China Commands the Economic Waves to Stop

Politics, not economics, is in command in China. But two recent decisions to defy the market may come back to haunt the leadership: price fixing for key commodities and the block on Singapore’s bid for a major stake in China Eastern Airlines.

It was not the first time and will not be the last that a government has tried to order the tides to recede. But if ever there was a sign of growing alarm among China’s leaders at the threat of inflation, it was the January 9 announcement aimed at stopping price rises by decree, a vain hope that somehow market forces can be leashed and the country can return to a command economy.

Beijing announced that companies wishing to raise prices for basic necessities would have to register with local price bureaus. If these were deemed excessive at the local level they would not be permitted. Quite how this will operate and what level of increases will be permitted has yet to be seen.

Meanwhile Beijing is also freezing energy prices despite world oil prices close to $100 a barrel, an interesting maneuver considering that the government is paradoxically trying to cut energy consumption. Freezing energy prices will keep consumption whirring. Although prices were raised in November, they still lag behind the world, requiring explicit subsidies from the state budget and implicit ones in terms of profits foregone by local oil, gas, and coal producers and refiners.

The lesson is that in the of Communist Party leaders asset prices, particularly of real estate and listed company shares, can rise exponentially – often mainly to the benefit of insiders – driven by high credit growth. But prices for retail essentials are not supposed to respond to supply and demand but rather to the political demands of the ruling party at a time when prices have been rising at their fastest pace in 11 years.

It is hard to imagine that the leadership believes it can do more than slow the pace of price increases, driven as they are by global prices for food and energy as well as by an over-stimulated domestic economy. This is not just a question of pig disease and some inclement weather.

Beijing is facing the cost of refusing a year or more ago to allow faster yuan appreciation and to raise interest rates. Both measures would have constrained money supply growth but the government was too concerned with growth for growth’s sake, and with being seen to not bend to US pressure on the currency, however beneficial an appreciation might be.

Now we enter the year of the Olympics with prices going up to the highest levels in a decade. This should remind those in power that the 1989 Tiananmen disturbances were preceded by a surge of inflation – and of popular outrage at the get-rich-quick antics of the party elite and their offspring. There is little reason to believe that inflation this time will equal those levels but popular expectations of prosperity are probably higher now. Revolutions are not made by the poor but by those whose rising expectations are frustrated.

Beijing doubtless hopes that its order will at least slow the increase in key commodities and that state enterprises will hold their prices down to uneconomic levels. That has been the case with oil and coal for a long time and Beijing evidently believes this can be extended by providing more budget subsidies to keep other prices down. At least the budget can afford such largesse even if it makes scant longer-term economic sense.

Economics are obviously not the priority. What matters is minimizing the potential for social unrest in the lead-up to the Olympic Games. China is fully conscious of the political unrest that preceded the 1988 Seoul Olympics – and speeded the demise of the Korean military regime.

China is anyway beginning to get choosy about which aspects of the market economy it embraces and which it does not. Take the January 8 defeat of Singapore’s attempt to acquire a major stake in China Eastern Airlines. Originally approved at the higher levels in Beijing, the deal, supported by China Eastern, fell victim to Air China’s own ambitions and its skillful exploitation of nationalist sentiment against selling a stake in a major domestic airline to a foreign group – a tactic roundly condemned by the Chinese government when Chinese interests were blocked by foreign governments from acquiring overseas assets, particularly in the United States.

Although the deal was officially rejected by the shareholders and not by the Chinese government, the underlying reality is that the state reversed itself and enabled Air China to promise China Eastern what seemed a better offer. Singapore was wisely not going to get involved in a bidding war with a state enterprise and so it backed off, leaving shareholders in China Eastern to wonder how they will now fare at the hands of Air China.

The two interventions – prices and China Eastern – may be unconnected and have few obvious lessons other than reinforcing the supremacy of political considerations. However, the cost could be higher than Beijing has calculated. Next time a Chinese bid for a major stake in a foreign company becomes controversial, China’s critics will be quick to seize upon this example. (Mind you, Singapore cannot complain too loudly given the state role in its own economy and the unlikelihood that foreigners will ever be allowed to a dominant stake in Singapore Airlines, Neptune Orient Lines or other jewels in the Temasek crown.)

The price freeze will also make it easier for critics to claim that China is not really a market economy and that it is creating unfair competition by providing a wide range of subsidies to help producers as well as consumers. China can expect a new surge in anti-dumping allegations based on its attempts at price controls.

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