Is autocracy built on the misconception that tyranny does away with some of the perceived economic shortfalls of liberal democracy?

Autocratic capitalism as an economic development model has won converts in recent years, especially as the increase in wealth achieved by China’s dictatorship swamps that of, say, India’s system of democratic capitalism.

The developed world’s financial crisis, political dysfunction in the US and the inability of the eurozone to formulate solutions for its crisis add to those losing faith in liberal capitalism as a path for economic advancement.

The case for the economic prowess of autocracy, when power resides in one person or one party, is built on the misconception that tyranny does away with some of the perceived shortfalls of liberal democracy. There are many myths behind the case for autocracy but two stand out when analysing China’s economic risks. The first is that dictators don’t have to bow to public opinion as do elected lawmakers. Tyrants can supposedly implement whatever changes are needed to spur economies, no matter how unpopular they are. Despots, in reality, are rightly paranoid for they survive by keeping people either happy or frightened. Either way, they are attuned to the popular mood for they have more to lose if their people become miserable and less terrified. In democracies, politicians beaten at the polls trudge unwillingly into comfortable retirement and their parties generally regain power within a couple of elections. Few dictators, however, die of old age in their palaces, metaphorically speaking. Mao Zedong, Stalin, Haiti’s “Papa Doc” Duvalier, Spain’s Franco, Syria’s Hafez al-Assad and North Korea’s Kim Il-sung and his son Kim Jong-il died this way, due largely to the effectiveness of their brutality as did China’s more humane though still purge-prone Deng Xiaoping. The rule of most tyrants, though, is usually cut short, even if they are ruthless (and sometimes happens via foreign invasion). Their chaotic ends include suicide (Hitler), firing squad (Ceau?escu of Romania), shot soon after capture (Mussolini and Libya’s Gaddafi), hanged (Saddam Hussein), jail (Noriega of Panama), exile (Cambodia’s Pol Pot, Haiti’s “Baby Doc” Duvalier, Iran’s last Shah, Paraguay’s Stroessner, Uganda’s Idi Amin and Zaire’s Mobutu) and house arrest amid legal harassment (Chile’s Pinochet and Egypt’s Mubarak).

The second myth spouted by autocracy advocates that is relevant when looking at China’s risks is that supposedly enlightened tyrants can enforce their will – as in, they don’t have a judiciary, free media, interest groups, trade unions, constitutions, state governments, opposition parties, independent MPs holding the balance of power, upper houses or even coalition partners blocking their policies. Only dictators with total control over all facets of society, such as Hitler, Mao, Stalin and North Korea’s Kims achieved, can boast such supreme enforcement of will. Most authoritarian systems are insecure dictators sitting atop a balance of power between fiefdoms that can generally block changes that will hurt their interests. Within a one-party state, most of these fiefdoms reside within the party and the major organs of power, such as the army, it controls.

These two myths about autocratic (or state or illiberal) capitalism are being exposed as such in China these days. While Beijing talks about reforms, rebalancing and other applauded intentions, the reality is that the government is failing to fully pursue the steps it advocates. Fears of a public backlash and countermoves by lower levels of government are nullifying much of any advances China’s central government has taken to diffuse the damage wrought by the excessive lending that insulated China from the global financial crisis.

This is not to underplay the economic achievements of autocratic societies in recent times. These regimes take many forms so it can be an oversimplification to generalise about countries such as Bolivia, China, Ecuador, Hungary, Russia, Singapore and Turkey that use different blends of coercion, populism, nationalism and centralism to rule. Autocratic regimes can change over time too. China’s dictatorship has moved from a Communist to a capitalist economic model since 1978 and has eased some political restrictions, all the while holding onto total political power. China’s government has allowed China’s economic growth to cool below double-digits so it has some credibility when it says it’s righting its economy. Perhaps President Xi Jinping will engineer such power that he can enforce his will throughout the country – he’s already being described as the most powerful and popular leader China has had for decades.[1]  Democratic systems are not perfect systems, either. While China has other political risks to monitor, especially the crackdown on corruption aimed at the highest echelons of the Communist Party, there’s little doubt that China’s autocratic model carries flaws that are adding to China’s longer-term economic risks.

How will the masses react?

China’s leaders have acknowledged in recent years that their investment-driven, construction-biased and debt-fuelled economic model that relies on low-cost and low-valued-added exports is in crisis. They accept that the economy’s distortions, financial weaknesses and inequalities this model spits out means the country needs to upgrade to a consumption-driven, services-led value-add-industrial prototype that will produce “slower but safer” growth, in the words of the IMF.[2]

Beijing, however, for all the good moves it has made, is failing to swiftly reform its economy for it worries that growth might slow too much and lead to excessive unemployment. It is sacrificing steps that would generate longer-term stability in favour of moves that will fan immediate growth. The regime has declared a 7.5% growth target for 2014 and has succumbed to the temptation of more stimulus to ensure the economy attains this goal. Recent plans to spur the economy include more fiscal stimulus including extra money for infrastructure, more lending for rural poor, pruning bank reserve requirements and reduced taxes for small and medium-sized businesses. A Bloomberg gauge that weights average loan growth, real interest rates and China’s real effective exchange rate shows that China loosened monetary conditions in the second quarter at the fastest pace in two years.[3] The central People’s Bank of China, which is just another arm of the Finance Ministry rather than being “independent”, is loosening monetary policy to help the economy. Over 2014, the central bank has steered loans to public housing and infrastructure. It recently gave about 1 trillion yuan (US$180 billion) to China Development Bank to stimulate lending[4] and injected 500 billion yuan into the country’s five largest banks to prop up lending.[5]

The risk is that more fiscal and monetary stimulus will add to the vulnerabilities and inefficiencies of China’s economy and make any reckoning more shattering. The IMF warns Beijing is “increasing the risk of a disorderly adjustment” – its jargon for crisis – if it to relies on government intervention to underpin growth and fails to rejig its economy and haul in the credit boom that has boosted total debt from 130% of GDP in 2008 to 207% of output now.[6] Yet the recent slowing in industrial production, investment, retail sales and sentiment and the slump in property construction, sales and prices is only likely to compel Beijing to do more prodding (possibly too via a devaluation of the yuan).

