Review of 'China's Crony Capitalism'

Sometimes I think that my Master’s Degree in Foreign Policy is the perfect academic background for today’s compliance environment. When we look at our newsfeeds, events such as the Arab Spring, the recent political and societal changes in countries as diverse as Brazil and Saudi Arabia, are all strong reminders that we live in a very fluid world. But the responsibility to know how these dynamics interplay with business development and operations is everyone’s responsibility. Not only should front-line personnel be aware and sensitized to local developments in the regions where they work, but business and compliance leaders should also be kept abreast of such changes. With that in mind, and given the changes that have occurred in China in recent months, China’s Crony Capitalism by Minxin Pei, Professor of Government, Claremont McKenna College is a must-read.

If you have assets, sales teams and/or operations in China, this book is essential reading for any business leader, including support functions such as finance, audit, HR, and all the way up to the C-Suite and Board. The peril starts with a description of “collusive corruption,” where high-level public officials conspire with a complex set of lower-level subordinates, as well private businessmen with the “explicit purpose of reaping material gains,” and to reduce the “risks of detection.” As the author well shares, to reap those benefits, it takes a “ring” of party and administrative officials, all in agreement, as “to overcome a mutual veto” which each state actor might retain, and which can disrupt corrupt networks and transactions.

In China, the corrupt ecosystem starts with the sale of public offices, where even someone in a modest position of power, with the purchase of a public “seat,” can generate “considerable corruption income” by extracting bribes from “subordinates and private businessmen.” As to the purchase price, that is “determined by the value of local state-owned assets or the government contracts that these officials could help private businessmen obtain.” In this political economy, as Pei describes, “bribes, instead of merit” are how positions of power are delegated, where “party secretaries enjoy an effective monopoly” over political and personnel decisions. But even the income derived from the selling of offices is nothing compared to the income streams generated “from collusion with private entrepreneurs.” And that’s the worrisome part for compliance and commercial leaders.

Pei reminds us that in China, the state retains control of property, resources, and infrastructure, which creates enormous incentives for these “colluding” networks of party and administrative officials to demand bribes where they have influence over the use and contracting of those assets. And as far as detection is concerned, we see countervailing forces, where President Xi appears to be shoring up anti-corruption resources, but where lower level and regional officials, even among “the CCP hierarchy…have a self-interest in quashing an investigation because they know that it could uncover their own misdeeds.” And where does this malfeasance take place? According to research shared by Pei, it falls into four general areas: 1) government procurement and construction 2) land, real estate, and urban planning, 3) finance, investment, loans, allocation, and payment of funds, and 4) administration of commerce, enterprise management, and restructuring of enterprise ownership. I ask, is anything remaining?

If you have assets, sales teams and/or operations in China, this book is essential reading for any business leader, including support functions such as finance, audit, HR, and all the way up to the C-Suite and Board.

And this web of what Pei calls “vertical collusion” is absolutely vexing, where the local party chiefs provide the “critical coordination function,” whereby corrupt payments to lower party officials are “bundled” by those higher-level functionaries. It’s much different than what I experienced in, let’s say, some South American countries, where bribes needed to be paid up and down the bureaucratic org chart, between winning a contract and getting paid for it. In Pei’s description, the “Chief Bribe Taker,” takes care of even the petty bribes that we often see during the final stages of a sales cycle, e.g., customs, inspections, duties and taxes. As we have seen in other parts of the world, “the power to grant licenses can easily be converted into means of extracting bribes.”

And where does all this risk originate? Here’s the troublesome part from a compliance perspective, where Pei describes “invitations to dinners at high-end restaurants, visits to foot-massage solons, and the presentation of small gifts and tokens of appreciation by private businessmen to officials they hope to befriend.” He describes small, incremental steps which move bribe takers and givers from “opening the door” over a dinner, to the final steps, where a bribe is exchanged, as “solidifying the relationship.” From a compliance perspective, the challenge becomes how to address those first steps, perhaps seen as ‘innocent’ and part of local custom, in a way to safeguard that they don’t move down the path that Pei describes. Also, when those final stages are at hand, the actual cash, transfer, or gift, might not even be to the public official, but to a spouse (or mistress), sibling or child, all of whom may have established private businesses to “benefit significantly” from the power of their relative.

If we think that current anti-corruption efforts in China might be a panacea to this peril, Pei takes a very skeptical view, where he shares that current anti-corruption tactics “are useless in eradicating systemic causes of the collusion in China,” due to the “patron-client relationship that underpins the hierarchy of the CCP.” Worse, in Pei’s view, on the local level, “corrupt party chiefs, mayors, police chiefs, and their business allies have turned their jurisdictions into virtual local mafia states.”

In conclusion, Pei shares that “beneath the unsightly surface of corruption hides a story of the looting of nominal state-owned property by elites who either have direct control over the disposal of such property or can seize such property through bribery or violence,” adding that until that political control of state owned assets is changed, public officials will have inbuilt “opportunities to convert the riches of the state into their personal wealth.” This “crony capitalism,” as Pei calls it, is the “only logical and inevitable” outcome of the current state, and we don’t see that changing in Xi’s recent consolidation of power. One could argue, it’s only exacerbated, where “elites in control of unconstrained power cannot resist using it to loot the wealth generated by economic growth.” Even the NSC, the anti-corruption watchdog, as Gilholm shares, “is a key tool in Xi’s fight against disloyalty and suspect ideological leanings, and even as a means to enforce policy,” as opposed to a laser-focused instrument against systemic and endemic corruption.

Furthermore, given this book’s publication in 2016, Pei unnervingly predicts current events when he shares how the disunity of elites and struggle for power creates the opportunity for a “strongman who can vanquish his political opponents through tactics disguised as anticorruption efforts.” For those in compliance who might look at China’s recently amended anti-corruption laws and the newly created NSC as ushering in a period of transparency and lowering the temperature on corruption risk, these authors all seem to advocate sustained caution and concern.

As Pei, Gilholm, and others have argued and demonstrated, as long as anti-corruption enforcement in China remains a political tool, as opposed to a function of an independent and accountable judiciary, not subject to manipulation, you don’t want to find yourself on the sharp end of an enforcement action, by being taken to a place and/or scenario where you don’t want to go. This isn’t quid-pro-quo petty corruption; as Pei describes it, these are highly sophisticated networks of party and state officials, intertwined with family and friends as intermediaries, all looking for relationships with those in a position to “pay to play” for the opportunity to participate in China’s emerging and attractive markets. So, the question remains, are these risks baked into your business plans, and are front-line employees sensitized and aware of these significant changes, coupled with the traditional risks, in China’s political, social and economic environment?