Why is China more prone to freeze tariffs than ASEAN countries?

Posted: January 7, 2011 in ASEAN, China, Public-private partnerships (PPP), Southeast Asia, Tariffs

It must be pointed out that China is an economy transitioning from central planning to market capitalism under the auspices of an authoritarian political regime.  For this reason, ubiquitous institutions that we may take for granted in jurisdictions with a dissimilar history such as contracts, private property rights, courts, etc. are not as fully developed in China compared to its Southeast Asian neighbours.

 

Specialist literature (e.g. Landry 2008) notes that China is an anomaly—it being designated as a ‘decentralized authoritarian’ polity.  Local governments in China enjoy an unprecedented degree of fiscal autonomy and devolved powers (including the power to sign contracts with private firms).  Brandt and Rawski (2008) notes that prior to the inception of reform, China developed a tradition of policy entrepreneurship in which local figures compete for high-level attention by demonstrating the beneficial implementation of the principles enshrined in broad central directives. This competition intensified under the reform, with GDP growth, exports, inflow of foreign investment, and other economic criteria replacing ideological benchmarks as the arbiters of success. Thus Li and Zhou (2005) find that promotion prospects for provincial leaders rise, and the likelihood of termination declines as provincial economic performance improves. Whiting (2001) makes similar observations about local officials.

 

Officials at all levels possess the authority as well as the resources needed to promote local growth. They also have strong incentives to do so, because their career prospects, as well as personal financial opportunities for themselves and their families, friends, and supporters, are closely tied to the economic trajectory of the jurisdictions under their leadership. Rapid local growth pushes local leaders to the head of the queues awaiting recognition, promotion, and bonuses. Growth also expands the pools of public revenue and enterprise profits over which officials exercise varying degrees of control, enlarges business opportunities available to the families and associates of local leaders, and swells the flow of (legal and illicit) rents directed toward official agencies and their managers.

 

These circumstances have transformed China’s local and provincial governments into eager champions of development, each striving to outdo its neighbours and rivals in expanding airports, highways, science parks, and telecommunications and in establishing firm foundations for local “pillar industries.” This competition contributes mightily to the persistent “investment hunger” visible in China’s economy, as local administrations resist central calls for restraint in enlarging existing facilities and building new ones.

 This drive to excel in growth-manship, which has become embedded in government behavior at every level, distinguishes Chinese public administration from the conduct of (especially) local governments in many low-income nations, where local administrations often pay greater attention to supporting local elites or to extracting income from existing economic structures than to promoting growth.  

 

My good friend and colleague from the University of California (San Diego), Barry Naughton (2008) observes a recentralizing reform since 1993 (where the number of vetoplayers was reduced and the center became more decisive). 

UCSD Prof. Naughton

In return for the revenues and authority the center reclaimed,  local officials were given much greater freedom to manage their local economies as they saw fit.  Central leaders set up a new relationship with local officials, essentially decentralizing to the local government ability to manage the process of selective opening.  Local governments were allowed vastly greater sway over their own economic development,  their own publicly owned enterprises,  and their relations with private and foreign businesses.  In this way, the central government relinquished its ownership claim of the tens of thousands of “state-owned” but local government-controlled firms in ordinary competitive sectors.

No longer did central and local governments jointly manage most assets. The separation of ownership became a de facto reality during the 1990s and, as mentioned earlier, was formalized in 2002, when central SASAC drew a line between the firms that it directly owned and those owned by local governments. One important result of clarifying local ownership was a wave of privatizations, a trajectory very different from that of the large, centrally controlled firms that stayed predominantly government owned.