China’s rulers feel pressured to keep the economy humming now rather than worry about where it will be in the medium term for two reasons. The first is that leaders are under pressure from vested interest to indulge in more of the investment and lending that buttress their wealth and power. The bigger reason, though, is that the Communist Party is afraid of the consequences of breaking its compact with its 1.3 billion subjects that goes something like; trust us with political power and we will enrich you. While the Chinese know that the ruling classes gorge themselves first, this agreement has held because hundreds of millions of citizens have risen from poverty in recent decades. Beijing’s fear is that the compact may crumble if lower growth spells unemployment and renewed impoverishment for the masses. Deeper despair, it frets, may add to the disquiet in China about land grabs, pollution, corruption and the inequality that each year is triggering, by the government’s count, about 180,000 “mass incidents” of unrest (demonstrations involving protests of more than 500 people) at a time when unemployment is officially 4% and wages are growing at a 10% pace.[7] While democratic leaders burdened with a sagging economy face losing the next election, China’s autocrats fear another Tiananmen, which started over concerns about inflation before encompassing wider political grievances. The protests in Hong Kong will only serve to rattle them more.

Unruly lower tiers

China’s central government has numerous national organs (or fiefdoms) clashing over the direction of economic policy. The outcome of the infighting in recent years has been a decision to reform the economy, even at the cost of growth. In November last year, for example, China’s rulers announced their biggest package of reforms since the 1990s that aim overall to boost the role of market forces in allocating resources. China’s leaders said they would ease price controls, relax the curbs on the exchange rate, liberalise interest rates, bolster financial regulation and supervision, reorganise fiscal management and rules of government land ownership and rein in local government excesses.

If only they had the power to do all this (assuming they had the will). China’s multi-tiered system of government includes 34 provincial governments (if you include Beijing’s claim on Taiwan) and almost countless lower levels of governments below that. This term “local” covers thousands of governments controlling provincial-level cities, counties, county-level cities, county-level districts down to villages. Officials in charge of these lower tiers are often in competition with neighbouring peers to achieve faster growth and build better infrastructure, to further their own careers, feed local prestige and to placate vested interests. The way China works, these lower-tier officials often ignore central economic directives that clash with their self-interest (though they are more in step on political matters). “Far from surging like a single river out of the capital, the transmission of economic policy is more like a series of locks, in which each locality takes what they want out of the policy waterway,” writes Richard McGregor in his book The Party. The secret world of China’s Communist rulers.[8] “Feigning compliance with the centre … they then let the policy stream flow downwards to the next level of government.”

Total central control in China or elsewhere is not necessarily an appropriate way to run a society or economy. But in China today the rulers in Beijing appear more attuned to China’s economic and financial instabilities than are local authorities. The list is growing of worthwhile actions decreed by the centre that are being unwound in the peripheries of government. As this count grows, so too do China’s risks.

Of special note is that local authorities are adding to China’s debt load and heightening the risk of a financial crisis by countermanding central directives on how to deal with collapsing businesses. In July this year, for instance, the government of northern Shanxi province bailed out Huatong Road & Bridge when the construction company faced being the second Chinese business in four months to default. Apart from the moral hazard in shielding businesses from bad decisions, this step was against Beijing’s request that small and medium-sized business should be allowed to collapse to prevent the misallocation of resources. It conflicted with Beijing’s goal to reduce total public liabilities, so as to lower the risk that the central government will need to prop up local or regional governments. It heightens the risk of a greater reckoning by encouraging more excesses.

Analysis at a macro level highlights how Beijing is failing to enforce its will on lower levels of government. A Bloomberg study in July found that 20 of 25 provinces and provincial-level cities in China reported a largely debt-fuelled pickup in growth in the first half of 2014, which basically shows provincial governments are undermining Beijing’s plans to rebalance growth and rein in lending.[9]

More micro analysis shows the same pattern. The Wall Street Journal reports that Beijing is having trouble reducing overcapacity in the 19 industries it classes as producing excessive supply because of countermoves by subordinate governments. In the debt-laced steel industry, for example, government officials in the northeastern city of Xingtai in July reopened a steel mill that Beijing had ordered shut eight months earlier. Government officials in the steel-making Hebei province that surrounds Beijing are stalling to obey orders to shrink an industry that provides 10% of its tax revenue and about 200,000 jobs for locals.[10]

These moves against central directives and Beijing’s timidity when it comes to confronting popular opinion do two things and will probably achieve a third. Firstly, they boost China’s short-term economic growth prospects. Secondly, they undermine China’s longer-term wealth by boosting the damage of any reckoning. Thirdly, they will probably eventually help those arguing that liberal capitalism is the best way to achieve sustainable prosperity.

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