotions if teachers were caught taking bribes. “We catch about a hundred of them a year.”

By neglecting education, Cambodia’s leaders are crippling the country’s development. Only about 75 percent of Cambodian children even enter the first grade. The average class size is 53 students. In many rural areas, teachers have no more than a third-grade education. Cambodian students repeat grades so often that it takes them an average of ten years to make it through the sixth grade. Only half the children who begin school get that far, and just 23 percent of those who get to the sixth grade make it to high school. And those who do graduate have diplomas that every employer and every university admissions officer will suspect were obtained through bribery rather than study.

Like many other Cambodian officials, Im Sethy blames the Khmer Rouge for today’s educational problems. He notes that about 80 percent of Cambodia’s teachers were killed under its rule and only ten percent of the schools were left standing. “We had to organize the education system from scratch,” he said. Thirty years later, Im Sethy insisted, the school system is still recovering.

A ROLLS-ROYCE IN A TRAILER PARK

Driving around Phnom Penh during the national election campaign last summer, one could see the same poster pasted to almost every fence and wall. “Hun Sen saved Cambodia from the Khmer Rouge,” it said. Actually, it was the Vietnamese who “saved” Cambodia from the Khmer Rouge; nonetheless, Hun Sen’s party, the Cambodian People’s Party, won the July 27 election by a wide margin, taking 90 of 123 seats in parliament.

To help assure the party’s victory, operatives handed out cash and gifts to voters all over the country in the weeks leading up to the election. In Samrithy, who works for the NGO coordinating organization the Cooperation Committee for Cambodia, said that his niece got two shawls and 20,000 riel (about $5). These payouts buy voters’ loyalty — even though after 30 years of Hun Sen’s party being in power, per capita income stands at about $590 a year and at least one-third of the country lives on less than $1 a day. About eight out of every 100 children in Cambodia die before they reach the age of five, according to UNICEF. Of those who survive, 37 percent are so malnourished that their growth is stunted physically or mentally. Seven percent of Cambodia’s children are, in essence, starving to death. Life expectancy, according to UNICEF, is 59 years.

These problems — and the government’s neglect of them — are most apparent in places such as Bon Skol, a village of 679 people about 100 miles west of Cambodia’s border with Vietnam. Mou Neam is the Cambodian People’s Party chief in Bon Skol. He makes earthen cooking pots and earns about $1.20 a day selling them at the market. Mou Neam lives in a two-room shanty on stilts. Like everyone else in the village, he has no electricity, no running water, no telephone, no toilet. But he is relatively well-off and has a small black-and-white television. Once a week, he trudges to town carrying a car battery. With a fresh charge, which costs 50 cents, “I can watch TV for a week,” he says with a grin.

His neighbor, Cha Veun, is not so fortunate. Forty-six years old and toothless, she says she stopped attending school after the second grade. She earns less than 50 cents a day, also making earthen pots. Cha Veun and her family of four live on a ten-foot-by-ten-foot raised platform with no walls and a palm-frond roof that leaks during the rainy season. She has no television or toilet — or much else.

About 80 percent of Cambodia’s 14 million people live in rural villages like Bon Skol, in conditions more or less like Mou Neam’s and Cha Veun’s. The government acknowledges that only 16 percent of the population has toilets, leaving the rest — some 12 million men, women, and children — to defecate outside, over the aquifers from which they draw water to drink, cook, and bathe.

Many people in Phnom Penh and other cities disdain Hun Sen and the members of his political party for living far beyond their official means. Although a minister’s salary is about $300 a month, Hun Sen is building himself a four-story mansion the size of a suburban office building, with a heliport on the roof. While it is under construction, Hun Sen is staying at his country estate, which has a private golf course. But Cambodians in the countryside seldom see any evidence of this ill-gotten largess. The government controls all the television stations; newspapers, although relatively independent, do not circulate outside the cities; and, according to the government, only about three percent of the population has access to the Internet.

Most Cambodians in the provinces hear about Hun Sen only when he comes to visit, as he did Bon Skol three years ago. On that occasion, the prime minister asked what the village needed. Someone suggested a Buddhist temple, and with a sweep of the hand, Hun Sen directed one of his ministers to build one. A gilded edifice now sits in the center of the village, like a Rolls-Royce in a trailer park.

