Why The Economic Battle Inside China Matters

Jim Jubak MSN Money March 20, 2012

3/19/2012 7:55 PM ET

By Jim Jubak

An upstart politician's downfall tells the story of an economy still divided between capitalism and communism. Plus: 3 reasons the result matters to investors.

Sometimes you can't tell the players in China even with a scorecard.

In recent stories about the extraordinary fall of Bo Xilai -- the Communist party secretary of Chongqing, who went from a front-runner for one of the nine slots on the Standing Committee of the Politburo that runs China to house arrest -- I've seen him called a conservative, a liberal, a reactionary, a progressive, a populist and a leftist intent on bringing back the Cultural Revolution.

I think most of those characterizations are accurate -- even though they position Bo simultaneously at what those of us outside of China consider contradictory ends of the political and economic spectrum.

In those contradictions, I think, you can find a key to understanding the current peculiar nature of China's state-run capitalism -- and the shape of the coming struggle over the direction of that economy. For an investor in any global market, I don't think there's a more important story right now.

Let me explain what has happened in China, the significance of Bo's fall and why this is important for investors outside of China.

Is there an economic bubble in China?

From the evidence of his history, Bo was a gifted popular politician. Refused membership in the Standing Committee of the Politburo in 2007 during the last leadership shuffle, Bo was sent off to languish in obscurity in Chongqing, then an economic backwater in western China. But Bo seized upon big themes of popular discontent in China to send his career into orbit.

He tackled corruption, then rampant in Chongqing, arresting thousands and sending hundreds to jail in an anti-mafia campaign that culminated in 14 executions.

Jim Jubak

He won more points with the millions of Chinese who have been left behind in the rush to private wealth, pledging to close the increasing gap between the haves and the have-nots. He built 750,000 apartments and set up a program to compensate farmers who lose land to the government. More than 2 million migrant workers won increased rights to social services in Chongqing.

While these programs addressed big issues of mass discontent, there wasn't anything democratic about Bo's methods. His anti-mafia campaign managed to sweep up many of his political opponents. His efforts to produce jobs in Chongqing relied on massive state subsidies to attract foreign investment (Apple (AAPL, news), Hewlett-Packard (HPQ, news) and Foxconn (FXCNY, news), to name just three) to that city and a big increase in the role of state-owned companies in the economy. Local government spending on big infrastructure and housing projects went to state-owned companies. Chongqing's economy thrived, but the model mirrored -- and possibly exceeded -- the broader move in China as a whole toward more state ownership and control over more of the economy.

Whatever his skills as a popular politician, Bo was an economic conservative on a Chinese scale.

The party still in power

Bo's downfall probably stemmed from his big success in organizing what increasingly looked like a power base that didn't rely on the party. Bo promoted a "red revival" that organized 10,000 mass gatherings focused on the singing of songs that echoed those from Mao Zedong's Cultural Revolution. Bo did update the Great Chairman's techniques, though. Campaigners sent more than half a million "red" text messages on cellphones.

The party leaders who decided to move against Bo got their excuse when Wang Lijun, Bo's chief of policy in Chongqing, showed up at the U.S. consulate in nearby Chengdu. He allegedly asked for political asylum and offered to spill whatever there was to spill to the Americans. Chinese police surrounded the building, and Wang left with them the next morning. He's been in custody since then.

For a while it looked as if Bo might survive the incident, and theories circulated that his popular support was so strong that party leaders would be afraid to move against him. (That public speculation almost certainly helped party leaders make their move. If people are talking about you being weak, you're likely to want to prove them wrong.)

But then the big guns came out: Premier Wen Jiabao warned against a return to the days of the Cultural Revolution. In fact, Wen used part of his three-hour press conference at the conclusion of the National People's Congress to reference the party's official 1981 take on the Cultural Revolution -- "A Resolution on Certain Questions in the History of Our Party Since the Founding of the People's Republic of China."

Communism's comeback

It's tempting to see Bo's downfall and Wen's use of the "resolution" to bring up the need for continued political and economic reform as evidence that the "reformers" have won a round. But I think it's a mistake to read events that way.

