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The Bain of China

9:21 AM, May 23, 2012 • By DAN BLUMENTHAL
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President Obama, envious of China’s economic model, proclaimed his admiration for the high-speed railways, bridges, skyscrapers, and solar panels that China is building.  (“That used to be us,” he famously said – a line apparently so powerful it became the title of a book.) But even the Chinese know that Obama’s envy is misplaced. 

Indeed, the irony is that Obama is now on the attack against the economic growth engine that the Chinese really need: firms that can finance companies with the most promise. Yes, that includes private equity companies—such as Bain. China is woefully misallocating capital and thus pouring money into unproductive industries that are a drag on Chinese GDP. 

In fact, the World Bank teamed up with an influential Chinese state-led think tank to produce a report on Chinese economic reform. One of the report’s many conclusions is that if China does not have a real financial sector soon it will be in a world of hurt, the kind of pain Japan has been in for two decades. As I have previously written:

The Economist reported that despite the cheap credit to favored industries, private firms may be seeing an average return on equity more than 10 percentage points higher than their state-owned brethren. According to China’s National Bureau of Statistics, Chinese companies that are not majority-owned by the state account for two-thirds of industrial output. The World Bank recently weighed in with a report, together with an influential Chinese state-run think tank, that concluded that China will not keep growing at sustainable levels unless it becomes less statist:

“Besides being less profitable, state enterprises, overall, are also less dynamic than private firms. A recent study shows that between 1978 and 2007 total factor productivity growth (a measure of efficiency improvements) in the state sector was a third that of the private sector, which has proved to be the more powerful engine of growth and innovation.”

How can China get rid of unproductive companies and make other companies more productive? Private equity provides one such path. Real capital markets, venture capital, investment banks—all those nasty things Obama is attacking during his re-election campaign—would help, too. 

But the Chinese severely curtail the activities of these firms. The Chinese economy, and therefore the Chinese people, suffers from what economists call “financial repression.” Chinese entrepreneurs have very few options to safely store and grow wealth or receive capital based on the merits of their businesses rather than their political connections.

What China does not need more of are the kinds of things Obama likes – five year plans meant to “transform” the foundations of its economy, which usually lead to more state subsidies for industries it believes will be “winners.”

Obama likes the part of the Chinese system that is the least productive.  The real drivers of growth in China have been the risk-takers who attracted capital from the informal financial sector despite the state-run juggernaut.

Yes, for most stagnating or developing countries, the American ability to deploy capital to the most productive industries is something to envy. For Obama it creates “unfairness.” Perhaps someone should bring to his attention just how unfair the statist Chinese system really is.

For a president who fancies himself dedicated to economically competing with China, the attacks on Bain demonstrate a lack of seriousness, both about the U.S. economy and about competing with China.

Looming behind many political issues is the China question: Will we recover, unbridle ourselves of debt, innovate, pay for our national security? Or, is China fated to become number one, leaving us to live in a Chinese world? If we destroy the most productive parts of our economy, then we should get ready for a Chinese century.

In this case, Romney could inject foreign policy into his defense of the free enterprise system. He might say that if we restore its foundations, we have less to worry about from China. Let Beijing remain statist. We will go back to a risk-taking, innovating, and producing economy that either leaves China in the dust or has them wishing they were us.

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