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  Business Times Singapore 27 Dec 06
Say adieu to the Black Cat theory
China's future progress depends on whether it can manage its external challenges and solve its internal problems
By Tiger Tong

THE year 2006 has been the year of China. With its increasing economic prowess, China has become the economic hotspot of the world. It is especially worthy to mention that even its once weakest link - the financial system - has seen some admirable achievements.

After the successful IPO of China Construction Bank (CCB) in 2005, another two of the Big Four state-owned banks - Bank of China (BOC) and Industrial and Commercial Bank of China (ICBC) - also successfully launched their IPOs this year. ICBC's dual listings in Hong Kong and Shanghai raised US$22 billion, making it the world's largest IPO ever.

With the non-tradable share system near its end, China's domestic stock markets are finally starting to match the country's economic performance. After a four-year bear market, 2006 saw the Shanghai and Shenzhen indices rebound sharply and reach new highs. China's future has never looked so bright.

Five years ago, Gordon Chang's The Coming Collapse of China represented a strong warning regarding its future. And even in early 2005, CCB was still struggling to find a foreign partner. Past pessimism was shown to be wrong.

Equally, can today's optimism be misplaced?

The future of China will turn on the question of whether it can manage its external challenges and solve its internal problems.

To strengthen its economic ties with the rest of the world, China has been very active on the diplomatic front. In 2006, three regional summits were held in China (Shanghai Cooperative Organization Summit, China-Asean Summit, and China-Africa Summit), which included 55 foreign countries. With complementary economic ties in place, the future of their relationships looks rosy.

Even with the stagnant China-Japan relationship, the stepping down of Junichiro Koizumi gave both 'face-conscious' countries an opportunity to improve their relationship.

For the more important China-US relations, there are some uncertainties. The Bush administration will be under increasing pressure from the incoming pro-labour Congress to take a tough position on China. But, being trapped in Iraq, and with the need to handle both North Korea and Iran, the US will need cooperation rather than confrontation from China. In the future, China and the US will be more like a married couple: sometimes quarrelling but still locked in a relationship.

The only serious geopolitical issue that could potentially derail China's growth is Taiwan, which is also the card Japan and the US could play most effectively to keep China in check. But thanks partly to Taiwan President Chen Shui-bian, things have been getting much easier for Beijing.

In her most recent bestseller, Mao, the Unknown Story, Jung Chang concludes that Hu Tsung-nan, one of Chiang Kai-shek's most trusted generals, was in fact Mao's 'Red sleeper' though some serious historians view the series of mistakes made by General Hu as being a result of his incompetence rather than because he was Mao's agent. As a parallel, it is possible that someday someone will claim Chen was also a Red agent since his deeds have successfully shaken the foundation of the Democratic Progressive Party (DPP), a party used to being viewed as upright and occupying the moral high ground.

At the same time, Ma Ying-jeou, chairman of the Nationalist Party (KMT), who demonstrated awkward crisis management skills in the past few months, is making Beijing feel even more relaxed about the political situation in Taiwan.

Daunting challenges

More importantly, the economic power relationship between the two sides of the Taiwan Strait is being reversed. In 1996, Guangdong, the biggest provincial economy on the mainland, was only 27 per cent the size of Taiwan's GDP. Barring unforeseen circumstances, Guangdong's GDP will beat Taiwan's by 2008.

At the same time, Taiwan's economy has become highly connected with the mainland's, and more and more people will realise that the prosperity of Taiwan is tied to the mainland's economy.

China's challenges at home are much more daunting: a widening gap between rich and poor; a deteriorating environment; and resource constraints, just to name a few. But to a large extent, solving these problems boils down to the way China develops its economy.

In the past, China was competing with the world in terms of cost efficiency, often at the expense of the environment. And while the corporate world benefited, the wealth created on the labour side of the equation was rather limited.

China's top leaders are aware of those problems, and are determined to focus on the 'quality' of growth rather than the 'pace' of growth. Therefore, innovation and energy conservation and environment protection were among the key words in the 11th Five-Year Plan. The central government's direction is indeed correct.

But to implement these polices efficiently, two hurdles lie ahead. For a country like China, the balance between its central government and local government is crucial.

In the past, people often mistakenly believed that in China, the emperor, the highest ruler, could do whatever he wanted; in fact, it was not always true. To a great extent, China was ruled by a bureaucracy. A famous example is an emperor in the Ming Dynasty who could not even make his favourite son the crown prince because he was not the elder son. The only thing he could do to get his way was to go on strike; for 20 years, he refused to go to his office.

Similarly, instructions from Beijing are not always implemented efficiently at the local level. According to China's 11th Five-Year Plan, by 2010, energy consumed to generate 10,000 yuan (S$1,970) in GDP should drop by 20 per cent. The target for 2006 was to reduce energy consumption by 4 per cent. But the National Development and Reform Commission (NDRC), the planning agency of China's economy, reported that for the first half of 2006, China's energy efficiency was far worse.

It is largely due to the fact that local governments ignored the warnings from Beijing and tried to make their local economy grow faster than their neighbours. This helped them create more jobs, collect more tax and enabled them to report a higher GDP.

Simply put, while Beijing pays more attention to 'quality', local governments want 'pace'. For local leaders, a pace-focused approach will make their achievements more visible, thus giving them a better chance of being promoted.

The removal of Chen Liangyu, the former Shanghai party secretary, has shown Beijing has the determination and ability to get rid of anyone who ignores orders. A strong central government could make the reform process smoother in the short run.

Black Cat hurdle

The flip side is that local governments, the true implementers of Beijing's master plan, could become less efficient. In the future, the true challenge will be to align the interests of local governments with that of the central government, thereby keeping China's hybrid economic system in its best balance.

The second hurdle is the Black Cat. At the start of its reform process, China was still divided between doing things the socialist or capitalist way. Deng Xiaoping's Cat Theory ended the argument. He said whether it's black or white doesn't matter; it's a good cat as long as it can catch rats.

The result-oriented approach liberated the mindset of Chinese, and the country has since grown very fast. But the side effects of the Black Cat have taken their toll on the sustainability of China's growth, and social morality has been diminished.

Too often, people looked at the results only, and no one paid attention to how they were achieved. And in China, success is now often viewed as having money.

An increasingly materialistic China has generated serious social problems. Indeed, there are certain things the Black Cat cannot achieve.

China is determined to be a country focusing on innovation. So it has to follow the WTO rules strictly. Intellectual property rights protection used to be viewed as being not very important; the Black Cat economy could produce an advanced product by copying. But the problem is that if all the cats are black, no one will want to invest in R&D.

Likewise, local governments - in the attempt to boost the economy - often ignore the consequences of pollution so long as they produce a good GDP figure in the short run.

Perhaps it is now time for China to say goodbye to the Black Cat theory. While there are challenges ahead, we believe China's hybrid economic system can work. And with people becoming richer, they will focus more on the non-material side of their living environment.

After all, compared to the past - say, 17 years ago - today's problems are much less daunting.

The writer is a senior analyst with China Knowledge, a premier information provider on China's economy
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