By Shaomin Li
The lure of 1.3 billion consumers is irresistible: Foreign investments flock to China in large volumes. But entering China’s market can be highly risky, thanks to rampant corruption, fraud and violations of property rights–either by private citizens or by the state. An understanding of the evolution of cultures in China, which is heavily influenced by China’s political economy, may help us see why safeguarding property rights is especially difficult there.
Mao Zedong’s China was characterized by its extreme radical communism and absolute poverty. Being rich was shameful. The less property one had, the more glorious one became. Private property was not respected or protected. The ideology of anti-wealth and anti-property ownership can be clearly seen in the four constitutions the Chinese Communist Party (CCP) has written over the past fifty years.
From the 1950s on, the CCP has been staging numerous political onslaughts, in which private properties were confiscated. Business people were forced to turn their assets over to the state. According to Chinese government figures, for example, in 1952, private businesses still accounted for 55 percent of China’s industrial output; by 1962, that number had dropped to zero. In 1958, Mao staged the “Great Leap Forward,” causing one of the biggest famines in history–some 30-40 million Chinese died of starvation. During the peak of the Cultural Revolution, from the 1960s to the 1970s, not only were private properties taken by the state, but state properties were openly robbed by the revolutionary masses as well. The history of the communist revolution in China is a history of repudiating property ownership. Usurping properties from the propertied class is a glorious act. When people had no private property, they lost their sense of the sacred, inviolable nature of ownership, one of the most important heritages of civilization. In all civilized societies throughout history, violations of private property rights, such as stealing and robbery, have been viewed universally as crime. However, when private properties were wiped out in the name of revolution and “social justice,” this was no longer true, especially so when it came to public properties, because they did not belong to a specific person or persons but to a vague, abstract notion of “the whole people.” The argument was that because every citizen was one of “the whole people,” everyone had a claim to the property. Thus it was perfectly moral for a citizen to help himself to public assets. Net result: little respect for property rights.
Mao Zedong’s death in 1976 brought an end to his ultra-leftist ruling. Beginning in 1978, China began its “reform.” Deng Xiaoping was a pragmatic man with a vision of making China prosperous. One of his most famous sayings was a reversal: “getting rich is glorious.” The Chinese people took him seriously. They began to get rich. But neither Deng nor his successors realized that to emulate the success of the advanced economies, China needed to restore the institutions of property rights, including formal institutions (laws) to protect them and informal institutions (culture) to respect them.
Thus the combination of Mao Zedong’s legacy of no respect for property rights and Deng Xiaoping’s call that “getting rich is glorious” implies that people can get rich by any means–no matter whether the rights of the state, foreign investors or private businesses are violated in the process. Thus we observe simultaneously the booming of money-making activities and the looting of properties in China.
In China, depending on the types of ownership, there are different ways of viewing property rights violations. The prevalent view is that stealing state property is not as bad as stealing from private owners. State properties belong to no one and are wasted by the bureaucrats anyway. If you don’t steal it, someone else will. The astronomical level of nonperforming loans of state-owned banks in China is a good example. According to Ernst & Young, by the end of 2001 China’s bad loans had reached US$480 billion (equivalent to about 40 percent of China’s GNP). Money from state banks is up for grabs. Whoever has power and connections will get it. In fact, banks in China give loans to related parties, such as senior bank officers and major shareholders, who never repay them. This is a primary concern about opening the banking sector to private investment in China: The major shareholders of these banks would simply “borrow” the money of depositors and never repay it.
For a different political reason, but stemming from the same genre of lack of respect for property rights, the rights of foreign investors are also violated. According to the communist doctrine, foreign investment exploits the indigenous people. Therefore violating the property rights of foreign investors is not only justified, but also popular among citizens, given that the act is viewed as “usurping foreign capitalists.”
One case illustrates this very clearly. A friend of mine, a Chinese American, is a partner in a U.S-based investment fund. He went to China to oversee the operation of a joint venture that his fund invested in with a local Chinese firm. During a meeting with the executives of the Chinese firm, the two sides disagreed on a major issue. One of the Chinese then pulled my friend out of the meeting and said: “Don’t protect the interests of these American capitalists, we can make a deal under the table.” My friend was outraged. But for the Chinese, there was nothing wrong with the proposition.
