ECONOMIC DEVELOPMENT IN CHINA & EAST ASIA:

LESSONS FOR INDIA

Leslie YoungProfessor of Finance

Executive Director, Asia Pacific Institute of BusinessThe Chinese University of Hong Kong

Russia China India

GDP/head (US$) 2003 2730 1070 507

GDP/head (US$) 2001 2740 790 450

Average GDP Growth 90-99 (%) -6.1 11.6 6.0

Average Inflation 91-00 (%) 166.4 7.2 9.0

Literacy (%) 99.0 82.9 53.5

Female Life Expectancy 72.5 73.5 64.6

Male Life Expectancy 60.0 69.1 63.6

Births per 1000 8.5 14.3 23.7

Deaths per 1000 15.3 7.0 8.4

Pop Growth 95-00 (%) -0.36 0.90 1.69

Macro Comparisons

GeopoliticsIndia China

Afghanistan/Central Asia developed military skills but racially/ culturally distinct.

Repeated conquest only implanted temporary, distinct, extractive elite

Wei River Valley “land within the passes” developed military skills but not racially/ culturally distinct

Conquered Yellow River Valley

= Chou and Qin dynasties

Ganges Valley not large enough to dominate South. Some internal barriers but not enough for secure states

Yellow River Valley dominated South

Few internal barriers

Extension of culture by conquest.

Culture integrated population that remained stratified and diverse.

No political tradition of unified empire

Steady southward expansion of Chinese civilization, assimilation of racially similar populations

Homogenous population, cultural unity, political unity

Geography and Political NormsIndia China

Ganges Valley is world’s largest, deepest alluvium bed

Ganges has many tributaries, hence alternative sources of water.

River control important but not critical

Yellow River has no tributaries below Wei Valley.

Break in dikes causes massive disruption of irrigation systems

Dike maintenance metered corruption

Can support dense population with light management

Yellow River valley requires intensive management and organization to support dense population

Change of rule by external conquest. New rulers required no justification

Change of rule by internal revolt

New dynasty had to justify rule

Extractive elite Responsible authoritarians justifying rule by performance

= “Mandate of Heaven”

Spiritual FrameworkIndia China

Deep oral culture => Self as universe

Tolerant, inclusive, multifarious religion

Alphabetic culture => transcendental thought/religion

Tension between oral and written => Enlightenment

Logographic writing

Analogical/Immanental thought

Taoism => quietism, laissez faire

Confucianism => social ethics

Legalism => ruthless state control, rule by law

Philosophical/intellectual depth and creativity. Detached, introspective elite

No duty to provide practical leadership

Stable literary culture restricted creativity and change.

Duty to provide practical leadership

Concept of enlightenment exported to China via Buddhism

Interpreted Buddhist enlightenment as breakthrough to understanding structure immanent in world (Zen)

Japan used Chinese logographs to write agglutinative language.

Constant tension between transcendental and immanental attitudes. Welcomed Zen.

First non-western modernization. Unique institutional/organizational creativity

Institutional StructureIndia China

Distinct castes of priests and warriors

Brahmins monopolized ritual but validated rather than constrained power

No ideology unifying the culture area

No unified civil service

Viceroys broke away at first opportunity

Unitary elite class of scholar/ gentry/administrators open to recruitment from homogenous population by examination.

Principled critics of emperors

Viceroys circulated around empire to disrupt personal power bases

Indo-Aryan languages spoken by 65%

Many scripts

Putonghua spoken by 85%

Universal written language

Periodic attempts at unification never completely successful or long-lasting

Attempts to capture wealth of Deccan let in more invaders from North

Political unity the norm

Empire stable and secure when unified

Multiple regimes

Short-lived dynasties

Unified dynasties typically lasted about 350 years

Peripheral StatesIndia China

Exported culture to Ceylon, Southeast Asia

Exported culture to Korea, Japan, Taiwan, Vietnam

Indian emigrants successful in business but insufficient numbers to transform overseas economies

Massive 19th Century emigration to Southeast Asia

Overseas Chinese developed business skills and networks

Peripheral states failed to provide alternative models for India.

After WWII, peripheral East Asian economies dominated by Overseas Chinese followed Japan in export-led growth

Alternative Modernizations India West East Asia

Democracy integrates diverse peoples

Democracy legitimized redistribution of economic power

Authoritarians earn legitimacy by improving livelihoods

Bureaucracy of rent seekers

Rule of Law, politically manipulated by lobbies

Meritocratic civil service

Insulated from lobbies

Multi-generational lawsuits withdraws disputed property from use

Law of Contract

Objective enforcement and regulation

Business networks and extended family relationships substituted for contract

Regulators not independent

Import substitution

Black economy

Market driven economy Export led growth

Concept of laissez faire native to China from Taoism

Mainland ModernizationsIndia China

Colonial period reconfigured institutions, property rights

West introduced industrialization but affected only the Treaty Ports.

