Far Eastern Economic Review
CHINA: People"s Republic Of Cheats
Rampant corruption is eating into the vitals of the Chinese economy. But unless Beijing builds robust institutions, the rot will continue
By Bruce Gilley/BEIJING
A LITTLE-NOTICED PROPOSAL raised at the annual meeting of China"s national parliament in March called on the government to step up efforts to build trust in the economy. Widespread fraud, piracy, evasion of debt and taxes and consumer rip-offs had "brought social
trust in our economy to the brink of collapse," wrote delegate Lu Guanqiu, chairman of Hangzhou-based vehicle-parts maker Wanxiang Group and chairman of China"s Rural Enterprises Association.
The proposal seemed a little esoteric. But for Lu and many other businessmen, the growing lack of trust in China"s economy has already reached crisis levels. "I have been cheated dozens of times, costing our company hundreds of millions of yuan," says Lu, ticking off instances in which subcontractors have run off with deposits and pirates have copied his products. "Now I"m running all over the
country talking about this issue and the reaction has been very good."
The high-profile hand-wringing about cheating in all its forms reflects a widespread fear that China"s economy is gradually being suffocated by a wave of dishonesty. Whether it"s tax evasion, counterfeiting, fraud or any number of other acts of deception, businessmen and officials say the phenomenon has reached epic proportions. Half of all business contracts signed in China are fraudulent in some way, officials say, while two-thirds of all state firms cook their books.
Economists say the problem is already slowing the economy because of the direct economic losses associated with cheating as well as the higher transaction costs it imposes on the economy. Domestic companies and consumers are the big victims. But foreign companies are not immune and this presents a dilemma: Either stay out of the market and miss opportunities, or get in and risk losing money to cheats. Microsoft, for example, admits it is losing money in China despite a dominant position because it is forced to sell its products at low prices to head off piracy.
Beijing has responded to the complaints with a new campaign--launched in April--against what it calls "economic disorder." But many analysts say that new institutions are needed--like independent production watchdogs and anti-corruption bodies--to solve the problem. In the absence of that, business advisers warn foreign companies piling into China in anticipation of the country"s entry into the World Trade Organization to be prepared to deal with pervasive dishonesty.
"So many weird things happen here. You find a local partner and four months later he"s siphoning off your business to his brother," says Patrick Norton, a partner with lawyers O"Melveny & Myers in Shanghai. Thorough due diligence, carefully structured contracts and on-site management are common defences for foreign firms, he says. Also important, he says, are cultivating government contacts that can help if a company is being cheated, as well as deep insider industry knowledge "so you know who"s doing what to whom."
Consider the extent of cheating in China"s economy, all according to recent officially published figures:
-- 50% of the 4 billion contracts signed in China are fraudulent in some respect.
-- Economic corruption eats up 13%-17% of the country"s annual GDP.
-- Tax evasion accounts for 50% of taxes due in the private economy, while total losses from tax evasion are 100 billion renminbi ($12 billion) a year.
-- Counterfeit goods and substandard goods account for 40% of all products made in China, with losses running at 200 billion renminbi a year.
-- Two-thirds of the biggest state firms produce false accounts.
-- The underground economy is the equivalent of 20% of GDP (actually twice that, say independent estimates).
-- 15%-20% of the spending on an average infrastructure or building project is lost to bribery, fraud, and poor-quality work.
China"s cabinet makes no bones about the problems. "Markets are flooded with counterfeit and shoddy goods, tax fraud has continued, commercial fraud and debt evasion are becoming increasingly serious and false financial statements are quite common," it said in launching the crackdown in April. "These problems are shocking. Not only have they had an impact on the healthy operation of the national economy, they have also caused a decline in public morality and undermined the credibility of the country."
To some, the widespread nature of cheating in China"s economy is an indictment of Beijing"s handling of the reform process. The dogma has always been economic reform before political reform, but the biggest result has been a lack of institutions to monitor and ensure fairness in the economic sphere. A new index by consultants PricewaterhouseCoopers, for example, measures the problems faced by business in five areas—the bureaucracy, the legal system, economic policies, accounting standards and regulations. China ranked worst out of the 35 countries surveyed with an aggregate score of 87 out of 100. The figures for other Asian countries went from a low of 29 for Singapore to 67 for Thailand.
Others point to the state"s lack of moral claim on individuals with the collapse of its communist ideology. That means cheating is often seen as a sort of righteous act. Until he was jailed for life last year for a $75 million bank-fraud scheme, China"s most famous entrepreneur, Mou Qizhong, proudly referred to himself as "The Big Cheat."
Many also point to the still-fresh impact of the Cultural Revolution, which set friends and families against each other, eating away at the "social capital," or ability of parties to engage in cooperation based on trust alone, which modern research shows is so critical to a successful market economy. Efforts to rebuild society, meanwhile, are hampered by official restrictions on social organizations not controlled by the state, including independent business associations.
Beijing"s response to the crisis has been to appeal to morals and to make threats backed up by repeated campaigns. Dozens have been executed for everything from outwitting banks into lending money to selling poisonous rice. The new drive launched in April relies on a Maoist-style "campaign" with promises of "severe punishment" and "severe crackdowns" along with "ideological and moral education."
ROOT AND BRANCH
"No matter what these people have done in the past, what advantages they provided or with whom they are connected, they must be comprehensively and totally investigated and destroyed root and branch without the slightest mercy," the party"s Seeking Truth magazine said in May. But most say Maoist campaigns are not enough. Rather, Beijing needs to make institutional changes to solve the problem. Accountability, law enforcement and transparency could all be improved by more aggressive and empowered institutions, including state auditors and courts. Loosened restrictions on social groups like the media and business groups, meanwhile, could provide a ground-up support. At present, both
are tightly constrained.
Critics like outspoken economist He Qinglian argue that the problems are not self-correcting and will only worsen in the absence of high-level political change that puts accountability at the top. Only then can society create a business-ethics system that will be self-monitoring, she says. As things stand, you can get away with anything and so most do.
Lu of Wanxiang agrees. "Political reform will be the principal way of resolving this," he says. To Lu that means bolstering the powers of commercial and tax inspectors in the face of protective local governments and giving courts more independence. Whether China needs a higher-level political shakeup to attain that remains in debate. But no one disputes that corruption is seriously hampering Asia"s fastest-growing economy.
"Cheating and scams, smuggling, tax evasion, fake goods and other cases have increased hugely and the amounts involved are becoming large," says a book published by scholars at the Central Party School this year. "The future dangerous consequences are getting bigger and bigger. It now bears directly on the success or failure of the whole reform effort."
