Tuesday, December 4, 2012

China: A Famine, a Bubble, and Dysfunctional Governance

I recently read two accounts of events in China. The first was a discussion of the Great Famine that occurred in the late 1950s to early1960s and took an estimated toll of at least 36 million lives. The second article was a description of the current real-estate bubble in China.  Each was interesting in itself, but what was striking is the similarity in the manner in which Chinese governance failed in both instances. China may be modernizing its society as rapidly as humanly possible, but ancient societies can have ancient behavioral patterns—and they need not be healthy ones.

Ian Johnson provided an article in the New York Review of Books titled China: Worse Than You Ever Imagined. His article is mostly a review of a book by Yang Jisheng Tombstone: The Great Chinese Famine, 1958-1962.

"....the Chinese journalist Yang Jisheng’s epic account of the worst famine in history. Yang conservatively estimates that 36 million people died of unnatural causes, mostly due to starvation but also government-instigated torture and murder of those who opposed the Communist Party’s maniacal economic plans that caused the catastrophe. Its epicenter was Xinyang County, where one in eight people died from the famine. The sixty pages Yang spends on Xinyang are a tour de force, a brutal vignette of people dying at the sides of roads, family members eating one another to survive, police blocking refugees from leaving villages, and desperate pleas ignored by Mao Zedong and his spineless courtiers. It is a chapter that describes a society laid so low that the famine’s effects are still felt half a century later."

What makes this famine unique is that it was not associated with drought or any other catastrophe; it was initiated and propagated solely by administrative actions.

When Mao gained power he took the land from the landlords and distributed it among the peasants. This, of course, made the peasants happy, but Mao soon became impatient with the growth in productivity and decided on a course of action referred to as the "rash advance." This involved collectivization and taking the land back from the farmers and putting it under the control of the government.

It is inevitable that productivity lagged under these conditions. But what is a local governor to do? Tell Mao he made a mistake? Tell the truth and suffer the consequences? Perhaps some did, but enough chose to invent progress in order to protect themselves—and they were believed.

"The problem took a deadly turn when Mao began to endorse opportunistic officials who boasted that the communes had created ‘Sputnik harvests.’ Henan, where the first communes had been formed in 1958, later that year began claiming wildly exaggerated yields....fanciful numbers that defied common sense and science. Local governments began to outdo one another trying to offer the biggest harvests, which they had to deliver to state granaries. Often, these were nothing more than mounds of husks covered with a thin layer of grain, but once-skeptical officials....endorsed these magical results during public inspection tours. Local officials began sending all their village’s harvests to granaries to meet these impossible targets, leaving villagers with nothing to eat."

When it became unavoidably obvious that many people where dying, some had the courage to suggest that the collectivization experiment be reversed. Mao continued to believe that his theoretical construct had to work unless it was being sabotaged. Those who spoke against the scheme were punished, sending a message to all other government officials.

"Chastened officials returned to the provinces eager to save their careers...."

"Officials launched campaigns to dig up grain that peasants were allegedly hiding. Of course, the grain didn’t exist, but anyone who said otherwise was tortured and often killed. That October, the famine began in earnest in Xinyang, accompanied by the murder of skeptics of Mao’s policies."

The details of what ensued make worthwhile but grisly reading. Here we are more interested in this insight provided by the author Yang.

"In a political system such as China’s, those below imitate those above, and political struggles at the higher levels are replicated at the lower levels in an expanded and even more ruthless form."

Let us move to the present day and an article in Foreign Affairs by Lynette H. Ong: Indebted Dragon: The Risky Strategy Behind China’s Construction Economy.

"Visitors to Beijing, Shanghai, and other major Chinese cities are quickly awed by impressive skyscrapers, glittering shopping malls, new highways, and high-speed rail lines, all of which leave the impression that China is a developed economy -- or at least well on its way to becoming one. Even in some smaller cities in inland provinces, government buildings make those in Washington and Brussels appear meager. In an area of Anhui Province that is officially designated an "impoverished county," the government office block looks exactly like the White House, only newer and whiter."

Some of this construction is in response to a rapidly growing economy, but some of it takes place in order create evidence of growth in the economy. If the central government wants growth, then growth will have to be delivered.

"....local Chinese officials are evaluated for promotions and other rewards based on how well the economy they manage performs. Construction and real estate activities are among the most straightforward ways to stimulate growth. White-elephant construction projects thus offer eager officials a perfect opportunity to impress their political superiors, even if massive developments do not necessarily make any economic sense. Take, for example, the city of Ordos in Inner Mongolia: Its elaborate urban infrastructure and its sea of new flats and office blocks are nearly all unoccupied, making it China's largest ghost city."

The central government was apparently so satisfied with this "growth" that they decided to secure some of the local tax revenues for their own purposes. This left local officials committed to delivering ever more economic activity, but with fewer resources.

"In the wake of the tax reform, sales and business taxes on construction, real estate, and other service industries became the main source of tax revenue for municipal governments. Not surprisingly, in the 1990s, local authorities started to engineer real estate and construction booms. According to Chinese law, collectively owned farmland must be converted to state ownership before it is leased to private developers. Local governments were thus able to expropriate farmland from villagers and then rent it to private commercial ventures such as factory owners and real estate companies."

And how do the officials finance the conversion of farm land into a business opportunity?

"Governments borrow money using land as collateral and repay the interest on their loans using funds they earn from selling or leasing the same land. All this means that the Chinese economy depends on a buoyant real estate market to keep grinding. If housing and land prices fall dramatically, a fiscal or banking crisis would likely soon follow. Meanwhile, local officials' hunger for land has displaced millions of farmers, leading to 120,000 land-related protests each year."

The bankers are in collusion with the developers.

"On the surface, banks' balance sheets have remained healthy despite these debts, since banks tend to roll over or ‘ever green’ loans by issuing new loans to help borrowers ‘repay’ old ones....The banks' accounting tricks treat only a symptom of the problem. Eventually, banks will become unable to roll over loans because they will run out of fresh money. And officials' ability to pay off loan interest depends on the continued rise of real estate prices and a buoyant economy, neither of which can be taken for granted."

If this reminds one of a Ponzi scheme, it should. Ong discusses in more detail the ramifications of this construction-driven economy and its effects on the poor Chinese citizens. Let us stop here and consider what has occurred.

Once again central authorities made a demand and local authorities believed it was necessary to use any means possible to deliver what was demanded, or at least its appearance. They were quite willing to harm the local population, and were willing to risk the economy of their country in order to secure their own reputations. While mass starvation and cannibalism are unlikely occurrences, China is still a poor country with over a billion people who will suffer when this bubble bursts.

I believe there is a lesson to be learned from these two instances but I am not sure exactly what it is. It could be that there is a cultural defect, developed over centuries, that persists in Chinese society to this day; or that centralized government is unable to manage as large and diverse a nation as China; or that a meritocracy inevitably breeds cheating and other bad behaviors. Or, perhaps, all of the above are true.

One thing I do know is that when I consider the unruly and cantankerous contesting over power and jurisdiction between our regional governments and our federal government I will have more tolerance for the system. It could be a lot worse.

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