Is China Succeeding in the War Against Corruption? Q&A with Bernard Yeung

In the past four years, China has been waging the biggest anticorruption campaign in its modern history. Is it working? 

 

 

Bernard Yeung
Bernard Yeung

In the past four years, the Chinese government has been waging the biggest anticorruption campaign in its modern history. Ever since Chinese President Xi Jinping assumed power in 2012, more than a million Communist Party members have been punished for bribery and other corruption-related charges, including dozens of high-level officials, executives, and other prominent figures. In 2015 alone, nearly 300,000 officials have been given some form of punishment, ranging from light to severe.

 

In addition to cracking down on corrupt officials, China has also adopted a series of reforms and regulations meant to reduce instances of graft and corruption. Chinese leaders have recently said that the campaign is far from over, claiming that China’s government is still plagued by “systemic corruption.” Overall, however, its effect has been unclear, with some reports suggesting that it may have contributed to the Chinese economy slowing down, and other reports portraying the effort as part of a power struggle within the Communist Party

 

A recent paper by Chen Lin, Randall Morck, Bernard Yeung, and Xiaofeng Zhao found that the anticorruption effort has helped some firms more than others. In areas and provinces that had a well-developed market economy, the authors found, the reforms have had a positive effect, while in poorly-developed provinces, reforms have had a detrimental effect on firms. This, they argue, suggests that pro-market reforms and anticorruption reforms are mutually reinforcing.

 

In order to better understand the effects of China’s anticorruption effort, we recently interviewed Yeung, the Dean and Stephen Riady Distinguished Professor in Finance and Strategic Management at the National University of Singapore (NUS) Business School. This month, Yeung will teach a mini-course of three stand-alone lunch seminars at the Stigler Center on the topic of corruption in China (register here). In his interview with ProMarket, he spoke about the impact China’s anticorruption reforms have had on its political economy.

 

Q: Your most recent paper (written with Chen Lin, Randall Morck, and Xiaofeng Zhao) deals with the Chinese government’s anticorruption campaign. What has been the effect of this campaign so far?

 

It has the effect of slowing down corruption, and it cleaned a lot of the government cronyism and the kind of dealings that are really scary for people. So for that, I think that is a very positive thing. It also creates a kind of bureaucratic freeze: people don’t really know what this means, because this could be possibly related to fundamental positive changes in the party. People were still thinking: is this an anticorruption reform, or is this a party struggle? Many officials, as well as the CEOs and the high-level management of the State-Owned Enterprises (SOEs), they’re concerned.

 

The reforms also coincided with a global slowdown. One would expect to observe that private sector investment is somewhat slowing down, and we do observe that, but we don’t know if this is because of the bureaucratic freeze or because of the global economic climate.

 

Overall, I think it’s a very good thing because like our paper shows, when it cleans up corruption China will be able to unleash potential market forces and allocate resources more efficiently.

 

One thing we don’t expect to see much of: when it comes to anticorruption reforms, we’re asking the question of whether this is about instilling the rule of law or the rule of man. So far, we’re not very confident of the rule of law in China, because of the current political factions. It’s not easy, but I’m hopeful. After cleaning by the rule of man, China may progress further towards establishing the rule of law.

 

Q: You write that China’s Eight-point Policy, the anticorruption drive announced by Xi Jinping shortly after he became General Secretary of the Communist Party in 2012, destabilized the equilibrium of China’s political economy. Can you elaborate?

 

I wouldn’t call it a destabilization. I would call this an unexpected event, a shock. When it comes to corruption, the world can get into what economists call a stable equilibrium. It is very, very hard to shock a system out of this stable equilibrium, and that is why getting rid of corruption is so difficult.

 

What happened in the case of China is that in China there is a mandated, pre-determined date of transition of power from one administration to another once every ten years. In 2012, the Chinese government moved to a new administration, from Hu Jintao to Xi Jinping. But before the transition there were a lot of power struggles, starting with Bo Xilai and later with Wang Lijun and Zhou Yongkong, and who knows who is backing them. This led to a lot of turmoil. People didn’t even know if Xi could even assume his position.

 

With every transfer of power, there is a pre-determined date of transfer and an appearance of smooth transition—but not this time. Rumors flew high. After Xi Jinping took over, within three weeks he announced this anticorruption reform. It’s a shock to people—usually major policies would be announced about a year after assumption of power. Not this time; the first shot in the anti-corruption campaign, the Eight-point Policy, came 20 days after Xi assumed his position as Party General Secretary.

 

Q: You find that these reforms, while limiting bribery extraction, hurt private firms in poorly-developed areas, while benefiting firms in more developed regions. You also note that this pattern “illuminates the economics of corruption in China.” How so?

 

Generally, an anticorruption reform will create two possibilities: it can unleash market forces and help the competitive firms and firms who were previously discriminated against, but also create a bureaucratic freeze.

 

Imagine that in the past I bribed someone to give me passage to business, and now that person cannot give me passage to business—my past investment becomes useless. Also, it becomes more difficult to do business because I don’t know how to get around bureaucracy.