Continued

Foreign Affairs, March/April 2009
By Joel Brinkley

Joel Brinkley, former Foreign Affairs Correspondent for The New York Times, is Professor of Journalism at Stanford University. Research for this article was carried out in Cambodia last August thanks to funding from the Pulitzer Center on Crisis Reporting.

Summary: While much of Cambodia — and of the world — holds on to memories of the country’s sorrowful past under the Khmer Rouge, few seem to notice that the government of Prime Minister Hun Sen is destroying the nation.

Theary Seng often thinks of that April morning in 1975 when she watched her parents cheering on the Khmer Rouge as its soldiers marched into Phnom Penh. She was four years old. Within days, Pol Pot’s foot soldiers had killed her father; three years after that, her mother died in a prison compound. Today, Theary Seng runs a nonprofit legal-advocacy group in Phnom Penh. She is eager to move on. But the rest of Cambodia, and much of the world, remains mired in the nation’s sorrowful past. During its four-year reign, the Khmer Rouge killed as many as two million people. Nowadays, the venal government of Prime Minister Hun Sen may take “ten lives or even a hundred lives,” she told me in August, “but what’s that compared to two million? That’s still the Cambodian standard, and that’s the international standard.”

The devastation Pol Pot wreaked on his country remains hard to comprehend, even three decades later. His goal, as he put it, was to return Cambodia to “year zero” and transform it into an agrarian utopia. To that end, he purged his nation of educated city dwellers, monks, and minorities, while imposing a draconian resettlement program that uprooted almost everyone else. These measures led to the deaths of one-quarter of the country’s population.

The Khmer Rouge fell in 1979, when Vietnam invaded Cambodia and replaced the regime with a puppet government, in which Hun Sen became the foreign minister. When Vietnamese forces pulled out ten years later, they left behind several Cambodian factions battling for control. Then, in 1991, these groups’ leaders signed a UN-sponsored peace accord, giving Cambodia the extraordinary opportunity to start over. Before Iraq, Afghanistan, Somalia, and even the Balkans, Cambodia was the international community’s grand nation-building project. The country’s new constitution awarded Cambodians the human rights, personal freedoms, and other protections of a modern democratic state. And in 1993, the United Nations staged a national election to select a democratic government. After the horrors of the Khmer Rouge, Cambodia would remake itself at last, and its people would have a chance to thrive.

But in the 16 years since that election, the government has squandered that opportunity. Hun Sen came in second in the 1993 election but muscled his way into the government nonetheless. Four years later, he staged a coup. Since then, his government has been looting Cambodia’s natural resources, jailing political opponents, kicking thousands of the weakest out of their homes, and fostering an expansive system of corruption, all the while ignoring any challenges or complaints from organizations and governments around the world.

“People in America, all they know of Cambodia is the Khmer Rouge,” Joseph Mussomeli, then U.S. ambassador to Cambodia, told me in August. “Cambodia is trying to make it in the twenty-first century, but Washington is still stuck in the 1970s.” Its perception skewed by this outdated vision, most of the world barely seems to notice that the Hun Sen government is destroying the nation.

GETTING AWAY WITH MURDER

One word comes up over and over again in conversations with Cambodians: “impunity.” Prime Minister Hun Sen and his family, aides, and friends do more or less whatever they want and face few consequences. In August, the prime minister’s nephew, Hun Chea, ran over a motorcyclist while speeding in his Cadillac Escalade, ripping an arm and a leg off the victim. Hun Chea began to drive off, but he had shredded a tire in the accident and was forced to pull over. The Phnom Penh Post described what happened next: “Numerous traffic police were seen avoiding the accident scene, but armed military police arrived. They removed the SUV’s license plates and comforted Hun Chea.” According to the newspaper, a military police officer was overheard telling him, “Don’t worry. It wasn’t your mistake. It was the motorbike driver’s mistake.” Meanwhile, the victim bled to death on the street. A few days later, Hun Chea gave the dead man’s family $4,000, and the case was closed.

