(This essay was published in Hong Kong Economic Journal on 18 February 2015.)

 

Public corruption can be defined as the capturing of economic benefits through the exercise of political influence by those in public office. China has waged a campaign against public corruption for the past two years and there is no sign of abatement. When it began, many speculated that it might be merely a cover for a power struggle and therefore short-lived. Increasingly, the campaign appears to be a means of forging a new social contract for the post-Deng era.

 

The old social contract forged by Deng Xiaoping traded market-driven economic growth for political stability. The rapid growth that followed enabled the government to acquire sufficient political legitimacy to preserve social stability. Some individuals and families amassed huge fortunes in the process. Many were private entrepreneurs whose gains were made through fair market competition, but others were public officials who had captured economic benefits through the exercise of political influence. The public has become incensed at this rise in public corruption.

 

For over two thousand years, the traditional Chinese economy was quite corrupt even though it failed to grow. Some have gone so far as to allege that corruption may even be inherent to Chinese culture. But the public corruption that existed in traditional China is, I believe, fundamentally different in nature from the public corruption that has appeared in a modernizing China.

 

Traditional China had an agrarian economy. Its defining characteristic was a large collection of nearly autarkic local economies – geographically-dispersed village communities founded upon kinship relations.

 

In 221 BC, at the end of the Warring States Period, China became a unified, centralized, bureaucratic imperial state and the landed aristocracy progressively lost political power in the ensuing centuries. It was an incredible political achievement matched only by Rome, whose subsequent collapse ended the future of a unified Europe.

 

The autarkic nature of village economies meant that the centralized state became the only glue to hold together a nation of diffuse village communities. Local agrarian economies did not have to be economically integrated to survive and they were not interdependent within China’s vast geographic space. This condition continued to prevail among the vast majority of China’s rural population up until Deng’s reforms, which brought hundreds of millions out of economically-isolated local village communities into urban centers.

 

The state ruled through an imperial bureaucracy that was based on merit, but was expensive and difficult to operate. At the minimum, the state had to defend the territory, administer justice, and fund the expenses of the bureaucracy. Tax collection required the onerous tasks of conducting population and land censuses and transporting in-kind revenue to administration centers.

 

Managing a bureaucracy entails recruiting officials, monitoring their integrity in the administration of justice, and preventing them from stealing from the state and plotting against the emperor. Large efforts are required to ensure their loyalty and keep them from becoming too entrenched in their local communities.

 

The European administration model relied on an unpaid feudal aristocracy. This is less expensive and easier to operate than the Chinese model. But what the European model achieved in terms of savings was sacrificed in terms of control. Decentralized European feudal lords ruled over semi-autonomous domains, often warring among themselves, and were seldom loyal to the king. The feudal aristocracy eventually became hereditary and some fiefdoms evolved into independent states. The Chinese model, on the other hand, kept the nation unified despite dynastic changes.

 

In traditional China, a local government official who accepted moneys and favors would naturally be regarded as corrupted because he was an employee of the state. In feudal Europe, a lord who accepted moneys and favors would not be so considered, as he was not an employee of the state, but the master of his own domain.

 

It is reasonable to conjecture that a traditional agrarian economy could barely produce enough economic surplus to support the Chinese administration system. Throughout traditional China, government officials were chronically underpaid, at least in comparison with the power they wielded. Public corruption became a normal practice for them to supplement their incomes. Embezzling and extorting large sums were still considered criminal activities, however, petty public corruption was accepted as a common cultural practice.

 

Inculcating public virtues in the training of officials became state policy to combat public corruption, using the official ideological weapon of upholding Confucian ethics. Unfortunately, the Confucian emphasis on familial piety hampered the effectiveness of this approach. The dark drive to embezzle and extort was ultimately tied to love and concern for the welfare of one’s family and kinsmen.

 

The conflicting requirements of piety towards the family and loyalty to the state pitched the interests of the state against the family. Family interest still is at the center of most cases of public corruption in China today.

 

In a modern economy, funding a centralized bureaucracy is easier because the economic surplus is much larger. Public corruption, however, can actually worsen because there are far more opportunities, including highly lucrative ones, for officials to sink their teeth into.

