China's transition merits caution: after the 'WTO euphoria' wears off, disillusionment awaits - Research

Japan, Inc., Dec, 2002 by Devin T. Stewart, Duncan Wrigley

THE JAPANESE FOREIGN MINISTRY was miffed at a New York Times report in August announcing that foreign correspondents were leaving Tokyo for China, drawn by the promise of a more compelling story: the rise and threat of China versus the near endless stagnation in Japan. China appears to be the one spot of economic vitality in a world of gloom. Words of advice often heard at Tokyo cocktail parties are, "It's time to learn Chinese." Should businesses in Japan move operations to China, too?

Clearly, there are good reasons for companies to move their more labor intensive tasks to China. With its abundance of cheap labor, China offers precisely what Japan lacks. Indeed, China could play a role in moving the Japanese economy away from manufacturing and toward upstream and downstream activities like research and marketing. Investments in China could provide the returns--based on economic growth--to pay for pensions for Japan's rapidly aging population.

Studies suggest that returns on investment in China over the last decade are comparable to those in other major emerging markets such as Brazil, despite stories of foreign businesses getting burned in China. In many ways foreign companies are even at an advantage compared with non-state domestic companies, as they enjoy preferential tax treatment and easier access to government officials.

Hidden risks

Yet the future does not exactly resemble the past, and the same dramatic transformation that brings prosperity for many Chinese and opportunity for Japanese companies also carries risks. One reason why these risks have been less appreciated so tar might be called "WTO euphoria": China's entry to the World Trade Organization last December has brought real improvements to the business environment but also hype based on promises and vague hopes. Foreign investors would be well advised to remember that previous waves of euphoria since China began opening up in the late 1970s have been followed by disillusionment.

A second reason is that the social system has been absorbing the risks associated with economic reform, lulling the observer into a kind of complacency in thinking that such risks will easily be absorbed in the future. But investors should remember that dramatic political change such as the collapse of the Eastern bloc is rarely anticipated, even though, with hindsight, the signs were there.

The establishment--members of the political, government and military elite in Belling and, at the senior provincial levels, senior managers and owners of state and non-state enterprises--share a primary fear: that economic reform will bring about social disorder stemming from economic dislocation and hardship. The official number of collective protests had risen nearly fourfold since 1993 to 32,000 in 1999 (the latest available figure), and there has been similar growth in protests attracting crowds of more than 10,000. Grievances include official abuse of authority, layoffs, late wage or pension payments, unfair taxes and fees, and the arrest of figures deemed responsible for organizing the protests.

In the countryside, many of China's 800 million people who are farmers or family members of farmers will struggle to earn a living. Most plots of land are too small to he farmed efficiently, and increased imports that followed WTO accession have put pressure on the prices of some agricultural produce. Farmers are also unhappy with the imposition by local officials of a raft of arbitrary and sometimes unlawful fees and charges, some of which go into officials' pockets.

The government in Belling will take steps to prevent a flood of imported agricultural produce that would disrupt the farming economy--for instance, no more than 5 per cent of grain consumption is to be imported for reasons of national security--and it is replacing fees with a unified tax. Urbanization acts as a release valve, allowing young migrants to supplement their families' incomes by remitting part of their factory wages back home. But the gap between rural and urban incomes is widening, and there is a danger that if the central government's policies go awry, it will face a large and unhappy group based in the heartland of Mao's own revolution.

But farmers will only provide a backdrop of discontent. Rural areas aren't going to be the source of political opposition because people are too spread out, social organization is limited and education levels are low. Revolutions begin in the countryside only when the security and military apparatus of the state is weak, and although the Chinese state is weak in other ways (especially when implementing central policy against local official resistance), it does not suffer from weak security. Green shoots of political opposition will be stamped out efficiently in the countryside.

Boiling point

In certain urban areas disaffection is boiling. The two most serious examples of social protest since nationwide unrest in 1989 took place in March this year in Liaoyang and Daqing in the northwest. People in Liaoyang remember days in which the surrounding Liaoning province, now part of the rust belt, was one of the richest in the country, owing to the state's prioritization of heavy industry under Mao. Now that there is a glut in the world steel market, factories are closing and unemployment runs at 20 or 30 percent in some areas. Wage arrears in Liaoning at the end of 2000 amounted to Rmb4.3 billion ($120 million) owed to 1.8 million workers in more than 7,000 firms.