Assimilated Fabian Socialism at Liberation

Converted to Marxism by revolution

Stable democracy maintained modest growth.

Upheavals of Great Leap Forward and Cultural Revolution decimated Communist Party, led to crisis of legitimacy

No alternative models from “Overseas Indian economies” Mauritius too small

Success of Overseas Chinese economies challenged mainland

Some experimentation amongst states.

NRIs discouraged by bureaucracy from investment

Experiments in Special Economic Zones and coastal provinces relaxed bureaucracy

Overseas Chinese provided capital, entrepreneurship skills

Rent-seeking interest groups cripple economic efficiency. Bureaucrats impede growth

Growth leadership brings bureaucratic promotions and share in profits

Mainland ModernizationsIndia China

Polity divided by class, caste, language/region, religion

Homogenous population

Democracy gave each group a voice and a veto over policy changes

Authoritarian government divided into factions, but few differences in policy

Economic reforms often disrupted by unrelated events and agendas

Consensus forced by need to keep power that is not legitimized by democracy

Democratic leaders overloaded by problems of managing diverse coalitions

Leadership divided into political managers and economic managers but integrated at the top in Standing Committee and Politburo

Elections introduce unpredictable element into policy execution. Leads to foot dragging

Turnover of leaders managed by having top leader appoint the next leader but one.

Reputation for fairness and integrity a strong plus.

Reforming SocialismCapitalism with Russian Characteristics Socialism with Chinese Characteristics

No “Overseas Russians”

Overnight promulgation of “Anglo-Saxon” formal rules without supporting institutions.

Overnight formal democracy, collapse of Party leaves no-one to enforce laws.

Overseas Chinese provide entrepreneurship

Evolution from state to collective enterprises

Contract enforcement via tacit relationships (guanxi) and through conglomerates of political units.

Cross-holdings by political conglomerates control agency problems, limit free riding

Wholesale expropriation of state assets, transfer to offshore havens.

Financial and economic collapse.

Large-scale corruption, but basic order and political control maintained. Capital account kept closed.

Strong economic growth

Socialism with Chinese Characteristics

•Collective (township and village) enterprises.

•State owns land, natural resources, key industries and financial institutions

•State holds shares in many other industries and institutions. Blocks Russian-style expropriation of state assets.

•Entrepreneurship by Overseas Chinese and by investment trusts spun off by many centres of political power: local governments, ministries

•Extensive cross-holdings by central government, local government and collectives. Gives political leaders leverage over business performance.

•People’s Liberation Army owns Hong Kong taxi company and rents artillery for recreational shooting outside Guangzhou.

•All governmental units participate in growth and rewards through tax-sharing formulae that allow them to keep a share of revenue collected.

•Political competition within elite channeled into competition in economic performance

Socialism with Chinese Characteristics

State Legal Persons

A Shares Employees B Shares

Shanghai 34.2% 27.4% 28.5% 0.4% 6.3%

Shenzhen 27.7% 29.9% 34.5% 0.4% 6.0%

About one-third of the shares are owned by the State, by individuals (A Shares) and by legal persons. Employee and foreign (B share) ownership is insignificant.

Socialism with Chinese CharacteristicsCorporate performance improves with:

•Lower private ownership: private shareholders have little leverage

•Lower state ownership: state administrators concerned with welfare of workforce.

•Higher ownership by legal persons, i.e., institutions such as stock companies, securities firms, trust and investment companies, finance companies and mutual funds. Such legal persons have substantial representation on the corporation’s Board of Directors and Supervisory Committee and thus have substantial leverage over management. This leverage they exert to improve corporate performance and thus the payoffs to their own units.