The continuing problem of contract killings is the signal example of impunity. Last summer, two men speeding by on a black motorcycle shot and killed Khim Sambor, a reporter for the opposition newspaper Moneaksekar Khmer (Khmer Conscience), and his 21-year-old son as they walked down the street. No suspect has been arrested. Nor have any suspects been arrested for the drive-by shootings, in broad daylight, of dozens, if not hundreds, of trade-union leaders, journalists, and political activists over the last decade or so. Although no one has proved that government officials were behind these murders, the police have made no effort to solve the crimes. Citing the deaths of union leaders in the last four years, the UN high commissioner for human rights said in a report last year that they were “emblematic” for what they revealed “about impunity for crimes which appear to possess a political dimension.”

Perhaps even more revealing is the laxity with which Cambodians long treated Ieng Sary, Pol Pot’s foreign minister and a key architect of the Khmer Rouge’s ideology. After the Khmer Rouge was deposed, many of its members, including Ieng Sary, went into hiding in the jungle in the western part of the country, from where they waged guerrilla warfare for almost two decades. Ieng Sary moved back to Phnom Penh in the late 1990s, having defected to the government and having been pardoned by King Norodom Sihanouk. In time, he settled in a comfortable housing development for ruling-party officers, down the street from the Senate’s golf course.

To most outsiders, permitting Ieng Sary to quietly return to the capital was akin to allowing Joseph Goebbels, Rudulf Hess, or other Nazi leaders to move back into their Berlin homes after World War II. But Cambodians find it utterly unremarkable that a Khmer Rouge leader lived openly among them for years. Ask anyone how that could be, and you get a puzzled look. And if Ieng Sary faced no retribution and no censure for years, why would the killing of a journalist here or of a trade-union official there raise concerns?

Ieng Sary was finally arrested in November 2007 to stand trial for war crimes and crimes against humanity, along with four other surviving Khmer Rouge leaders. After years of tortured negotiations, the UN convinced the Cambodian government to try Ieng Sary and the others in a hybrid Cambodian-UN court. But delays and charges of corruption are now hobbling the proceedings. (The tribunal announced in January that the first trial would begin in March.) Several court employees have complained that their supervisors are forcing them to kick back 20 to 30 percent of their salaries. These claims have enraged UN officials but have evoked little surprise among Cambodians. After all, they learn about corruption firsthand — starting in the first grade.

Copyright © 2008 – Heinrich Böll Stiftung, WWF and International Institute for Sustainable Development.

China’s investments in agribusiness, hydropower and mining

The natural resource sectors of the three Mekong countries have long been described as under-developed. However the emergence of China as a major investor in the three sectors as well as a principal market promises fundamental changes in the landscapes and societies of the region. Chinese state-owned enterprises are becoming major investment players in Cambodia, Laos and Vietnam and fuelling natural resources extraction. For instance, the China Nonferrous Metals International Mining Co. Ltd. (CNMIC) is active in copper mining in Vietnam and bauxite mining in Laos. Chalco (Aluminium Corporation of China) has partnered with Thai and Lao companies to put forward an environmental impact assessment for bauxite mining in the same area as CNMIC in Laos and is also engaged in Vietnam. The Sinohydro Corporation, the largest hydropower dam building company in China, is developing numerous hydropower projects in both Laos and Cambodia. And the China Southern Power Grid Co. Ltd. is either active or exploring opportunities in all three countries.

In spite of its high potential, hydropower has remained largely untapped. However, in Laos and Cambodia, China is involved in roughly 21 hydropower projects either as an investor or developer. Most of the Chinese projects are designed and implemented by Chinese companies and backed by the China Exim Bank and Sinosure, which are involved in the majority of China’s overseas investments. China’s current role in hydropower in Vietnam appears to be quite minor. There are no joint ventures, with most hydropower development carried out by Vietnamese firms, formerly dominated by Electricity of Vietnam. However, China supplies most of the turbines and other equipment for small and medium hydropower and Vietnam currently imports 200MW of electricity from southern China. This is expected to increase tenfold by 2015, with projected imports of about 2,000MW.

Mineral extraction has been small in scale and intensive in labour to date. However, in Laos along the Bolaven Plateau and in the Central Highlands of Vietnam, China is starting to invest in large tracts of land for bauxite mining to export aluminium for its growing construction, transportation and packaging industries. Other mining investments and/or exports in the three countries include gold, copper, iron, zinc and coal. It is expected that China will remain a large market for minerals and a key investor in the region.

