Elite Chinese Politics and Political Economy

Well, now that my life is somewhat back in order after my trip, I would like to provide a couple of observations from my trip to China.

First, I was quite taken back by how pessimistic foreign investors, especially those in the financial sector, are about the Chinese economy. Many talked about the "post-Olympic" crash. The PBOC is definitely aware of this expectation and is doing everything they can to prevent this from happening. I suspect that the leadership as a whole is aware of this and is directing all government agencies to prevent this. But part of the strategy seems to be to slow down foreign involvement in the financial sector. The leadership probably reasons (understandably, in my opinion) that it can still directly control Chinese financial institutions, so it is better to keep most of financial assets in Chinese hands to prevent any rapid outflow or crash.

The Communist Party also confronts its own difficulties. The Hu-Wen Administration is focusing on domestic welfare issues. Direct central transfers to rural areas will increase by four to five folds (to approximately 500b RMB) in the next five years. With tax collection increasing at such a healthy rate (surpassing 20% of GDP this year), they will be able to accomplish it. I actually went down "to the basic level" to observe how fiscal transfers are being spent. On a whole, I have been impressed that at least half of the central transfers are being spent on their intended purposes. Schools are being built; highways are being built....etc. True, much of the money is wasted, but the infrastructure and services provided really provide marginal improvements on the livelihood of the farmers.

The other issue that the Party is confronting is the "diversification of interests" issue. Traditionally, the CCP is mainly concerned with providing "warmth and a full stomach" to the masses in China. As the economy grows, especially in coastal areas, people want more than just "warmth and stomach." Party sources say that the regime is pretty worried about what the Chinese people will demand in the future and are coming up with plans to deal with the "diversification" of interests.

Is the welfare drive necessarily good for the foreign investment community? For foreign direct investors, the domestic welfare drive will drive up labor costs in the short-run because farmers are not as desperate to get out as before (also, there is currency appreciation risks). In the long-run, however, the drive to improve rural education will continue the flow of high quality human capital to foreign investors. Rural education was on the verge of collapse in the late 90s, but it has enjoyed an upswing in the past two years.

For financial investors, the leadership and hence the bureaucracy is perhaps more closed off to foreign lobbying than before (with the exception of the PBOC). Foreign investors will on a whole have less access to the policy making process. This might increase the risk premium for investing in China. The weird thing is, however, that it is not stopping the torrent of money being poured into Chinese financial institutions. Go figure. Perhaps someone can enlighten me about this.