The root of China's economic troubles? It's politics, stupid

Chinese President Xi Jinping, left, talks with former President Jiang Zemin during a military parade marking the 70th anniversary of the end of World War II in Beijing on Sept. 3. © Reuters

Judging by the reaction of financial markets to the recent spate of bad economic news from China, it is clear that the global business community had no inkling that the Chinese "economic miracle" would unravel so suddenly. But for those familiar with the political economy literature on predatory regimes, China's stumble was not only expected but inevitable.

     Most executives and investors may be too busy to read a dense theoretical classic like "Institutions, Institutional Change and Economic Performance," by the Nobel Prize-winning economic historian Douglass North, or a more accessible book, "Why Nations Fail," by Daron Acemoglu and James Robinson, economists who teach at Massachusetts Institute of Technology and Harvard, respectively. The insights from these scholars, who have pondered the relationship between politics and economics, are worth attention.

     Their central concept is that of the "predatory state," an academic term for a rapacious government. Despite the superficial differences in how the ruling elites "prey" on society, the core feature of a predatory state is the use of political power for the self-enrichment of rulers.

     If the power of the state originates from the consent of the governed and is constrained by the rule of law, the ruling class will have a very limited capacity to steal from the people. However, if rulers place themselves above the law and use violence monopolized by the state to defend their privilege to steal, they can extract wealth from society at will. The most notorious examples in recent history are Ferdinand Marcos in the Philippines and Mobutu Sese Seko of Zaire, both synonymous with kleptocrats.

A slow siphoning

States taken over by predatory regimes can impoverish their societies. The most extreme and catastrophic form of such pauperization is the outright plundering by dictators with a short time horizon.

     The more sophisticated predatory regimes, usually run by highly organized authoritarian political parties with a much longer time horizon, prefer a more subtle and durable strategy of extracting wealth from their societies. Instead of undisguised and instant thievery that might destroy the capital stock of their nations and hence threaten their long-term collective interests, predatory regimes controlled by organized political parties rely on indirect, concealed and routinized means of theft.

     Typically, they devise elaborate rules to limit the mobility of capital (freely movable capital is hard to steal), make property rights insecure (unprotected property is easier to loot), control the banking sector (to tax the population through negative interest rates and channel credit to favored borrowers), maintain large state-owned enterprises (to transfer wealth to the rulers who control these companies), and monopolize key sectors (to tax society indirectly).

     In comparative terms, collective-based predatory regimes are obviously far more sophisticated than individual predators and tend to stay in power much longer. While such slow theft may be preferable to fast plunder, this offers little comfort to private entrepreneurs and ordinary people who must live under such regimes and see a considerable part of their hard-earned wealth taken without their consent. However sophisticated and stealthy the means of slow theft may be, citizens and private entrepreneurs will eventually recognize the system for what it is and lose the incentive to work. Moreover, while a system of slow theft may produce more wealth than a system of fast plunder, it remains a hugely inefficient economic system. Under such a system, precious resources are squandered on projects favored by the rulers because these projects can help them secure political support or benefit their families and cronies.

     The predatory state perspective provides a deeper and more disturbing insight into the causes of China's economic slowdown. If we take a look at China's key economic institutions and practices, we can quickly detect a classic system of slow theft: a closed capital account, no meaningful protection for private property, a state monopoly in the banking sector and key industries (such as telecoms and energy), gigantic state-owned enterprises (accounting for at least a third of gross domestic product), and totally opaque government budgets.