The High Price of China's Fight With Corruption

Minyanville

On the heels of several high-profile political scandals involving members of the Chinese Communist Party, incoming president Xi Jinping has pledged to fight corruption. He has little choice; graft is not only a widespread problem in China, but one that is becoming all too visible. When petty deals between local officials and real estate developers caused a riot in Wukan a year ago, it made international news. The New York Times recently sparked trouble when it revealed that Prime Minister Wen Jiabao and his family have amassed a $2.7 billion fortune. One study claims that in a single year -- 2010 -- more than $400 billion (USD) in illicit money was taken out of China.

The scope of the problem demands action, and so does an increasingly outspoken Chinese public. The new government, meanwhile, sees this as an opportunity for political consolidation. Of the two senior officials netted so far in corruption probes -- Bo Xilai and Li Jianguo -- one is a rogue populist, and the other is a partisan of outgoing president Hu Jintao. The question appears to be not whether reform will take place, but who will be the target.

It's a dangerous situation. In a country where corruption is often the invisible hand that moves markets, any attempt at removing it will be economically disruptive. To take one example, China's real estate boom has enriched officials and well-placed individuals who found ways to circumvent the country's strict property controls. Housing bureaucrats illegally acquired apartments intended for low-income families, and profited from a rental market that is the only option for many millions of migrant workers. A woman named Gong Aiai became a media sensation -- and incurred the wrath of authorities -- when she amassed over $160 million in Beijing real estate under multiple identities. She's fled police... and she's not alone. The Sydney Morning Herald reports that "a wave of luxury home sales began last November and has accelerated since December" in response to the anticipated crackdown. The China Daily has called for requirements that officials disclose their property holdings.

At the same time, China is attempting to reform an abusive practice by which local governments seize land from farmers, compensating them at a fraction of the property's value, and then sell it to real estate developers. In many areas, these land sales account for a larger share of local revenue than taxes. Each year sees roughly 100,000 mass demonstrations as a result of land seizures, and the number of rural Chinese evicted from their homes is estimated at 4 million annually.

Here are two cases that, to the extent that reforms are pursued, will impact an already-troubled real estate market, and a real estate development sector that in 2011 accounted for a tenth of China's economy. The local governments, who have amassed trillions of dollars in debt, would be in even worse shape.

The inclusion of several individuals with close ties to state-owned enterprises has led some to speculate that the new government will be gentle to the SOEs (state-owned enterprises) that constitute more than a third of the national economy. It seems likely, though, that Beijing will be forced to take action. The infrastructure boom that began in 2009 has produced two very noticeable results: large profits for a construction sector that is overwhelmingly state-owned, and a rash of collapsing bridges. While smog in Beijing is nothing new, the public reaction to it in January was unusually strong. The growth of Internet forums like Sina Weibo has allowed Chinese citizens to voice their complaints, often with favorable results. Beijing has pledged to enforce stricter standards on air pollution, and China's bloggers are now turning their attention to the country's polluted groundwater.

The risks posed by any reform are magnified by the fact that, through a rapid expanse in credit -- an increase of $14 trillion between 2008 and 2013, according to Fitch -- the Chinese economy has become heavily interdependent. Local governments have leveraged themselves to fund dubious infrastructure and development projects, while corporate debt has reached more than 120% of GDP. SOEs were mostly prohibited from speculating in the real estate boom, but many of them became lenders themselves, using the banks as intermediaries. Housing is primarily a cash market, but real estate development is not; there is at least anecdotal evidence that some of the recent growth in wealth management products –- China's equivalent of shadow banking -– is driven by liquidity problems in the development sector. All of this makes rocking the boat a dangerous proposition.

Xi Jinping has argued that the Party's survival is at risk, and that reform is necessary. It would be better to say that reform is inevitable. The faults of China's model have become too great to ignore. However, the economy may be too fragile to bear such a reform, and Beijing's anti-corruption campaign could carry a higher price than anyone realizes.

Also see:

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