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China After Deng (Int'l Edition)


Business Week International Cover Story

CHINA AFTER DENG (int'l edition)

For each of the past seven years, Deng Xiaoping has headed for the Xi Jiao Guest House in Shanghai to celebrate the lunar New Year and enjoy the coastal city's milder weather. This year, the 90-year-old leader is breaking with tradition. Even though Shanghai is experiencing its warmest winter on record, Deng remains in Beijing so hobbled by health problems, including kidney failure, that many wonder whether his doctors will be able to keep him alive for long. "The situation is deteriorating by the week," says one well-connected Chinese economist.

Whenever it comes, Deng's long-awaited departure will create a huge void in a political system where he has called the shots from behind the scenes for years. A power struggle is already quietly under way as various factions jockey for control. At first, the leadership is likely to present a unified front, and it could take anywhere from six months to several years for Deng's true successor to emerge. None of the contenders wants to spark political instability in a country experiencing massive economic change. "Stability, both politically and economically, is a main concern for them," says Shan Li, international economist for Goldman, Sachs & Co. in Hong Kong.

Preserving stability will have steep economic costs, however. While Deng carried out many daring reforms that led to explosive growth, he didn't address some of China's deepest problems. The political structure is archaic and dominated by often corrupt Communist Party hacks. Large and inefficient state-run companies, relics of the old Maoist days, still dominate nearly half of the economy and hog an estimated 40% of the central government's resources. With no safety net to provide for displaced workers, Beijing dares not press ahead with a wave of privatizations or bankruptcies. That leaves Beijing no choice but to force its near-bankrupt banks to keep credit flowing to state factories, though inflation hit 25% last year.

As a result, the new central leaders will face a tough choice: either to allow high inflation or high unemployment. A report by the Shanghai Municipal Research Center claims that slowing the growth rate from last year's 12% to around 8% would result in layoffs or bankruptcy at a quarter of China's 200,000 state enterprises. Since few leaders want to be blamed for an economic bust, analysts say Beijing apparently has opted to stay on the high-growth track.

UPROOTED. That means politically risky moves, such as reforming state enterprise and lifting commodity price supports, are likely to be put on hold (table). "There has been a degree of policy paralysis," says Geoff Lewis, Hong Kong-based economist for Smith New Court Far East Ltd., who thinks China will way overshoot its 1995 targets of 13% inflation and 8% growth. If inflation spirals out of control, it could spark instability among China's downtrodden, particularly among the 100 million uprooted peasants without jobs. And high inflation would raise concerns among foreign investors.

Fiscal restraint also will suffer as Beijing is likely to buy the support of the poor by handing out more subsidies. To compensate for a 50% rise in food prices last year, some provincial capitals have begun issuing citizens coupons that offer discounts on basic commodities such as grain. As a result, Beijing's fiscal deficit is expected to be about twice the official target of $7.8 billion. At the same time, China will be slow to make the needed compromises on market opening to get into the World Trade Organization because state enterprises are in no position to compete with multinationals.

The disparity between China's wealthy provinces and their poor inland cousins also could worsen. But it's unlikely Beijing will move to regain much of the financial latitude given to the coastal provinces under Deng because that would disrupt growth. Guangdong province already manages with little input from Beijing. Last year, Guangdong's economy expanded a sizzling 18% while exports soared by 70%, accounting for some 40% of China's exports, compared with 28% in 1993.

In fact, the forces ef decentralization are likely to accelerate in the post-Deng era. Some scholars, such as David S.G. Goodman at the University of Technology in Sydney, believe China is headed for an "informal federal" structure in which Beijing deals with the provinces on a flexible basis but cannot impose direct edicts on them. "Power has to be shared in many different ways," he says. "China is no longer the state that Mao ruled over."

One implication of that is that China's Open Door to the outside world almost certainly will remain open. Almost no one in China wants to close off the country and return to the old isolationist economy championed by Mao Zedong. In one of his most important legacies, Deng managed to root out almost all hard-line Communists from positions of power over the past 16 years. Virtually all major factions, from local party bureaucrats to the military, voice support for reform.

For foreign business executives, the coming months will be dicey. In a country where guanxi, or connections, count most, the uncertain succession makes it unclear which companies have guanxi that matter. One obvious victim is the power sector. Big-ticket deals cut with local leaders can unravel if they're not vetted by the proper authorities in Beijing--but figuring out who the right people are is difficult. For months, big deals involving companies such as General Electric Co. and Wing Group have been delayed in part by the long Deng deathwatch.

RIGHTS TENSIONS. The good news is that Beijing's worries about keeping the lid on domestic problems will prompt China's leaders to maintain good relations with the outside world. There are signs that Beijing is moving toward resolving a dispute with the Clinton Administration over the issue of intellectual-property piracy. The Administration has issued a Feb. 4 deadline for the Chinese to crack down on pirates who rip off U.S. products--or face stiff trade sanctions. Although no Chinese leader wants to be seen capitulating to the U.S., the last thing Beijing wants now is a full-fledged trade war with the U.S.

