January 2023. GrowthPolicy’s Devjani Roy interviewed Meg Rithmire, F. Warren McFarlan Associate Professor of Business Administration at Harvard Business School, on China’s role in the global economic order, Beijing’s model of party-state capitalism, capital outflows from China, and the public perception of the CCP. | Click here for more interviews like this one.
Links: Faculty page | Personal website | Land Bargains and Chinese Capitalism: The Politics of Property Rights under Reform (Cambridge University Press, 2015) | “The New China Shock: How Beijing’s Party-State Capitalism Is Changing the Global Economy” (Foreign Affairs, December 2022) | Professor Rithmire’s 2018 interview with GrowthPolicy
GrowthPolicy: One hears news stories about China “buying the world” and expanding its global economic reach by transitioning from recipient to supplier of foreign capital. According to data from the Chinese Ministry of Commerce, the total stock of outward foreign direct investment owned by Chinese firms in 2017 was 1.8 trillion USD, sixty-two times the 2002 amount (cited in Rithmire 2022). What do these patterns of investment reveal about where China is headed in the global world order in the twenty-first century?
Meg Rithmire: To understand how China’s status in the global economic order, we must understand how the Chinese Communist Party (CCP) makes economic policy and the trajectory of its economic reforms since the late 1970s. The key elements are (1) campaigns, a technology of politics that involves setting a high-level goal—such as “zero COVID,” or one birth per family, or to make China into an advanced manufacturing powerhouse by 2025—and mobilizing actors throughout the political system to achieve those goals. The second (2) element is experimentation, which is related to campaigns. Deng’s famous aphorism—“crossing the river while grasping for stones”—captures the spirit of much of China’s economic reform era; rather than detailed blueprints and clear regulations or instructions, the CCP would set a direction of policy or reform and expect local-level officials and other social actors to experiment, even compete with one another, to pursue it.
Observers typically imagine most investment from China to be connected to Beijing or the CCP’s strategic goals and unfolding in a methodical way. Yet, even when China’s outward foreign direct investment (OFDI) is part of state goals, like the Belt and Road Initiative and Made in China 2025, these investments are happening quickly and sometimes chaotically, as firms of all kinds rush to be part of the government’s campaigns and to benefit from preferential lending and an enabling policy environment. Their goals may be to demonstrate that they are useful to the CCP, or even Xi Jinping himself, or simply to pursue their own goals under the guise of state priorities.
Often, investment decisions are far less strategic than is often imagined. As Made in China 2025 incentivized firms to pursue high-tech acquisitions, even in very strategic sectors like semiconductors, various Chinese firms were bidding against one another and making public statements about high-profile acquisition targets, only attracting the attention of U.S. regulators, who essentially closed the sector to Chinese capital. Under the BRI push, large Chinese construction and infrastructure firms, many state-owned enterprises (SOEs) would identify lucrative opportunities in various countries and pressure Chinese state banks to lend to finance those projects. The massive expansion of lending produced some predictable problems, including overextension, poor quality loans, poor quality projects, and politicization of economic relationships with China.
The reality about China’s identity as a global financial player is that it is new, and even naïve. Western multinationals have generations of experience investing abroad and complex risk management procedures; Chinese firms, state-owned and private, do not. As China’s economic influence has grown in the world, the CCP is experimenting and learning about how best to use it, but that process has been filled with fits and starts and serious mistakes.
GrowthPolicy: The Chinese state, along with the state in countries such as Malaysia, Brazil, and India, has always participated in the country’s economy, to a greater or lesser extent, through either state-shareholding firms or state-owned enterprises. What lessons can we learn from China about the role of state intervention on a country’s political economy?
Meg Rithmire: It is interesting to compare China to those countries especially because they are democracies (or, at least Brazil and India are, and Malaysia has many democratic institutions and processes). There has been this idea for some time that “state capitalism” is a new variant of capitalism featuring heavier state involvement. The rapid industrializers in East Asia (Korea, Taiwan) relied on state intervention to manage development, and many countries have national champions, many state-owned, at the height of globalized sectors.