 

Particularly in fast-growing coastal provinces, restructured and new industrial and commercial firms exploded, creating significant resources and wealth. Conversion of state firms into new corporate forms, and frequently into private firms, generated lucrative opportunities for local officials. Local government officials were quick to set up alliances and various forms of partnership with local entrepreneurs.  Sometimes favored entrepreneurs were beneficiaries of privatization, and sometimes more complex (and hidden) forms of cooperation were instituted. The process of selective opening became a locally managed one, in which local officials struck bargains with local entrepreneurs. Entrepreneurs were usually more than willing to reach accommodation with local officials (Dickson, 2003). Control of land emerged as a crucial resource under the control of local officials and real estate development became an especially lucrative business for local officials. In essence, local officials were given the freedom to make their own arrangements with emerging businesses, and they formed tight alliances with local business groups. Foreign firms were brought into increasingly wide-ranging and lucrative partnerships with local government. Local patronage complemented the central patronage described earlier.

 

Central and local were held together, as before, by the nomenklatura system. At its bare-bones essentials, the nomenklatura system ensured that the heads of provincial and municipal government and party organs were appointed by national leaders.  Thus, the center always reserved the right to replace the top officials of any locality and, in practice, frequently rotated the top provincial leaders. The hierarchical system remained firmly in place with respect to the top jobs at the local level.

 

Moreover, the regularization of rules for promotion in that hierarchy now began in earnest, as changes introduced tentatively in the 1980s began to be enforced as norms in the nomenklatura system. Rules of promotion in the hierarchy became far more institutionalized than ever before.  Mandatory retirement ages, minimum educational standards, and effective term limits had been gradually built into the personnel system during the 1980s, and now, with the end of “elder power,”  they began to apply in earnest (Bo, 2004).

 

Application of these procedures throughout the nomenklatura system resulted in more  predictable career paths that served to bind ambitious professionals to the hierarchical system. They also ensured steady turnover and made career mobility and advancement a realistic prospect. Capable individuals, as they moved up, were increasingly rotated among various regional posts, and sometimes through different functional specialties (Li, 2004). The career path of the mayor of Beijing, Wang Qishan, while not typical, gives a flavour of  the way the system works. Over the past fifteen years, Wang was moved  successively into positions as the vice head of the state-run Bank of Construction, the vice governor of Guangdong province (to clean up financial problems), back to Beijing to serve as the head of the Office of System Reform, then First Communist Party Secretary of Hainan Province, and finally mayor of  Beijing.

The breadth of Wang’s experience is unusual, as is his privileged Party background, but the pattern of rotation through different regional and national jobs is increasingly common. The heads of some of the largest centrally run SOEs now serve in the Communist Party Central Committee. This kind of career path binds the managers of huge and powerful enterprises to the hierarchical system. It also means that the patronage resources of those enterprises are potentially at the service of the hierarchical system.

Wang Qishan

 

The increasing predictability and institutionalization does not spell the end of politics or patronage or make it any less necessary for leaders to promote their own factions and followers. It simply means the game is played by different rules, played out over a new terrain with more clearly delineated pathways.

Even Jiang Zemin, the top leader, was subject to the new constraints. Deng Xiaoping had insisted that Jiang should step down from his top posts after two full terms and proposed that Hu Jintao should succeed Jiang in 2002.  Deng thus used his own prestige to create a new elite consensus about the rules of political succession that constrained. the subsequent generation of leaders. Assuming that Hu

Jiang Zemin

Hu Jintao

Jintao steps down at the end of his second term in 2012 and confirms the precedent, regular turnover and predictable career paths will have been established.

 

Empirical literature indicates that failure of most infrastructure PPPs can also be traced to the imprudent exuberance of local governments (who are apparently in a race with each other in building infrastructure).  Compounding the situation is the apparent lack of a national PPP template that could guide sub-national actors and private partners. (See Adams et al. 2006; Bellier and Zhou 2003;  Li 2007; Zhong et al. 2008). 