CORPORATE GROUPS IN ASIA

Leslie YoungProfessor of Finance and Executive Director,

The Asia Pacific Institute of BusinessThe Chinese University of Hong Kong

Percent of Asian Companies that are Group Affiliated

0

10

20

30

40

50

60

70

80

90

Hong Kong Indonesia Japan Korea (South) Malaysia Philippines Singapore Taiwan Thailand All

Percent

Percent of Stock Market Capitalization Controlled By Top Families

0

10

20

30

40

50

60

70Percent

Top 1 Top 5 Top 10 Top 15

Hong Kong Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand

84%GDP

22% GDP

2%GDP

13%GDP

76%GDP

47% GDP

48%GDP 17%

GDP

39%GDP

Ownership Concentration and Indices of Institutional Development

Philippines

Thailand

Taiwan Malaysi

a

Indonesia

Korea

HongKongSingapor

e

Japan

0

2.5

5

7.5

10

0 10 20 30 40 50 60 70

Ownership by top 15 families (%)

Efficiency of judicial system Rule of law Absence of corruption

EXPROPRIATION, ASIAN STYLE

Japan Overseas Chinese China

Entrepreneurship Bureaucratic/ Managerial

Family Political units/ families

Stock markets Long-established Well established Recent

Objective of group organization

Managerial control Expropriation of minority shareholders

Theft of state assets

•Downside •Economic stagnation Asian Financial Crisis

Unstable banking system

Many Asian corporate groups are today organized to exploit low transparency and poor shareholder protection. The group structures and styles of expropriation depend on:

•The type of entrepreneurship that originally created the surplus to be expropriated

•The maturity of the stock markets

MITSUBISHI KEIRETSU

1. Core.

Mitsubishi Corporation (trading)

Mitsubishi Heavy Industries (manufacturing)

Mitsubishi Gingko (bank)

/Mitsubishi Trust and Banking/Tokyo Marine/Meiji Life

2. Kinyokai (Friday Club): 25-30 Main companies

3. Group Companies: several thousand

About 25% of Japanese derive livelihoods from Mitsubishi companies

MITSUBISHI KEIRETSU

Core companies: about 3% of equity held by other core companies

Kinyokai: about 30% of equity held by core and other kinyokai

Group companies: over 50% of equity held by keiretsu members

MITSUBISHI KEIRETSU

Suppose that companies 1,…, 100 each hold 1% of the equity of each of the others. How to take control of company 1?

Control all outside shares (1%) of company 1 and control the shares held by companies 2,3,4,5…,50.

But control of company 2 requires control of all its outside shares plus control of shares held by companies 1,3,4,5,..,50.

Thus to control company 1, must control all the outside shares of companies 1,2,..,50.

But even this might not be enough..

MITSUBISHI KEIRETSU

To take control need to attend 50 shareholders’ meetings. At each meeting, argue that you have control because you control all outside shares plus each of the other 49 companies. Why?

Because you control each of their outside shares plus each of the other companies. Why?

Because you control…. etc.

This argument is difficult to press home at any one meeting since it depends on winning the arguments at all the other meetings, which depend on winning the arguments at all the other meetings…..

What if all shareholder meetings are held on the same day?

What if shareholder meetings are held on different days?

… at each meeting hear the sound of one hand clapping….

EXPROPRIATION IN INDONESIA

Wijaja Family100% Forestry, wood

family business

100%

middle companies

65% 53% 68%

Asia Pulp & Paper (APP)

PT Sinar Mas Multiartha Tbk

Asia Food & Properties

96% 100%18%

28%

PT Purinusa Ekapersada

APP China Group Ltd

PT Bank International Indonesia Tbk ( BII )

PT Sinar Mas Agro Resources & Technology

Corp

20%

53% PT Indah Kiat Pulp & Paper Tbk.

Fuji Bank International Indonesia

63% PT Pabrik Kertas Tjiwi Kimia Tbk.

Other Fin. Institutions50 - 100%

98% PT Pindo Deli Pulp & Paper Mills

80%

PT Lontar Papyrus Pulp & Paper

20%

1) Placing of deposit in BII (on net basis)

2) Lending to Widjaja's related companies

3) Funds finally flow to Widjaja Family

Step 2

Step 1

Step 3

EXPROPRIATION IN THAILAND

Construction Company D

51%

51%

30%

Company B

Company C

Private company ofcontrolling family

Bank E

Foreign Bank Loan to constructioncompany secured bymortgage on over-valued land.