China’s state capitalism has always been met with a different sort of suspicion, partly because of its regime type, but for a long time the economic conflict between China and its trade partners was about state intervention. The U.S. and others complained that the government supported favored firms through subsidies, for example, and that sectors (like finance, telecom) in China were not open to foreign competition but dominated by domestic champions. Over the last five to seven years, especially, we have seen a transition from these concerns to security ones. OECD countries in particular are not so much worried about unfair competitive terms with Chinese firms or in China but rather about whether Chinese firms are agents of the Chinese state. They have made this shift with good reason: while there was traditionally a division between the state and private sectors, a suite of new laws seem to give the CCP a wide legal foundation for intervening in any firm, and new policies (like Made in China 2025) focus on extending state finance and state oversight to strategic sectors. So we have seen OECD countries, and especially the United States, overhaul or invent new institutions to manage these concerns. The Committee on Foreign Investment in the U.S. has seen its purview expanded, export controls have become routine on Chinese firms and whole sectors, and policymakers are considering outbound investment reviews or controls to preclude U.S. businesses from investing in certain firms and sectors in China.
As my co-authors and I have written, this shift from “state capitalism” to what we call “party-state capitalism” has had profound effects on global and national capitalism elsewhere, and the impacts are still unfolding. In addition to new barriers to transnational commerce, there is a reconsideration of the role of the state in the economy even in the U.S. The U.S. has long been allergic to industrial policy, but the CHIPS and Science and Inflation Reduction Acts contain lots of money and incentives for domestic firms. In this way, many countries are reacting to, and learning from, China and competing with China.
GrowthPolicy: During the Trump administration, we read about wealthy Chinese entrepreneurs pursuing investor visas in the United States (called the EB-5) as a wealth-management strategy and path towards future emigration (New York Times). What do these capital outflows mean for the future of the Chinese economy? Why are Chinese business elites continuing to invest abroad, expatriating assets at a time when China has emerged as a global super-power?
Meg Rithmire: One of my favorite graphs to share is a basic one of China’s capital outflows over the last 15 years. People are typically surprised to see that between 2013 and 2020, the period of collective global astonishment that “China is buying the world,” the errors and omissions line—essentially money moving across borders in unaccountable ways, e.g., suitcases or casinos in Macau—moves with and very close to Outward FDI every year. So, on average, as much capital was leaving China irregularly as it was being invested overseas.
This fact really displays the lack of trust between business and the state in China. Over a generation and a half, scholars looking at entrepreneurs and the private sector in China went from expecting this class of citizens to advocate for political liberalization to explaining that they would not because they were co-opted by the CCP, very close to the party and more than willing to accept its monopoly on political powers, at least as long as the economy was growing. But much of the dramatic phenomena in the Chinese economy show that many entrepreneurs never trusted the CCP to protect their interests. And with good enough reason: the history of the People’s Republic of China (PRC) has been one of what I call (in a book coming out with Oxford University Press sometime next year) cycles of accommodation and reprisal. Since the early 1950s, the CCP has realized that they need to permit some private economic activity to produce prosperity, even survival. But there are limits to what they tolerate, and periods of accommodation, like the early 1950s, the early 1980s, and the 1990s and 2000s, feature periods of reprisal, like the late 1950s, the Cultural Revolution, the “anti-spiritual pollution” campaign of the late 1990s, and Xi’s crackdowns of today.
The expectations of accommodation and reprisal have led Chinese entrepreneurs to be quite politically savvy in their political and business operations. They understand campaigns as periods of mobilization and resource availability, periods of “overcompliance” and excessive activity, and periods of recalibration. For example, this is exactly the trajectory of the Belt and Road Initiative over 2013 to the present. Many entrepreneurs took advantage of a policy environment open to capital outflows and sought safety, for example invested in the U.S. and western Europe where they expected their assets, and even their persons, to be beyond the reach of the CCP. During the height of “zero COVID,” we know that many of China’s most elite citizens were rushing to emigrate, and the policy environment for private sector actors, especially in strategic sectors, seems less hospitable for reasons unrelated to COVID-19, so I would expect these trends to continue.
