As growth in the United States slows and many European countries head into negative territory, the eyes of the world's investors are on the next big shoe to drop: Will China, the recent engine of the global economy, fulfill its role of Great Eastern Hope by saving the world from another sharp recession? Given its track record, this concern might seem overdone: Commentators generally agree that China's economy will continue to grow between 5 and 8 percent a year, far higher than all other major economies. China's leaders, however, view the decline as a source of great concern -- China's economic growth dropped to 7.6 percent year-on-year in the second quarter, its slowest rate in three years. Their claim to authority has been built on delivering double-digit growth rates that have transformed China into a global economic power; without such growth they see a threat to their "Mandate of Heaven."
Many analysts both inside China and out see this slowdown continuing and argue that China's development model should shift away from its heavy emphasis on investment and exports to one based more on domestic consumption. Over the past three years China splurged on a decade's worth of infrastructure projects; the country won't need any more roads, airports, trains and bridges for a long time. So as global demand for China's exports slows and such investment projects are finished, the best hope for continued growth is stimulating the Chinese consumer. The poor performance of the country's stock markets supports such an argument, suggesting why a new development direction is needed and also shedding light on some of the difficulties such a transition would face.
Since 1992, the MSCI China Index, the most broadly referenced indicator of Chinese market performance, is down over 40 percent, while the Shanghai Composite Index has risen only a meager 180 percent. During the same period, China's GDP has rocketed 1,700 percent. This suggests that China's listed companies have not been significant drivers of the country's fantastic growth, and that the capital they have received from investors -- some $950 billion from the Hong Kong and domestic markets over the last 20 years -- has been seriously misallocated.
The underperformance of China's listed companies is a direct consequence of Beijing's deliberately awkward adaptation of Western-style stock markets to a command-type economy. Despite the country's increasingly first-rate infrastructure and all the other trappings (bankers, investors, regulators, scandals) of development, China's markets only superficially resemble markets elsewhere. A market is where the ownership of a commodity or service is exchanged, not just where securities can be traded on a daily basis. Chinese stock markets do the latter extremely well, but have nothing to do with the exchange of ownership. At a fundamental level, China's markets do not price companies and their businesses because its listed companies are not for sale, and never have been. As Liu Hongru, the first head of the securities regulator and the godfather of China's markets, said in 1992, "The shareholding system is not privatization."
Beijing created its stock markets in the early 1990s because of concern with the poor performance of its state-owned enterprises (SOEs). During the 1980s, private enterprise growth far exceeded that of the SOEs. The government became convinced that adopting the Western capital markets model -- diversifying ownership, creating clear corporate structures, and establishing professional legal and audit industries and strong market regulators -- would improve SOE management and help them become more competitive both domestically and internationally.
What happened instead was that Beijing excluded non-state companies from the markets and required that absolute ownership control (at least 51 percent) of SOEs remain firmly in the state's hands. As a result, the stock markets have always been the near-exclusive preserve of the state and its own enterprises (the very recent opening in 2009 of the Shenzhen Exchange to private enterprises notwithstanding). This means that only a minority of a company's shares trade. The negative repercussions of this arrangement have reverberated far beyond the markets themselves.