Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise

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Carl E. Walter & Fraser J. T. Howie (2011). Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise

Red Capitalism


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Named Book of the Year by The Economist, Carl E. Walter and Fraser J. T. Howie’s Red Capitalism is a refreshing and compelling reading from two Asian banking experts who have been living and working in China for 25 years. And what they have to say will tear up all your old (mis)conceptions about Chinese economy. Written in 2010, Red Capitalism does not offer any groundbreaking prophecies for the future but, rather, what it offers is a delightful description of the way the Chinese Communist Party manages and controls its ill-fated economy. The June 2015 crisis, however, is absolutely coherent with the picture offered by these authors.

As we can read in the preface to the new revised edition,

“the current Chinese system does not allow for market pricing of capital, requires almost continuous injections of capital into banks, and has created an oligarchic and still uncompetitive state-owned corporate sector despite 30 years of reform efforts.”

Because as for 2010, China’s banking system has been bankrupt for 10 years –if not more.

There are two important methodological issues that make this book worth reading. Firstly, it rejects the “GDP Myth” and the validity of economic claims based on GDP performance. As the authors explain in their preface, when the Qing Dynasty collapsed in 1912 their GDP was US$241 billion, larger than those of the European empires of Germany and England and, at the time Japan invaded China in the 1930s, China’s GDP surpassed the Empire of the Rising Sun. “In short, the size of a country’s GDP says little about a country’s economic competitiveness, its overall power as a nation, or the well-being of its population.” In fact, China did quite well even during the Cultural Revolution in terms of GDP growth and, if we listen to official sources, even the Treasury had a surplus of one billion yuan. As many scholars have pointed out, however, “China’s growth was written to suit the Party.”

Which leads us to the second point I always like to mention: the Great Development Myth of 1978 and the impact the post-Tian’anmen reforms had in Chinese economy, which are reflected in the “trends in regulation graphic” below and in the interpreted data collected in the book


Many critics –we got them at every side of the ideological landscape– will concur with the idea that China must have been doing something good since it was not affected by the international crisis that hit the rest of the world –leaving aside the delirious and ludicrous declarations of Mr. Xi Jinping in Mexico before he became Mr. President of China–. Rather than being the result of Chinese exceptionalism, as state-sponsored nationalism claims every now and then, Chinese healthy economy in the dark days of Western capitalism is the result of it being walled up from international capital markets, having little, if not zero, exposure to the dangers and benefits of free market. This includes non-convertible currency, minimal foreign participation or few overseas assets. This is, according to the authors, the real reason behind the apparent health of the Chinese banking system, but it is also its greater weakness –as the recent collapse of the Chinese stock markets and the devaluation of its currency show.

Likewise, China only looks rich in a few strategic points –its mist-hidden capital Beijing in the North, movie sci-fi landscaped Shanghai in the center, and the Pearl River Delta city of Guangzhou (or Canton), which is important because of its strategic position for international trade and its proximity to the Special Economic Zone of Shenzhen and the Special Administrative Region of Hong Kong. As it has been pointed out before, successful enterprises in China are either joint-ventures or Hong Kong based FIEs (Foreign Investment Enterprises), such as Huawei or Lenovo. Foreign exchange reserves, the manipulation of its currency, violation of copyright laws –which saves China a lot of money on R&D–, and the centralization of its economy on politically relevant cities such as Shanghai –after the Tian’anmen interlude– and Beijing –capital of the Party’s Empire– are all important reasons behind China’s success, but we should not forget that this is only the success of a few cities at the expense of the rest. Although China may look capitalist for many foreigner observers, it remains a highly intervened economy intrinsically “Soviet” behind its Red Curtain.

For instance, in a capitalist system the market regulates and “decides” the risks, whereas in China risks are determined according to the Party’s elite judgment. Chinese banks exist for the only purpose of providing “unlimited capital to the cherished state-owned enterprises” (p. 25) which, honestly, do not produce too much at the end of the day. Indeed, many foreigners working in China complain that their Chinese middle class co-workers are rather unproductive –in contrast with overseas Chinese–, wasting too much time with increasingly complex and useless protocol excused on Chinese uniqueness and, thus, having to work more hours in order to achieve normal production rates (a well-known example is the “wine culture” invented in the late 1990s, at odds with the Confucian tradition China boasts about all the time).

But, as the authors rightfully remind us, there have been an extraordinary amount of positive changes in China since the end of the Cultural Revolution or the Tian’anmen interlude. These changes, however, are not a trend but the result of a shift from radical Maoist Communism to “Casolism” (Capitalism-based Socialism, or Red Capitalism) that will lead inevitably to stagnation. Right now China is a three-layered social system: at the top we have the centralized elite of the CCP; then, we have an accommodated middle class concentrated in the littoral zone and a number of important urban areas. Some of them are rich, and not only by Chinese standards, but their life style is closer to a Western pimp from a very bad Hollywood movie –bragging about the money they have but not being able to use it to improve their situation, they may have an expensive, luxurious car and a cheap, broken house.

This middle class survives because it does not challenge the government. And why should they? After all, they may have no access to Facebook or Youtube but they are far better than the third layer: the peasants, low-income workers and other dirty “private entrepreneurs” who offer the most basic services in China. Some of them are construction workers who only get paid at the end of the year, and there are many reasons a company may “avoid” to pay them for endless hours of work after such a long time. But they are also the smartest people in China because, without any former education –or brain-washing–, they are aware of what is going on behind that Red Curtain of 100 yuan bills with Mao’s smiling face on it.

During my last week in China I bump into one of the brightest minds I have ever met in China: a taxi driver. Forget about university teachers, brilliant students, financial analysts or any other guru. If you wanna know what’s going on, ask the taxi driver. This was a guy from Hebei who had lost his house (private property until the State decides to increase China’s GDP in your backyard) and had to come to Tianjin to make a living. He did not only complain about human rights, lack of freedom, censorship, the Sentaku Islands and every president from Mao to Xi Jinping, but he went as far as to say that even in North Korea the government provides you with free housing instead of demolishing it. And he has a point. At the end his taxi broke down in the middle of the highway and I left joking about it being the result of his criticism of the CCP.

The big problem China will have to solve in the coming years –one of many– is the stagnation of this giant Keynesian machine of byzantine and Orwellian machinations. The Chinese economy is like a giant with feet of clay standing on the top of a house of marked cards and, for the most part, the giant is playing against himself to avoid money flowing out into foreign hands. It is not a threat to the world, but to itself and, especially, to the Chinese people who will suffer its consequences.

As The Economist puts it, “anyone who is overly impressed with the apparent resilience of China today would do well to read” this book.

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