Holding the ‘red line’: why Evergrande is state-led capitalism’s moment of truth
Beijing would rather face an economic crash than a political crisis of legitimacy
In lieu of this week’s Policy Opportunities, today I wrote an in-depth piece on the Evergrande crisis. With the fate of China’s largest property developer still up in the air, this moment gives us a chance to contemplate the deeper differences between US and Chinese capitalism, and that's what I will expound upon below.
The story is developing each day and with more than $300 billion in liabilities at stake, it is far from over. Who knows how many months, years or decades we will be feeling the reverberations of this one.
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Holding the ‘red line’: why Evergrande is state-led capitalism’s moment of truth
Much has been made of Beijing's determination to avoid the fate of the USSR, yet as the fate of Evergrande hangs in the balance this week, it is Washington's mishandling of the 2008 financial crisis Beijing is desperate to not repeat.
Chinese leaders are keenly aware of how the bail out did permanent damage to American democracy and turned a financial crash into a prolonged political crisis in the US and, if faced with the choice, would opt for economic pain today over a delayed crisis of legitimacy. Not only does Beijing’s renewed prioritization of the middle class make a bail out untenable with new economic doctrine, letting Evergrande go would reassert what separates Chinese capitalism from its American rival —that the government, not the corporations, run the country.
Lessons in Legitimacy
The US government’s fateful move to bail out the banks in 2008 exposed the injustice that lay at the heart of the country’ capitalist system. As famed economic historian Adam Tooze contends in Crashed, the mobilization of trillions in honest taxpayer’s money to save crooked banks from their own folly morphed the financial crash into a prolonged political crisis.
The fact that the bailout was bipartisan, carried out by the Treasury Department first under first Republican Bush and then Democrat Obama, fuelled feelings that American voters only had an ‘illusion of choice.’ It was this indignation, felt by millions of working class people who’d lost everything, that undergirded the populist wave that carried elite-bashing political outsider Donald Trump into power in 2016.
China may watch the unravelling of American democracy with a sense of triumphalism, but it has still noted the lessons therein. Beijing, obsessed with stability over all else, is acutely aware how perceived economic injustice can spread discontent throughout society and is determined to steer clear of a similar fate. This is particularly prescient warning for as China’s growth slows, the party that has for so long built its legitimacy on GDP figures, knows it must change tone.
The ‘Three Red Lines’ to ‘Common Prosperity’
The country is quickly shifting away from Deng Xiaoping’s famous maxim ‘get rich first’ that once guided its economic policy for decades and so well reflected its desperation for growth by any means. The replacement, Xi’s campaign for ‘Common Prosperity’, by contrast looks to shift the conversation from slowing growth toward sharing the spoils around.
With a crackdown on the country’s billionaire class combined with a renewed push toward wealth distribution, Xi is hitting ‘reset’ on the country’s ideological underpinnings and shifting the locus of legitimacy back to the masses.
China’s billionaire entrepreneurs, once celebrated as national rockstars when the country needed the growth they created, are now painted as a potential fifth column and hit by all manner of disciplinary actions. Instead, the government is focused on shoring up support among the masses by eroding the ‘Three Mountains’ weighing Chinese families down -- education, health, and housing.
Seen as the root cause of China's endemic inequality, the real estate industry has been the prime target of reform. In fact, it is Beijing’s new rules, the very ones aimed at taming soaring housing prices, that is now sending Evergrande on its white-knuckle ride toward bankruptcy. It is, essentially, a state-triggered credit crisis.
China’s ‘Three Red Lines’ — a 70% ceiling on liabilities to assets, a 100% cap on net debt to equity, and a cash to short-term borrowing ratio of at least one — are meant to whip debt-ridden developers into shape and deny them further credit should they cross them.
Now that desperate scenes of homeowners protesting outside the company’s headquarters have gone viral, rescuing Evergrande would be terrible optics and show the masses of Chinese who dream of homeownership who the government is really looking out for. The government does not plan to commit such a fateful mistake.
The fact these protests have been allowed and have not been censored tells us as much. It actually signals their intention to make an example out of the company.
State-led or state-insured capitalism
Though 2008 validated the belief in China that its state-led economy was structurally superior to the market-led economies in the West, Evergrande could be Beijing’s chance to show it's also morally superior.
If it defaults, Beijing intends to turn the screws on the company, not only as a warning to all the other property developers in China that may dare to flaunt its regulations, but as a demonstration it can live up to the promise of state-led system -- one where, when ‘crunch time’ comes for debtors, the state can be the judge, jury and executioner of the bankers, and not simply their savior.
“Remember Friday March 14 2008: it was the day the dream of global free-market capitalism died,” was how the FT’s Martin Wolfe put it at the time. “We’re all state capitalists now” was how historian Neil Ferguson later phrased it.
In truth, the division of “market” and “state capitalism” is an unhelpful oversimplification considering most countries are on, as Neil says, “a spectrum where both the intent and the extent of state intervention in the economy vary.”
In 2008, the US showed its variant as ‘state-insured capitalism.’ Here the government acts as a specialized emergency service for corrupt corporations, on call to put out the fires of Wall St while the bankers play matches with global finance. In this variant, the government plays a supportive, almost subservient role to corporations.
Just the opposite is true in China. Rather than companies relying on government generosity to survive a crisis, as per the CCP’s 2020 guidelines, it is enterprises that must reliably support the Chinese state in “times of crisis.”
In the same line, the CCP’s charter, modified by Xi in 2017, affirms that private enterprise serves the goals of the party, which “leads on everything."
Thus, letting wayward banks go, no matter their size, demonstrates the state always has the final word, and that is the essence of Chinese state-led capitalism.
There is, after all, only one entity China’s communist party will ever allow to be ‘too big to fail’ — themselves.
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- Liam
Founder of Policy People