5%

Loan guarantee

5%

5%

51%

Land sold to Dat 10x value

51%

Company AManager fromcontrolling family

Figure 1: Ownership, Control and Group Affiliation

A

C

B

50%O&C

10%O&C

Ownership of company C = 50% * 10% = 5%Control of company C = Min(50%;10%) = 10%Ownership/Control = 5%/10% = 0.5

B is tightly affiliated to group controlled by A (i.e., at the 20% level)C is loosely affiliated to group controlled by A (i.e., at the 10% but not at the 20% level)

Example of expropriation:C buys asset from A overpriced by $10,000Gain by A = $ 10,000 * (1-Ownership of C)

=$9,500

Ownership and Control in Western Europe & East Asia

TABLE 1: OWNERSHIP AND CONTROL IN WESTERN EUROPE, EAST ASIA, CANADA AND USASource: “Dividends and Expropriation” Mara Faccio, Larry Lang and Leslie Young, American Economic Review, March 2001

20% cutoff 10% cutoff

Europe Asia Canada US Europe Asia Canada US

A: Percentage of corporations by controlling owner

No-one has > cutoff percentage of control rights 39.01 43.60 36.25 69.25 15.60 20.28 17.79 38.97

Family (has > cutoff percentage of control rights) 43.13 19.94 40.85 30.20 55.90 45.05 56.17 38.27

State 3.30 4.58 2.02 0.079 3.49 6.26 4.42 0.23

Widely-Held Financial Institution 10.12 4.94 11.07 5.16 19.64 17.80 17.81 19.94

Widely-Held Corporation 2.38 9.02 9.68 2.4 1.46 10.61 10.80 4.46

Misc. (Foreign-owned, reciprocal holdings) 2.06 0.00 4.92 1.28 3.91 0.00 10.79 3.02

B: Percentage of corporations with controlling owner that use control enhancements

Top manager from controlling shareholder'sfamily

68.12 57.10 15.98 4.98 66.04 54.55 71.43 66.78

No one else has > 10% of control rights. 54.69 67.80 54.91 62.26 62.60 77.33

C: Percentage of corporations by forms of control

Affiliated to group 46.30 48.48 49.24 63.93

Controlled via pyramiding 15.33 39.60 18.41 45.68 33.82 8.52

Controlled via cross-holding 6.01 10.12 6.27 11.02 8.18 1.15

Controlled via reciprocal holding 0.90 n.a. 0.69 n.a. 2.6 0.13

Table 2: Group sizes in Western Europe & East Asia

20% cutoff 10% cutoffEurope Asia Europe Asia Europe Asia

Range for groupsize n

gps Co.s gps Co.s gps Co.s gps Co.s Loosely-affiliatedcorporations

100< n 0 0 0 0 0 0 3 359 0 229

50 < n < 100 1 51 1 53 5 326 3 252 80 84

20 < n < 50 6 175 7 221 3 78 2 45 11 1

10 < n < 20 6 78 13 166 10 129 14 182 1 21

5 < n < 10 34 201 21 165 46 304 36 256 1 8

n<5 . 1020 . 657 . 785 . 570 4 59

Total group aff.Corporations

1525 1262 1622 1664 97 402

Total corporations 3294 2603 3294 2603

Conclusions• Higher dividends are paid by tightly-affiliated corporations • For corporations tightly affiliated to a group, dividends are

negatively related to the O/C ratio to offset investor anticipation of expropriation.

• For corporations loosely affiliated to a group, dividends are positively related to the O/C ratio; investors less alert to expropriation.

• Most loosely-affiliated corporations belong to a few large Asian groups.

• Dividends are higher in Europe than in Asia;• Multiple large owners imply higher dividends in Europe

(monitoring) but lower dividends in Asia (collusion). Why?• In Europe, other large owners help contain expropriation of

minority shareholders by monitoring the controlling shareholder. • In Asia, other large owners collude with the controlling

shareholder to expropriate minority shareholders.

In the smaller East Asian economies, private ownership of assets and stock markets have been long established: the structure of ownership and control permits the controlling family to exploit minority shareholders who have already contributed capital.

By contrast, the structure of company groups in China appears designed to exploit opportunities to expropriate the state during the transition to private ownership.

Since China’s companies have high state ownership, the controlling family does not need a pyramid to control a substantial portion of the shares available to the public.

Family company F buys D’s shares at a low price. D then invests in Companies A, B and C which are about to receive valuable state assets. When these investments are announced, D’s stock market price increases, benefiting the controlling family via its holdings through F.

Expropriation takes place, not through related-party transactions, but by exploiting insider information and manipulating the news reaching the market.

Public Company D

Family Company F

Company A

25%

80%

100%

Company B Company C

90%30%

Holds D’s Stocks

Lessons from China

•Cannot transplant policies requiring authoritarian regime based on homogenous population

•Precipitate privatization can result in massive theft of state assets via manipulation of stock market

•Attract NRI investment to zones cleared of bureaucracy.

•Offer bureaucrats high rewards for measurable improvements in efficiency and productivity

•Convert state agencies into profit centres, gradually spin off as companies

•Keep capital account closed but make foreign investment attractive and simple.

Opportunities for Collaboration

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