For the Chinese economy, I argue that the regime is trapped between its desire to accomplish things that require markets, like the internationalization of the RMB, and its desire to limit the instability that markets sometimes bring. If the PRC wants the RMB to be a credible global currency, it needs to allow convertibility. But allowing capital outflows means that some domestic actors and some global actors may move money in ways that CCP elites dislike, whether expatriating assets or speculating or simply withdrawing money from China when its economy seems bound for trouble. So far, we see this cycle of embracing markets or market mechanisms and then reverting to state action—arresting people, propping up badly managed firms, injecting capital into markets to stop bubbles from bursting—when markets might correct the allocation of resources.
GrowthPolicy: While the Chinese Communist Party (CCP) is implementing many proactive reforms to accelerate China’s growth, the CCP is frequently associated, in the West’s perception at least, with corruption, political coercion, and personal loyalty/cronyism that impacts political appointments. Is this an accurate perception of the CCP or is this changing?
Meg Rithmire: The CCP has long prided itself on being meritocratic. Though it does not share power and welcome open political competition, the idea is that there is plenty of competition within the party, and those who rise to the top do so because of their superior skills or achievements. (The CCP also used to pride itself on a predictable alternation of power among leaders, but Xi’s removal of term limits in 2018 and commencement of a third term this year clearly contravenes that claim). Social scientists studying China have spent a generation measuring political competition in China to determine whether and how it is meritocratic and what sorts of skills and achievements are rewarded with promotion.
That said, China’s formal political institutions do not do things like protect property rights or enforce contracts through an impartial judiciary, and the CCP does not subject itself to the rule of law. So, as we might expect, corruption is rampant in China. Sometimes corruption helps firms overcome problems associated with weak or inhospitable formal institutions and it facilitates growth, and sometimes corruption takes the form of widespread cronyism and even fraud, and it hurts the economy by misallocating resources.
It seems that, prior to Xi’s rise, there is evidence that cronyism and corruption was inhibiting meritocracy, enabling political appointments based on factions or connections and harming party discipline, the CCP’s own ability to get things done within its organization. So some have posited that Xi’s anti-corruption campaign has been an effort to root that out and restore meritocracy, and others have argued that it is an effort to oust rivals and centralize power. For a time, it could have been both, but when power becomes excessively centralized and Xi’s close allies comprise the entirety of upper echelons of the state (as happened in the 20th party congress with the new Central Committee), it seems hard to maintain that Xi has restored meritocracy.
What does any of this have to do with the economy? Well, of course, a ton. The CCP is trying to do something that very few countries have ever done (maybe only Singapore), which is to enter the ranks of rich and technologically advanced countries without undertaking political liberalization. So we might ask: are there ways in which China’s political system could inhibit its efforts to steer development toward strategic industries and to become prosperous? In what ways might it help?
My wager would be that the answers go in different directions depending on sector and goals. For example, there is good research (David Yang in Economics) showing that China’s political system enables fewer data protection efforts and is therefore facilitating innovation in AI. But in the financial sector, the unwillingness of the CCP to submit to rule of law, or even market discipline, makes the sector home to bubbles, arbitrage, fraud, and moral hazard. Insufficient transparency and insufficient protection for minority shareholders is built into the political system; the CCP will not tolerate transparency for itself and wants to benefit from shareholder investment in its own enterprises but does not grant them real protection or power.
I find it very hard to imagine a large and efficient financial sector emerging in a place with a single-party monopoly on power, which has implications for China’s internationalization (dealing with dollar primacy) and for its domestic growth. If there is not an effective and independent financial sector, we have to imagine that the next stage of growth will come from the state making the right choices. I would not be willing to say that they will make none of the right choices, but neither would I say that they’ll get it all right.