Until recently, agricultural production in Cambodia and Laos was largely for local consumption and lacked intensive inputs and practices. But those days are over. China provides a major source of investment capital for agricultural inputs in the two countries and is a principal market for goods in all three. Such commodities as cassava, sugarcane, corn, palm oil, cashews and eucalyptus, among others, are major sources of investment by China in at least one of the three GMS countries. China’s rising demand for natural rubber, for example, has already led its southern neighbours to convert large areas of land to rubber production. China is a major investor in rubber production in Laos, although less so in Cambodia. And while China’s investment in Vietnam’s rubber sector is presently negligible, China is already the principal market for its rubber exports.

Towards environmentally and socially sustainable Chinese investment

China’s growing presence and role in the three Mekong countries raises new opportunities through foreign direct investment, trade and regional partnership. These new opportunities could play an important role in generating income for some of the poorest countries in Southeast Asia and building closer regional ties for both China and the countries in which they invest. But the vastly expanding demand for investment opportunities, the porous borders that facilitate informal movement of goods and people and the limited local capacity and resources to implement various regulations in the three countries presents considerable risks to these hoped for opportunities. These environmental and social risks can translate into significant impacts on riverine ecosystems, agricultural lands and communities.

China is starting to make efforts to improve its profile in the international arena by showing its willingness to take on board international best practices such as the Equator Principles for banks, public participation strategies and green credit policies, among others. However, many of the mainly state-owned Chinese companies operating in the mining and hydropower sectors continue to have a poor social and environmental track record abroad. China now has the chance to become a global leader in environmentally and socially sustainable investment by carefully monitoring Chinese overseas investments, strengthening its own investment regulations and adopting global best practices and principles. However, the onus cannot be on China alone. China will need to partner with governments within the countries it operates in order to help resource providers strengthen their own regulations, which does not necessarily have to come at the expense of investment inflows

The End

Copyright © 2008 – Heinrich Böll Stiftung, WWF and International Institute for Sustainable Development.

China’s emerging role in finance and trade in Cambodia, Laos and Vietnam

In the Mekong region, China is gaining prominence as an important bilateral trading partner and investor while at the same time emerging as a strong competitor for global markets and investments with its southern neighbours. China produces almost half of the East and Southeast Asian region’s gross domestic product (GDP) and one third of the region’s exports. While China and Vietnam compete for foreign direct investment and markets around the world, China has also become Vietnam’s leading trading partner. Further, China is the most important donor and foreign investor in Laos and Cambodia.

Official development assistance

The Chinese government provides considerable foreign aid to Cambodia, Laos and Vietnam, often without any major conditions attached and frequently integrated with cultural exchange and support. While significant compared to other donors, China’s ODA is not often linked to the agribusiness, hydropower and mining sectors but mostly includes support for transport; communications; health, education and human resources development; and construction (of sports, culture and government building complexes) sectors. Cambodia is the only country among the three where the Chinese government has earmarked aid for hydropower development projects.

China’s trade structure with its neighbours–importing resources, exporting manufactured goods

China’s trade structure with Cambodia, Laos and Vietnam is presently dominated by China’s imports of natural resources and exports of manufactured goods. More than 90 percent of exports from the three GMS countries to China comprise agricultural goods and raw materials. This stands in marked contrast to the structure of trade between China and some other Southeast Asian countries such as Malaysia, the Philippines and Thailand, where the trade structure is more complex and exports to China are less resource-intensive. While the relative importance of investment and trade with China varies among the three countries, what they do sell to their large northern neighbour is overwhelmingly commodities. What they buy is mostly Chinese technology, machinery and consumer goods, many of which are of low quality, but within reach of poorer consumers in Cambodia, Laos and Vietnam.

Informal (or illegal) trade in commodities is widespread in the three Mekong countries. For instance, some state officials in Vietnam estimate that the majority of the coal and rubber exported to China is informal, with no duties paid to the state and no records of the exported tonnage and value. In northern Laos it is widely known that companies from China are setting up informal operations for commodities such as sugar, cassava, corn and timber, which are then transported across the border. In parts of Cambodia it is generally suspected, though not formally confirmed, that several Chinese companies are involved in informal ventures in timber, gold and other minerals destined for markets in China.