 

Public corruption typically worsens in three circumstances. First, if a larger share of the economy is under state ownership, there is greater opportunity for officials to siphon off public resources into private pockets. Second, if a larger share of economic activities is regulated by the state, there is greater opportunity for officials to abuse their public authority for private gain.

 

The implication of these two circumstances is that large intrusive governments tend to increase the scope and opportunities for public corruption. Economists have long argued that public corruption is curtailed when governments are small and limited. Strengthening free competitive markets diminishes the opportunities for public corruption.

 

A third aggravating circumstance is that in the process of economic modernization, old economic sectors will decline and new sectors will emerge. There will be many opportunities for public corruption as government officials act to hinder or facilitate this process through public policies that tax, subsidize and regulate various activities.

 

For example, policies that protect sunset industries from declining in order to save companies and jobs, or prevent sunrise industries from competing with old industries, become opportunities for public officials and politicians to extract tangible private economic benefits for themselves in the name of some public cause. Public corruption under such circumstances unfortunately hurts economic modernization by halting or delaying the adjustment process of “creative destruction”.

 

It is of course possible for public officials and politicians to promote sunrise industries and facilitate the demise of sunset industries, and still have public corruption be present. Interestingly, under such circumstances economic modernization is promoted by corruption. While this has occurred on occasion, the opposite is more frequently found. The main reason is that future beneficiaries are less likely to be a well-organized lobbying group compared with the present victims; creative forces are clearly less powerful than destructive ones.

 

Deng Xiaoping’s reform agenda was challenging because he had to convince those who would only become potential future beneficiaries – the people – to accept his proposition. It was a proposition with considerable uncertainty. For this reason, Deng’s success is an unusual one in the history of economic modernization.

 

Deng’s reforms unleashed the creative energies of the Chinese people as markets were being reinstituted. The economy soared at breakneck pace to achieve the greatest economic miracle since the Industrial Revolution. But the mixture of economic markets and the grabbing hand of government officials in almost all walks of economic life created unprecedented opportunities for public corruption.

 

The winners of the Deng reform era who occupied public office have, after 30 years, begun to metamorphose into a force that resists further reforms. Their interests have increasingly become entrenched into a new status quo. Xi’s campaign against public corruption threatens to shake up large segments of the establishment. This will be an enormous political challenge because their interests appear to be deep and interwoven.

 

Building up Xi’s personal authority may be a necessary and inevitable development to enable him to push his campaign forward. There is much speculation about whether concentrating the authority in a top leader will lower the incentive to reform markets further at a subsequent stage. Rationally, the leadership in China understands this danger.

 

Without further reforms to reduce the government’s role in the economy and expand the role of the market, the campaign to root out public corruption will only produce a one-shot effect. The grabbing hand of public officials will return sooner or later. The successes of industrial economies have always been sustained by allowing markets to grow, which has simultaneously promoted economic modernization and limited public corruption.

 

A market economy integrates the nation within a seamless economic network. This alleviates the political need to keep the country united through only centralized state control. The local village communities in a traditional agrarian economy are by nature autarkic. They cannot nurture the centripetal integrating tendencies that help foster the need for national unity through economic interdependence.

 

Experience has shown modern economies are necessarily market driven. They produce enough economic surplus to do away with the need for petty corruption in the public sphere. The campaign to root out public corruption in China will pave the way for long-term economic modernization if it leads to a leaner bureaucracy and a more limited and inclusive state.

 

Traditional China with its Confucian ideology also favored a limited and inclusive state. It extolled its rulers to exercise self-discipline and avoid interfering with and intruding into the social and economic activities of the local village communities excessively. But its emphasis on familial piety fomented corruption in public life, which became a weakness of its virtues-based ethics. This also contravened the state’s need for justice to be applied to all equally before the law.

 

An efficient competitive modern market economy also requires a level playing field to be applied to all equally. This is the rule of law in economics. Conceptually, this provides a strong complement to the state’s need to be rid of public corruption in order to uphold the law. China’s drive towards economic and political modernity may also be helped by the coming of a new generation that is no longer connected by local kinship ties due to urbanization and the unintended consequences of the “one-child” policy.

 

Xi’s political legacy, like Deng’s economic one, will be enormous if it leaves sufficient room for markets to grow and the bureaucracy to become lean.

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