 

In provinces with some developed market machinery, the anticorruption reforms benefit non-SOEs, because they get money and utilize their growth potential. For the private sector firms in backward provinces, they suffer quite a bit because the cost of doing business has gone up, past investments in relations have disappeared, and overall they face a bureaucratic freeze.

 

Imagine that you’re in these provinces, and you have invested in some shopping malls. You pay bribery to the government in various forms, expecting your malls to be able to open and operate. Now, with the anticorruption reforms, you stop. The government won’t give you the license, because they are afraid of being accused of being corrupt. If I mingle with you, I may be suspected of being corrupt. So this is very difficult, very challenging, and you may lose money.

 

If you do the same thing in, say, Shanghai, then the fact that the government cannot ask you for favors is good news for your shareholders.

 

If there’s a market machinery, it will allocate resources more effectively to more competitive firms, and we do see that, especially in the private sector: firms that are more productive, that have more growth potential, their stock prices will actually go up in provinces with good market development. Firms in the bad provinces suffer because of the bureaucratic freeze, but also because their past investments have disappeared.

 

There is another layer to this that helps non-SOEs: anticorruption stops bribery extraction, and shareholders will always be happy about this. Cutting bank on bribery extraction is especially good for private sector firms. The Eight Point regulations also tell SOE managers not to consume corporate resources for their personal gain, and that benefits their shareholders.

 

However, if there is a bureaucratic freeze, firms in the backward regions will suffer particularly, because there is no market machinery, and the value of past investments dissipates.

 

Q: You end the paper by calling on policy makers who wish to implement effective anticorruption reforms to consider implementing pro-market reforms first, in order to shift the political economy balance in a direction that supports anticorruption. Why is this important?

 

The argument is straightforward in my opinion: you are a government official. If you try to implement anticorruption reforms, first you’re betraying people who in the past invested in you, and second, when you attack corrupt people they counterattack. China has a lot of regulatory and legal gray areas: I blow the whistle on my neighbor accusing him of being corrupt and my neighbor does the same to me, because we all have a foot in the grey areas. So the cost of attacking corruption is very high—you expose yourself and you also you betray your friends, and you stop using your power to gain personal benefits.

 

Attacking corruption comes at a cost, and you need benefits to balance off the cost. When the government stops meddling and you basically say let the market take actions, if there is market machinery, there will be growth, politicians and people are happy. But if you don’t have the market machinery, the market won’t know what to do. There will be an economic freeze and no one is happy.

 

In order for anticorruption reforms to generate good things for the government you need market forces: in the capital market, the raw materials market, and in the labor market. You need the machinery to allocate talent, capital and other inputs to productive firms with growth potential. Unleashing the market forces creates growth.

 

When you don’t have the market and you just act against corruption, in the end everyone stands still. Politicians suffer from the cost, but don’t have the benefit. Therefore, for the anticorruption reforms to really work you need to go in parallel and also develop the market.

 

Q: You have studied corporate governance in China. How did anticorruption reforms affect corporate governance?

 

In the past, boards were not very effective in China. The Party Secretary is important, the government is important. Now boards are getting more important. People take independent directors a lot more seriously. We have the right signal and the right movement. All this will take time, however.

 

Q: So you would revise or soften your position from a previous paper, that China “appears to be adopting the form, but not the substance, of American corporate governance”?

 

We do see the effect [of the anticorruption reforms] coming in. The Chinese government introduced all the rules and regulations, but they are not properly enforced. The ecosystem is not quite ready. But I am seeing positive signs that the ecosystem is developing: people are starting to develop a mentality of corporate governance and following the law.

 

But this positive news is just the beginning, there could be setbacks. It’s easy to conflate the weak economy with the anticorruption reform, and so people can blame anticorruption reforms. It takes time, and we see positive signs, but how effectively the government will allow the appearance to turn into substance, that is uncertain. I would move the probability of this from about 30-70, with 30 percent being the good outcome and 70 being the bad one, to 40-60, or even higher. It will continue moving in the direction.

 

Overall, I think China is looking very promising nowadays.

 

Q: You have previously warned that China could end up like many other developing nations, with a period of rapid development that ends with failure to build functioning institutions and an entrenched oligarchic elite in control of the economy and the state. Would you say the danger of this happening has been reduced?

 

This is my 30-70 to 40-60 prediction. The basic argument is that some people got rich and the country grew but after that they want to protect what they have. They can do two things: continue liberalizing the market or keep the market as it is and become the monopolies. That is Luigi Zingales’ and Raghuram Rajan’s point about the “great reversal” in Argentina.

 

What happened in the case of China is that thanks to the widespread transmission of information, the anticorruption reform is also supported by the public. Social media exposed a lot of the things, and the communist government had no choice but to do something. The wide distribution of information reduced the likelihood of this “great reversal.”

 

The second that is important to recognize is that with all the digitization, there is a lot of intermediation: buyers meeting sellers and borrowers meeting lenders. This intermediation reduces the ability for the oligarchs to entrench. The only thing they can do is to entrench by political decree, which now I think is getting less and less likely. Transparency is sunshine.

 

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.  

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