The principal difference among the three countries in their relationship with China is in the relative importance of investment and foreign assistance versus trade in relation to the agribusiness, hydropower and mining sectors. In Cambodia and Laos, Chinese investment in all three sectors is considerable. For Vietnam, on the other hand, China is only the fifteenth largest overall investor, and Chinese investment is considerable only in the mining sector. Vietnam itself is a regional leader in hydropower and mining, with its own investments in Laos and Cambodia, and it has extensive experience in growing rubber, also with investments in neighbouring countries. For Vietnam, trade with China, its largest trading partner, is most significant in the three surveyed sectors.

Continued

Copyright © 2008 – Heinrich Böll Stiftung, WWF and International Institute for Sustainable Development.

China’s strategy in Mekong region

China’s relationship with the three Mekong Region countries Cambodia, Lao People’s Democratic Republic (Laos) and Vietnam is dynamic and complex. On the one hand, relations have never been so good. Border and sea issues are handled peacefully, eclipsed by economic interests. The close proximity of these countries eases trade flows as infrastructure improvements are connecting major regional cities and borders are open for business through international gates.

The future promises greater economic integration through the ASEAN (Association of Southeast Asian Nations)–China Free Trade Agreement (ACFTA) which will see progressive liberalisation of trade and investment between the two trading partners over the coming years. Under the ACFTA’s Early Harvest Programme, tariffs on around 600 unprocessed agricultural products were already eliminated by January 2006. China’s major investments within the Greater Mekong Subregion (GMS) Economic Strategy have improved the infrastructure for transporting commodities, in part through the Asian Development Bank’s (ADB) GMS Economic Corridors, which includes a network of roads connecting all countries in the GMS spanning Vietnam, Cambodia, Laos, Thailand, Myanmar and Yunnan Province of China. Further connectivity is extended through an expanding regional power grid and planned railway links from Kunming to Singapore, funded in part through development assistance and investment from China. All this has enabled China to build strong bilateral and multilateral relations through investment, trade and aid with its southern neighbours and protect itself from further western influences by securing its border areas through friendly relations.

In recent years, Cambodia, Laos and Vietnam have seen two related trends working in opposite directions. The first is the partial withdrawal of International Financial Institutions (IFIs) such as the World Bank and the Asian Development Bank (ADB), which have become hesitant to invest in environmentally and socially controversial mega-projects. In recent years the IFIs have developed international standards and best practices for investment in projects with potentially large social and environmental impacts, such as hydropower, mining and industrial agriculture. These standards are often criticised by host governments as being onerous and cumbersome and it can take years for projects to get approved. This has left an investment vacuum that has been gradually filled by largely Asian financiers, and has enabled ‘new financiers’ such as Chinese companies to take advantage of the favourable investment climate and abundance of natural resources of its immediate neighbours.

Currently, Chinese investment banks and companies are not yet bound to similar standards in their overseas activities, even though they may be required to follow them in their home countries. China brings a different kind of investment package to the table: one that does not have benchmarks of compliance with human rights, democratic ideals and environmental protection regulations, but is built on relationships and friendship. China is also seen as a ‘soft power’ of culture and ideas, one making friends all across the region, with friendship spearheading business activities. For example, the Chinese government has supported the construction of several important cultural and state buildings, such as the National Cultural Hall in Laos and the new office of the Council of Ministers in Cambodia.

However, the role of China is perceived differently within Cambodia, Laos and Vietnam as well as across different social strata. The question of Chinese ethnicity is a complex and sensitive subject, with millions of people who were born and raised in the three lower Mekong countries claiming Chinese heritage. Vietnam, naturally, carries the collective memory of China as a historical colonial power. The Cambodian government is welcoming of Chinese influence and capital, but there are concerns in the countryside about dams and other Chinese-funded investment projects. The divergence between the perspectives of the elite and the grassroots on the growing influence of China presents considerable challenges for Cambodian, Lao and Vietnamese leaders. Where a civil society is emerging, people have begun to voice opposition to Chinese investment interests, as in the case of the Spratly Islands, an oil-rich area in the South China Sea. In Laos, where there are no formal civil society institutions, there has so far been no public outcry against the influx of Chinese immigrants who accompany investments. However, public concern over the proposed construction of a Chinatown satellite city in Vientiane has been widely documented in various newspapers, newswires and listserves.