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Will Power Struggle Spell Paralysis?


International Business: China

WILL POWER STRUGGLE SPELL PARALYSIS?

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. 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. The leadership is likely to present a unified front at first, 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.

UPROOTED. 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 Mao era, 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, even 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. If inflation spirals out of control, it could spark instability among China's downtrodden, particularly among the 100 million uprooted peasants who don't have jobs. And high inflation could also touch off worries among foreign investors. Despite those concerns, few leaders want to be blamed for an economic bust, so analysts say the government apparently has opted to stay on the high-growth track. That means risky moves such as reforming state enterprises are likely to be put on hold (table).

As Beijing tries to buy the support of the poor, fiscal restraint will suffer. As a result, the 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 foreign 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. In fact, the forces of decentralization are likely to accelerate. 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 is that China's door to the outside world almost certainly will remain open. Almost no one in China wants to 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 matters. 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.

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--and 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 U.S. Congress pressing for a tougher stance on China, the two nations' relations could be in for a rough ride.

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 death began in mid-January, Hong Kong's Hang Seng Index has fallen 7%. Taiwan's market 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.

Despite the sell-off, most 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 1.5 million-square-foot 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. They are prepared to invest even more as the domestic economy opens up. "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 headed by President Jiang Zemin, with Premier Li Peng leading the government and Vice-Premier Zhu Rongji directing the economy. Jiang has maneuvered to put allies in powerful positions within the party and the military. But many analysts doubt that he can survive. Zhu, who has alienated many with his brusque style, hasn't managed to control the overheated economy. And Li could be in trouble if the leadership decides to change its verdict on Tiananmen. Beijing's new leaders may try to come to grips with Tiananmen, 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, one of the few remaining leaders from the early days of the revolution. Some Chinese sources also say Yang is close to another ousted leader, former party boss Zhao Ziyang, purged after Tiananmen. Zhao, now 75, retains many supporters in the party. Qiao Shi, 70, chairman of the National People's Congress and said to be a liberal, is also mentioned by many as a contender.

Whether the military prefers one politician over the next is anyone's guess. It has amassed a business empire with revenues estimated at anywhere between $6 billion and $20 billion. Although some money may go directly into the pockets of top officers, most of it has gone into improving the quality of life for officers and soldiers alike.

With all of this infighting, foreign investors are 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 more than a mile 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 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 haven't reached 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."

MIGRANTS. The pace of contacts with Taiwan, however, is picking up speed. On Jan. 24, China concluded a pact with Taiwan on the repatriation to the mainland of hijackers and illegal immigrants. But a weak center in China could spell problems for Hong Kong. Deng's policy of "one country, two systems" could fall by the wayside, argues S.L. Wong, a sociologist at the University of Hong Kong. Once the territory is part of China, a weak Beijing may be unable to stop the flow of migrants. "It will take a very strong government to impose the rule that Chinese citizens cannot freely enter Hong Kong," he says.

The biggest questions, of course, center on what will happen inside China. With a bankrupt ideology, the Communist leaders will probably try to assert their legitimacy by reinventing themselves as technocrats who can deliver stability and 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 may therefore be chaotic and perhaps violent. But the driving force of China's thirst for prosperity will mean that whoever wins will have little choice but to continue leading the world's largest nation down the the path toward a more modern, open economy.

ECONOMIC REFORMS

A prolonged struggle could jeopardize some central government initiatives but allow local leaders more leeway

AT RISK

--The central government's effort to control inflation and bank credits

--Efforts to reform the national financial system

--Attempts to devise a national taxation system

--Approval of big-ticket foreign investments

--Privatization of inefficient state enterprises

--Freeing up pricing of certain staples

PROCEEDING

--More ties between coastal regions and Hong Kong, Taiwan, and South Korea

--Deals at provincial level for foreign companies

--Growth of businesses in the nonstate sector

--Opening of key sectors like telecoms

--Provincial resistance to paying taxes to Beijing and to heeding the center's edicts

--Increasing disparity between wealthy coastal provinces and poor interior

DATA:BUSINESS WEEKBy Joyce Barnathan and Pete Engardio, with Dave Lindorff, in Hong Kong, Margaret Dawson in Taipei, and bureau reports


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