FOREIGN INVESTORS AND CAPITAL FLIGHT
Beijing also expropriates foreign investments indirectly by levying exorbitant fees. For example, a survey published by the Chinese government found that in Liaoning Province taxes and surcharges amounted to 63 percent of enterprise earnings. A study of Anhui Province reported that the average gross profit was about 10 percent of total revenue, whereas the sum of taxes and fees was greater than 10 percent. In addition to high fees and taxes, existing laws make it virtually impossible for foreign investors to exit China. For example, one of the factors that made IDG (a U.S.-based investment fund) one of the biggest players in China is that because it could not take its investment profits out of China it was forced to re-invest there.
The lack of property protection also leads to capital flight. Most of China’s nouveaux riche feel insecure about their assets. Evidence of this can be seen in the trend common among them to move a substantial portion of their assets overseas. The recent high profile case of Liu Xiaoqing is a good example. Liu, a movie celebrity, allegedly transferred most of her assets abroad. Beijing does not release numbers on capital flight. One way to estimate it is to examine the item called “errors and losses” in the official international revenue and expenditure statistics. In 1989, this figure was US$300 million. By 1997, it increased to US$17 billion. From 1989 to 1999, it soared to US$130 billion. The Economist magazine estimated that capital flight from China was US$20 billion and US$48 billion in 1997 and 1998, respectively.
In sum, the combination of lack of respect for and protection of property rights and the drive to get rich by any means has undermined the confidence of investors–both domestic and foreign. It will hinder China’s economic development.
“If foreign investors are routinely cheated and expropriated, why do they keep coming to China?” This is a question often raised. While further studies are indeed needed, I offer some explanations. First, there is a bandwagon effect, a “me too” mentality among the multinational corporations. If, for example, AT&T went there, French Telecom must go, too, lest it be left behind. (Both, in fact, went to China, only to find out that there was not much business for them, because the state still tightly controls and monopolizes the telecom industry.) These multinationals with deep pockets invest in China for “strategic”, “long-term” goals and can afford to lose. Second, there are foreign firms that have made money in China. After all, there are in China, compared with more mature economies elsewhere, more opportunities.
What can China do to overcome the lack of protection of property rights? First, legitimize them. Second, nurture a culture that respects them.
To achieve the first, China needs to amend the constitution in a fundamental way, or completely rewrite it. The current constitution says that “socialist public property is inviolable.” Private property does not enjoy the same status. Without full legal protection of all property rights, especially private property rights, people will never feel safe with their assets, and capital flight will continue. Re-writing the constitution is not easy, however, given the lack of opposition parties and representative democracy. The present constitution was written by the CCP. It gives the Party absolute power and establishes communism as the sole legitimate ideology. Unlike democratic constitutions, the Chinese constitution is not a basic law that safeguards the fundamental rights of citizens, limits the power of government and institutes checks and balance of power. Instead, it is a marching order toward socialism, more like a set of by-laws of “Socialist China, Inc.” Asking the CCP leaders to change this unconstitutional constitution, as Mr. Bao Tong (a leading pro-democracy figure in China) put it, is “asking the tiger for its skin.” However, there is hope that China’s entry to the WTO may precipitate genuine constitutional negotiations among different interest groups and thus expedite the process of constitutional change in this direction.
The second task, developing a constitutional culture that respects property rights, is even more difficult. Legal codes can be changed literally overnight. Changes in culture, however, come much more slowly. After decades of communism and the shifting-sand nature of China’s constitution, the people simply do not take the law seriously. Nor does either the CCP or the government. To establish a law-abiding culture, China must begin repudiating its communist ideology. This is a fundamental change, a quiet revolution at the very least. But without a constitutional culture, constitutional order cannot be established. And laws will remain ink on paper.
Shaomin Li is one of the founders of the Center for Modern China, a Princeton-based think tank that advocates democracy and a free market in China. He currently teaches international business at Old Dominion University in Norfolk, Virginia.