 

In a study of 16 failed infrastructure PPPs, Ke et al (2009) identified legal, regulatory and political risks as key reasons for adverse project outcomes.  Legal/regulation risks especially change in law risk is one of the most frequent risks encountered in China’s PPP projects. This risk includes the adoption, promulgation, modification, or reinterpretation after the signature date of the concession agreement by any governmental authority of any laws of the host country; and the imposition by a governmental authority of any material condition in connection with the issuance, renewal, or modification of any approval after the date of signature of the Concession Agreement that in either case establishes requirements for the construction, operation, or maintenance of the BOT project that render the performance by the project developer according to its terms illegal. For example, the State Council issued a notice on abolishing the existing projects guaranteeing the fixed rate of return from foreign investments in 2002.

Thereafter, those existing projects with a promised fixed rate of return from local government were forced to be handled in the way of “modification”, “purchase”, “transfer” or “cancellation” on the basis of the particulars of the concerned project.

 

Besides the laws/regulations risk, political risks are regarded as other most frequent risks, which describe the risks of the actions from the central, provincial, or local levels of government. The specific risk factors critical to the success of PPP projects in China may include poor political decision-making process, public/political opposition, government reliability and corruption. Other risk factors include change of local government and its key official, government’s fiscal situation and capability to purchase guaranteed output (especially of power/water/gas), government’s poor knowledge and high expectation, etc.

It is important to be noticed that the authors suggest the private investors not to take advantage of government’s poor knowledge/ experience and sign unfair contracts, especially when local governments promise some incentives to improve the attractiveness of the target project to private investors due to the urgent pressure of infrastructure development.

 

Ho (2006) believes there has been too much emphasis on attracting investment from the private sector and too little attention to market competition. The main objective of PPPs is to make use of market competition in order to ensure the effective use of resources in the provision of public facilities and services. However, some local governments have placed too much emphasis on attracting private investments by offering even more favourable terms than the normal national status. In order to attract foreign investment, some local governments have promised more than they are capable of doing.

When the relevant government officials change, the new officials may look for ways to terminate those agreements which are found to be unfair or unreasonable. PPPs have been treated as the privatization of public facilities/services, focusing on short-term return without a spirit of long-term partnership. In order to achieve a high return on investment, both the government and private investors have tried to charge a high fee for the provided facilities and services as well as assigning land use without paying any charges. The financial risk and burden are shifted to the public who face a high price for the public facilities and services without getting the corresponding increase in service quality.

 

Choi et al cite the case of the Da Chang WFOE BOT water project, the earliest PPP water project in Shanghai, begun by directly negotiating with the Thames Water and Bovis consortium in 1995. The scope of the project is to build a water treatment plant with a capacity of filtering 400,000 cubic meters per day for two million customers and to operate the plant for 20 years.

 

The project was initially regarded as a successful case in that the municipal government independently proceeded with the project without any symbolic support from the central government, such as comfort letters or guarantees, so as to limit the financial risks involved.   

However, later, during the operation phase in 2002, the profitable project faced a sudden change of government policy targeting large international companies with bargaining power to an extent enough to insert the fixed return clause into contracts that the guaranteed rates of return for infrastructure projects are illegal, and risks and returns in BOT projects should be shared by Chinese as well as foreign partners according to the State Council’s decision in 2002. The project guaranteed with a fixed return rate of 16% was not treated as exceptional and thus became illegal.

 

Despite all the efforts of Thames Water to negotiate the new terms with the Shanghai Waterworks Company (owned by Shanghai government), the company could not reach any agreement and finally exited the project by selling its assets to the Shanghai Shibei (Northern City) Water Treatment Corporation in June 2004.  In similar cases, the bulk water supply contract of  Shenyang Public Utility, in which Suez held a stake, and the Xian water treatment project held by Berlinwasser were terminated because the demand was lower than the forecast, and the municipality stopped subsidizing the companies as promised in the contracts.

 

REFERENCES

 

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Brandt, Loren and Thomas Rawski. 2008. “China’s Great Economic Transformation.”  In L. Brandt and T. Rawski, eds. 2008. China’s Great Economic Transformation. Cambridge University Press, pp. 1-26.

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Deng Xiaoping: architect of Chinese reform

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