China proclaims to the world the virtues of its socialist market economy. It wants the benefits and blessings of a market economy with all the control of rigid, centralized authoritarian communism. Herein lies the eternal conundrum of governance.
China is wrestling with how to reduce the debt risks associated with heavily indebted provinces and real estate firms. The latest real estate firm in the market crosshairs is Shenzhen-based developer Vanke. Vanke is one of the healthier real estate firms in China, primarily because of its heavy investment in Shenzhen and the surrounding area, although this is still akin to saying that it’s the healthiest of cancer patients. Shenzhen wants to impose market discipline on Vanke, but not too much discipline.
This is where it gets complicated. Shenzhen noted that more than 30 percent of its state-owned assets and yearly income come from its state-ownership stake in Vanke. The incestuous relationship extends beyond mere passive ownership. Shenzhen sells land that Vanke purchases at elevated prices funded, in significant part, from loans from Shenzhen-based banks.
This multi-layered relationship feeds both sides but also gives each side an incentive to act independently of market discipline norms. The city needs Vanke to help feed its voracious revenue needs through land sales and dividends, so it needs a well-funded, profitable developer and uses that power when necessary. Vanke exerts less discipline and acts on behalf of the state, expecting everything from more funding than competitors to favored treatment, but also understands that it must act as an arm of the state when called.
This symbiotic relationship received full attention on Nov. 6, when Shenzhen authorities called upon local banks to purchase Vanke bonds as a show of strength and solidarity with the developer. Now, developers in China need many things, but additional debt doesn’t top the list. With just more than 5,000 total units sold last month in Shenzhen, with a total housing stock of approximately 6 million units, more building and debt to build up serve only the state coffer, not Vanke. This presents the stark power of the state to support incumbent firms but also the differing needs between the state and market institutions.
Shenzhen desperately needs the revenue provided by Vanke, and Vanke desperately needs state influence to avoid collapse. This is the eternal paradox of a socialist market economy.
In his masterful book titled “The Party: The Secret World of China’s Communist Rulers,” Richard McGregor peeled back numerous major scandals in modern Chinese business to show that they stemmed from leaders attempting to placate the demands of the Party while running businesses. Business leaders act as both the Chinese Communist Party (CCP) head of the company and the executive leader of the business. Therefore, they follow Party diktats while trying to balance market demands, knowing that the Party reigns supreme. So when given the choice of which to follow, the CCP always wins. This leads to the eternal paradox: Business can’t endure market discipline if the Party always protects.
However, there’s logic to the Party-state behavior in this case. Chinese finances teeter on a precipice of insolvency from local governments to real estate developers and state-owned enterprises. Beijing just announced that 27 provinces would issue another 1.2 trillion yuan in refinancing bonds just to roll over debts into long-term vehicles after similar amounts in September and October. The problem is simple for the CCP, even though it does nothing to help market discipline: If the Party imposes market discipline, it creates a financial crisis and social unrest as real estate developers collapse and people lose homes for which they’ve made prepayments. At least by bailing them out, it hopes to buy time to find a solution for such an enormous problem. The Party prizes stability and achieves this by creating moral hazard.
The fundamental problem is the paradox of what makes up a socialist market economy. If the Party reigns supreme and refuses to allow market discipline, then market discipline never happens despite its pleadings and protestations. Market discipline can’t exist in the shadow of a state that refuses to allow market discipline.
The great Christian philosopher St. Augustine succinctly summed up China’s pleas for market discipline when he prayed, “Oh, Master, make me chaste and good, but not yet.”
If only financial debts were as easy to forgive by an almighty Party as the trespasses of the sinner by the Almighty.