Tensions could flare up, though, over human rights violations. A jittery leadership is certain to continue its clampdown on dissent. With key members of the Republican Congress pressing for a tougher stance on China, relations between the two nations could be in for a rough ride. The next tussle could happen in February, when the Clinton Administration will back a resolution by a Geneva-based United Nations human rights panel criticizing Beijing's poor human rights record.

Even under the best of circumstances, Deng's passing will subject China's leaders to their toughest period since the 1989 Tiananmen massacre. That recognition has sent Asian stock markets into a selling frenzy. Since the latest rumors of Deng's impending death began in mid-January, Hong Kong's Hang Seng Index has fallen 7%; on Jan. 23, it dipped below the 7,000 mark for the first time in 17 months. Taiwan's market similarly plunged 4% after reports that Deng was in a coma. "Investors will step back from China over the next six months to see how the succession plays out," says William R. Ebsworth, chief investment officer at Fidelity Investments Management Hong Kong Ltd.

Even with the financial sell-off, most U.S. and other direct foreign investments are committed for the long haul. "The forces of capitalism are overwhelming," says David M. Friedson, president and CEO of Miami Lakes (Fla.)-based Windmere Corp., a $180 million manufacturer of small appliances. His company is adding 13% more capacity to its 140,000- square-meter Shenzhen factory this year.

Indeed, from the biggest multinationals to the small original equipment manufacturers, many executives doing business in China are used to riding out the vagaries of its topsy-turvy political system. Many are prepared to invest even more as the domestic economy opens up. For instance, Motorola Inc. plans to invest as much as $1.5 billion to expand its operations in China. "Multinationals have already factored in the Deng succession in their risk analysis," says Thomas D. Gorman, president of Hong Kong publishing company CCI Asia-Pacific Ltd. and chairman of the American Chamber of Commerce in Hong Kong.

Once Deng dies, all eyes will be on the uneasy coalition he appointed to succeed him. It is headed by President Jiang Zemin, with Premier Li Peng leading the government and Vice-Premier Zhu Rongji directing the economy. A cautious former Shanghai party boss and mayor known more for his survival techniques than his innovative policies, Jiang has maneuvered to put allies from Shanghai in powerful positions within the party and the military.

Jiang, whom Deng also picked to head the state military commission, lately has taken to wearing old-fashioned Mao jackets rather than Western suits in public appearances--a symbol to the old guard of his ideological correctness.

Jiang will have to do a lot more to gain their trust. Deng had appointed two party elders, General Zhang Zhen and Admiral Liu Huaqing, to serve on the Central Military Commission to make sure that the military supported Jiang--and ensure that he didn't grab too much power while Deng was still around. Both are expected to retire soon, leaving Jiang without much of a base among the generals. None of Jiang's own military appointees holds positions of real power. "Jiang is seen a lot like Bill Clinton," says one Western military observer in Beijing. "He's obeyed because he's the commander in chief, but there's not a lot of respect." Many analysts doubt that Jiang has the clout or the resourcefulness to cling to power for long. "Jiang was chosen because he was the least objectionable," says Kenneth G. Lieberthal, a China expert at the University of Michigan. "His record proves his mediocrity."

Whether the military prefers one politician over the next is anyone's guess. Even if the generals don't back Deng's designated heir, within the military there is widespread support for economic reform. Ever since Deng sanctioned the People's Liberation Army to get into business as a way to fund its modernization, the military has amassed an extensive business empire with revenues estimated at anywhere between $6 billion and $20 billion. "The military is at the leading edge of economic reform and modernization," says a Western diplomat in Hong Kong. Although some money may go directly into the pockets of top officers, much of it has gone into improving the quality of life for officers and soldiers alike.

TROIKA TROUBLES. Aside from Jiang, the other members of Deng's troika have similarly weak positions. Economic czar Zhu Rongji has alienated many with his brusque style. He has also taken lumps for his austerity program, which has brought howls of pain from both cash-strapped state enterprises and capital-hungry provincial officials. With inflation still high and his banking reforms limping, Zhu doesn't have many victories to help his cause.

Zhu's boss, Premier Li Peng, leads the core group of conservatives in the power structure. Known for ordering the crackdown on political dissidents in 1989, Li could be in trouble if the leadership decides to change its verdict on Tiananmen. Many in China believe that the country's leaders must come to grips with the Tiananmen massacre after Deng dies, in the same way that Deng denounced the Cultural Revolution after Mao died.

Other leaders are vying to take advantage of the trio's weaknesses. Among the most powerful is 87-year-old Yang Shangkun, the former President whom Deng cleverly maneuvered into retirement in 1992. Yang, one of the few remaining leaders from the early days of the Communist revolution, suddenly emerged in January, making a high-profile, 17-day "private" tour in Shenzhen to many ef the places he and Deng visited during their historic "southern tour" in 1992. Yang even echoed Deng's calls for "seizing the opportunity and speeding up reform."

