Sunday, January 5, 2020

Is The Chines Economic System the "Mandarin Growth Model" or the "Chinese-Style Keiretsu System"?

The first term in this choice was the title of a paper presented this morning (1/4/20) at the ACES/ASSA session at 8 AM in San Diego by Wei Xiong of Princeton University.  It was a highly mathematical model I shall describe shortly, but which drew heavily on the paper presented before it by Chenggan Xu of Cheng Kong Graduate School of Business in Beijing, the alma mater of Jack Ma who founded Alibaba and the founder of Sinopec and the richest woman in China, etc. His paper was titled "Institutional Genes of China's Socio-Economic Development," with it discussed by the current ACES (Association of Comparative Economics) president, Scott Rozelle of Stanford.

The simplistic version of the "Mandarin model of growth" according to Wei Xiong is "political centralization with fiscal decentralization."  He then presented a math model of incentives for regional governors in a growth tournament being judged by the central government.  These governments face a choice of long term growth-enhancing infrastructure investment versus short-term consumption spending.  He argues this leads to a "rat race of shadow banking borrowing" that is putting the Chinese system into peril as the debt-GDP ratio has been sharply rising, with much of this in the shadow banking sector. This was what I heard about personally on my last trip to China a few years ago, a lot of concern about the growth of the shadow banking sector, driven by local governments.

The historical underpinning of this Mandarin growth model was laid out in the paper by Xu who presented a tripartite system: The ruling bureaucracy, the system of deciding who was in that ruling bureaucracy, and the system and reality of land ownership.  In the imperial system the bureaucracy was the Mandarin elite who were in the  earlier and less-corrupt stages of dynasties selected according to the Confucianist Mandarin exam system originated in the Han dynasty.  This was separated from land ownership at that stage, but at later stages of a dynasty the  sign of rising corruption was the breakdown of the exam system as land-owning Mandarins got their incompetent sons appointed to the bureaucracy.

In contrast to this clearly still important system, it appears a new system is arising in China.  I should be clear that the label in the title is my neologism for this. system.  The paper that presented it was titled "The Growth of Conglomerates in China," presented by Chang-Tai Hsieh of the University of Chicago, with Chong Bai of  Tsinghua University in Beijing and two professors from the Chinese University of Hong Kong as coauthors. Chang admitted upfront that what he was describing are not really conglomerates, which are single corporations operating in many sectors. This is what the pre-WW II Japanese  zaibatsu looked like and what the current South Korean chaebol (jaibul) look like. But these structures now taking over the Chinese economy are not single corporations but rather large interconnected groups of them. While they do not exactly resemble the Japanese keiretsu groups, that looks to me to be their closest models, although they have substantial differences. Hence my neologism: "Chines-style keiretsu."

So here is the bottom line.  The paper was inspired by a 2012 New York Times story on "hidden ownership" in Chinese companies that led to the NY Times getting blocked in China, still in place. These researchers followed the sources used by the Times to investigate and fully lay out the ownership structures of leading Chinese corporations.  A crucial pattern in this is of multiple layers of holding companies owning holding companies holding companies owning holding companies to an almost unbelievable degree along with "real companies" and state-owned companies, with this structure like the Japanese keiretsu involving a vertical structure of input suppliers and output subsidiaries of several layers often.  This even gets down to a large company owning a major provincial bank that then owns many local banks that fund many local enterprises, some of whom are either suppliers or outlets of the core company, with many of these involved in joint ventures with other companies in other networks.  Oh yes, this is really complicated.

The current summary stats on all this are that that the top 100 Chinese companies now own half the capital stock of China. The average number of layers of ownership in one of these companies is 23.  A weird detail is that when they finally come to the end of these long trails of holding companies to actual people, usually well connected politically, it seems to almost always be two of them.  Why this Hsieh had no explanation.

An  important issue involves what is at the core of this. In a Japanese keietsu, it is a privately owned bank.  In these Chinese-style keiretsu it turns out to be a major state-owned enterprise.  The paper shows a link between the size and political connectedness of this core SOE and both the total size of the network and the number of layers within it, with a math proof of the latter point.

To get to the intra-Chinese systemic competition point, in the older Mandarin model the local Communist Party chief was running the show.  In this newer emerging system that person gets bypassed as local companies get absorbed into these larger national entities that depend ultimately on the political connectedness ot the owners of the various related firms and the power and connectedness of the ultimate core state-owned enterprise.  That the core is state-owned is another difference between the Japanese keiretsu and these Chinese-style keiretsu.

Which system will come to dominate in the future remains up in the air, but for now it looks like this newly emerging "Chinese-style keiretsu" system is what is what is on the risee, and maybe it can avoid and maybe even mitigate the mushrooming shadow banking debt arising from the  inter-provincial growth tournament of the old Mandarin growth model.

Oh, Hsieh mentioned that there was one major Chinese company that did not at all exhibit this structure, looking like a more or less "normal" international company.  That is Huawei.

Barkley Rosser

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