WASHINGTON, Nov. 15 (UPI) -- China is passing the torch from Jiang Zemin, the outgoing head of the Communist Party, to Hu Jintao, the new head of the party's powerful Standing Committee and thus, the de facto head of state.
Investors, naturally, are asking whether, under Hu's emerging leadership -- which will take some years to consolidate -- China will continue to evolve towards what is widely regarded as a market economy, muddle along, or even reverse course.
On the surface, there are some good trends. Hu is by no means a prominent liberalizer; he came to power, largely like Jiang before him, by being discreet.
He was party secretary in Tibet for several years, including during the March 1989 crackdown, which was certainly ordered by Beijing but which Hu carried out. On the other hand, Hu was recommended as a natural successor to Jiang by Deng Xiaoping, the father of China's capitalist opening.
Hu probably is not far from than the mindset of the current leadership, which is to favor continued "market" opening and especially tolerance of economic elites. It also includes a strong arm against dissent from labor, religious, intellectual, or other groups -- about which, more below.
In recent weeks, China also has moved to extend laws allowing individuals (to some extent) to buy and sell property, permitting expanded ownership of companies by foreigners, and incorporated entrepreneurs and as bona fide members of society under the constitution.
Under the new regime, capitalists will be accepted as members of the Chinese Communist Party.
Then again, investors and merchants have been fascinated with China for centuries. In the late 1800s, a British banker, reporting to his home office, gushed: "It is not a question of immediate gains, of which there are few or none, but of the near certainty of returns to be had from investment in this nation, of such vast potential, not beginning for some years, but then extending over many years."
More than 125 years later, it is still "not a question," for most Westerners of immediate gains but of potential -- for a payoff that may take "some years" indeed.
In recent years, China has defaulted on a bond payment to Shearson-Lehman, attempted to deny McDonald's Corp. leasing rights in Beijing, censored Web companies such as Yahoo and AOL, pulled the plug on an initial public offering with Morgan Stanley when it didn't like the price of its unattractive shares, and, of course, emerged as a leading pirate of computer software, music, aerospace, pharmaceutical and other intellectual property.
In short, while Chinese capitalism appears to be making a lot of money for some Chinese, it is not clear if it is doing so for many of China's investors.
The Chinese economic story, from the top down, is well known. By allowing state-owned firms to operate in the 1980s and 1990s, and allowing some transition to more truly private firms, China has grown at an annual pace of 8 percent to 12 percent for two decades, nearly doubling the growth of even India over the period.
The country has cheap wages, a naturally mercantilistic people, and a huge population -- hence a huge potential market, if the vast majority of the people ever become significant consumers.
China's stock market even appeared to weather the Asia crisis of the late 1990s, although, as some analysts predicted at the time, there was a delayed reaction. Chinese shares have declined more than 50 percent from their peak some five years ago, despite the country's entry into the World Trade Organization and the relatively successful takeover of Hong Kong.
Perhaps one gains a better understanding of the Chinese economy, then, viewing it from the bottom up.
Over a decade in which the Chinese economy grew by a factor of 7 percent or 8 percent, wages in manufacturing haven't yet doubled and income to farmers, miners, and most other sectors of the economy trail even that.
Incidents of worker unrest aimed at party officials doubled between 1992 and 1997, and doubled again between 1997 and 2002, according to a survey of Chinese and Western press reports and an internal Chinese government report this spring.
The point is not that "capitalism" has been bad for workers, but rather, as Richard McGregor and James Kynge have pointed out recently in the Financial Times, that most of China's billion-plus people don't have capitalism. The system, as the FT argues, more closely resembles the one-party rule of the Philippines circa 1984, or Mexico in 1994 -- a "crony capitalism" in which the state is, in fact, heavily involved in dispensing favors to the well-heeled and denying them to the masses.
Peasant farmers, for example, may "buy" land, at least for a period of 25 to 70 years, but may not, as a practical matter, sell it for a profit. Individual home-"owners" in Beijing and Shanghai often find themselves ejected without compensation.
Would-be startups find that getting a permit to do business is easy for large enterprises that can rationalize the cost of paying fees and options -- in effect, bribes -- to party officials. It is difficult to impossible for a small entrepreneur.
The mining sector continues to be troubled by repeated deaths, reflecting a relatively low level of interest in worker safety. As a result, miners are increasingly militant. Their militancy has not yet spread to the manufacturing sector, but it might.
The banking sector has grown rapidly but is now troubled by Japanese levels of bad debt. China's rural credit cooperatives supply between 70 percent and 80 percent of capital to peasant and township businesses. Their non-performing loan rate is also estimated at about 50 percent.
Meanwhile, the tax burden is large, growing and selectively applied -- as with permits, property and legal disputes, larger enterprises and wealthy individuals (often government officials) may evade taxation altogether, while peasants and factory workers pay effective tax rates of 30 percent to 60 percent in the form of various deductions from their paychecks or in-kind payments to their local collective.
Farmers suffered actual income declines in 1998, 1999, 2000 and 2001 -- and that was before taxes.
All these statistics, of course, are from semi-official sources or based on estimates compiled from them.
It may be, as German banks found of their investments in Russia in the 1980s and 1990s, that the reality is worse.
An interesting factor to add to all this is China's demographic situation. Thanks to its one-child policy of the past four decades, China has one of the oldest populations in the world, and it is growing more so.
This will put a great strain on pension and social welfare services for the elderly in the coming years. The burden on young workers will grow, and put pressure on bank deposits and stock prices to fall. Aging countries, as the work of economist John Mueller has demonstrated, tend quite understandably to want to sell stocks and other assets to support themselves in their years as non-workers.
These considerations illustrate the dilemmas that face Hu and will intensify in the future. He can lower the tax and regulatory burden, but will then face difficulty caring for a half a billion pensioners. He can urge Western and Chinese firms to raise wages, but this lessens one of China's main competitive advantages.
He can pressure local and federal party officials to allow smaller firms to flourish, and to apply market rules fairly -- but this will alienate them and weaken his base in the ruling party.
He might even choose to allow other competing political parties and a free press, to do the job for him, but this approach seems to have little attraction for the current leadership.
It's a good bet that China's corruption will be cleaned up, and when it is, it will be a very good time to buy Chinese stocks and bonds. For now, the bottom line is, you don't want to be invested in the country when this happens, any more than you want to own shares of Enron, United Airlines or Worldcom before the inevitable house-cleaning.
In the meantime, such companies as China Mobile (CHL on the New York exchange) and the China Fund (CHN) are attractive shorts. So is China Aluminum and other exposure in the mining sector, though these shares are less liquid.
An investor who managed the Sears pension fund once recalled a young securities salesman assuring him that a particular company would be making a profit in four or five years -- "a great investment," he said, in the long run.
"Well then," the pension manager said, "in the short run, I'll put my money somewhere else. But give me a call in the long run."
That logic probably applies to China today.
(Gregory Fossedal is chief investment officer of the Democratic Century Fund in Washington and chairman of the Alexis de Tocqueville Institution, a public-interest research foundation. Fossedal or his fund may hold positions in some of the securities mentioned. No decision to buy or sell securities should be made on the basis of this feature, nor without consultation with an investment professional.)