That message undoubtedly helped him score points with local leaders in Guangdong, China's wealthiest province. Some Chinese sources also say Yang is close friends with another ousted leader, former party boss Zhao Ziyang, purged in 1989 after Deng and others accused him of sympathizing with the Tiananmen demonstrators. Zhao, now 75, was under house arrest in the months after his ouster but now is said to travel around freely. He has never recanted for his actions during the Tiananmen protests. Many of his supporters remain in the party and may back him in some kind of political alliance with Yang.

Within the power structure there are other contenders who could ascend to the top. One often mentioned candidate is Qiao Shi, 70, chairman of the National People's Congress, the country's legislature, and former head of the secret police. A slippery politician, he is extolled as both a legal reformer and a Chinese version of Soviet KGB Chief Yuri Andropov. Qiao has managed to remain untarnished by Tiananmen: Although he was the security boss at the time, he allegedly abstained on the vote to impose martial law.

Back then, the students in Tiananmen Square found that their complaints about corruption struck a chord with many ordinary Chinese. The issue is perhaps even more explosive six years later. In a recent survey of 6,150 people conducted by the China Youth Daily, nearly 90% of respondents said that corruption remained a serious problem, and some 39% chose corruption as China's biggest social problem. Some observers think the new leadership will single out a high-profile family for punishment to show they mean business.

Deng's children present an easy target. They're involved in a wide range of businesses, from property deals in Hong Kong to book contracts in the West. As their father's health has deteriorated, they've helped call the political shots, serving as his interpreter and liaison with the Politburo. But once the old man goes, "the children should withdraw from politics," cautions one observer from the mainland. "If they don't, they'll be in trouble." Deng Rong, the daughter who disclosed in January that Deng Xiaoping was seriously ill, apparently did so without consulting the central authorities. Perhaps even more revealing were her evenhanded comments on Tiananmen, which she called a tragedy for both sides. Some believe she was trying to place the family in a better light should Deng's successors reassess the massacre.

With all of this behind-the-scenes infighting, foreign investors are understandably proceeding with a great deal of caution. Hong Kong-based Wharf (Holdings) Ltd. has taken a go-slow approach to its much publicized plans to build a big container terminal spanning 1.8 kilometers along the Yangtze River in the inland city of Wuhan. Before proceeding, Wharf wants a green light for approval from the State Planning Council in Beijing. The company has been waiting for more than a year now. "We aren't going to throw money into something until we are absolutely satisfied we have every permission," says Nick Thompson, the company's spokesperson.

The policy paralysis in Beijing could also be responsible for the holdup in foreign investment in China's energy sector. GE's 400-megawatt oil-fired plant in Shanghai is just one of dozens of big foreign-funded power projects that were on hold all of 1994. The reason for the delay: Indecisive leaders in Beijing have been unable to reach a consensus on how these plants should be financed. A messy transition after Deng's death, says Delbert L. Williamson, president of GE Industrial Power Systems Asia, "will slow things down more."

The pace of contacts with Taiwan, however, is picking up speed--and that probably won't change after Deng. On Jan. 24, China concluded a pact with Taiwan on the repatriation to the mainland of hijackers and illegal immigrants and has finally agreed to Taipei's request to consider protecting Taiwanese investments in China. Chinese leaders believe Taiwan's money will help China tackle the nagging problem of unemployment by creating new jobs.

At the same time, Taiwan has offered some help to Beijing. In January, Taipei announced plans to open direct shipping links with China from the southern port city of Kaohsiung. Technically, the port would be considered "offshore," to preserve the fiction that the Nationalist government has no direct contact with the Communists. Even so, the plan will establish shipping routes with China for the first time since 1949. With bilateral trade estimated at more than $16 billion in 1994, both China and Taiwan are eager to streamline trading. "The two sides are on the same wavelength when it comes to continuing negotiations and cementing closer economic ties," says Andrew Yang, secretary general at the Chinese Council for Advanced Policies in Taipei.

For Hong Kong, the picture is not so rosy. Some believe that a weak center in China could spell problems for the territory after 1997. The absence of a strong government in Beijing could mean that Deng's policy of "one country, two systems" will fall by the wayside, argues S.L. Wong, a sociologist at the University of Hong Kong. Once the territory is part of China again, a weak Beijing may be unable to stop migrants from flocking across the border. "It will take a very strong government to impose the rule that Chinese citizens cannot freely enter Hong Kong," he says.

TECHNOCRATS? The biggest questions, of course, center on what will happen inside China itself. With a bankrupt ideology, the Communist leaders will probably try to assert their legitimacy by reinventing themselves as new-era technocrats who can deliver social stability and economic prosperity. That may be a stretch for men who have risen to the top largely on their connections to strongmen from a discredited system.

The transition to the post-Deng era therefore will probably be chaotic--and possibly violent. But most China watchers agree that the central goal of China's 1.2 billion people is to improve their standard of living. Whoever wins the battle to take the place of Deng Xiaoping will have little choice but to continue leading the world's largest nation down the path toward a more modern and more open economy.By Joyce Barnathan and Pete Engardio, with Dave Lindorff, in Hong Kong, Margaret Dawson in Taipei, and bureau reports


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