Yes, Bo's economic success in Chongqing relied on a shift in the economy in favor of state-owned businesses that is a reflection of a process that has been going on in China as a whole for much of the past decade. The increase in government ownership of the economy in this period is a reversal of the economic opening that began in the late 1970s. The Organisation for Economic Co-operation and Development estimates that state-owned enterprises accounted for 77.6% of industrial production in 1978. By 2004 that figure was down to 30%, according to estimates from the People's Bank of China. Total contribution to China's gross domestic product from state-owned enterprises came to about 34%, according to the OECD.

At the end of 2010, a report for the U.S.-China Economic and Security Review Commission issued in October 2011 estimates, that percentage had climbed back to 40% or 50% of China's GDP (depending on how you define "state-owned enterprise"). Revenue for China's state-owned enterprises was equal to 43% of China's GDP in 2011, recent Chinese government statistics show. China's mixed economy is less mixed than it was six years ago.

And Bo's replacement in Chongqing isn't some economic reformer but an economist (and one trained in North Korea at that) allied to the party faction controlled by former President Jiang Zemin. I think it's fair to characterize Jiang's faction as economic conservatives who believe in continued state control of the high ground of the economy -- the strategic sectors that include industries such as steel and oil -- and in state control of the financial sector.

In spite of Wen's rhetoric, the battle for political and economic reform isn't by any means over. In fact, it appears to be intensifying, with the forces of economic reform facing an uphill battle. Wen's speech marks the beginning of a fight over the direction of the country that will be determined when seven of the nine members of the Standing Committee of the Politburo step down (because of age) and are replaced in November. And so far, at least the way I'm keeping score, the best that the economic reformers can claim is a tie: Bo is out and won't sit on the Standing Committee, but his replacement in Chongqing is an economic conservative.

Continued on the next page. Stocks mentioned include General Electric (GE, news) and Siemens (SI, news).

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"Chinese police surrounded the building, and Wang left with them the next morning"

I guess we did not extend diplomatic immunity to what might have been a very valuable asset. That's what happens when you owe other countires more money then you can ever repay. They tell you what to do in situations like this.

0 0ReportSpamMCIAHEL4 hours agooabam ,obama , dollar is losing again, what to do, **** raise gas prices some more. and food, and any commodities will do. screw China, this might be the big one coming. 4 10ReportSpamgreedisglorious4 hours agoWhen China and India's economy, along with higher fuel/shipping cost's reaches a certain level to where it will no longer be sustainable or profitable for American companies to operate from there they will begin to come back to America. That is unless the companies can find another region of the world to set up shop and operate from in order to continue thier quest to make as much money as humanly possible. However, when and if this does begin to take place all the jobs that left here that payed 12, 16, 18 dollars an hour will come back as 8 and 10 dollar an hour jobs. Certainly not enough to get by on but we will all be glad to get them after going so long doing without, going hungry, and or living on government assistance. I think this was the master plan all along in corporate America's endeavor to keep it all. I once watched a program on tv about 20 yrs. ago where company ceo's were in a debate with workers unions. The ceo's were all unanimous about one thing. We are sick and tired of financing the American dream. That's all I needed to hear. They fully intend to keep it all, and that is exactly what they are doing. Greed will never loosen it's death grip, it will only fester and grow untill it kills us all. Isn't greed glorious? IMHO, we are all screwed 27 3ReportSpamcommonsense13634054 hours agoUm, China doesn't have geishas...that's Japan 7 0ReportSpamTom Johnson4 hours agoChina, what a cess pool. 6 2ReportSpamMaurice Newallo-Singh5 hours ago

Jen forgets that a lot of things non-industrial are not made in China. Software, a lot of American sneakers like State Street , American Eagle. My point is China does market its exports all of them

but is American exports based on food

0 1ReportSpamhavasu4614 hours agoWhy not just invest in Apple, Intel, Ford, GE, Microsoft and Nokia and let them worry about China. 1 2ReportSpamIce Cold Sangria15 hours ago

Jubak has been yapping about China for a long time. So he's got a thing for geishas or something.

But he won't talk about TNK. Whatta chump.

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Whatever his skills as a popular politician, Bo was an economic conservative on a Chinese scale.

Continued on the next page. Stocks mentioned include General Electric (GE, news) and Siemens (SI, news).

Why The Economic Battle Inside China Matters

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