With much talk of the Chinese trade deficit in the news cycle lately, we should not lose sight of an important contributor to the friction: the Chinese trust deficit. In fact, China is facing a crisis of public trust, and this is partly to blame for its current trade strife.
Stories of deception by firms and public officials have dominated headlines. Popular artists stand accused of tax fraud. Hundreds of peer-to-peer lending platforms have vanished, along with their clients’ funds; household products are often reported tainted; faulty vaccines, fake data and knockoff labels persist despite new standards and penalties. Yet when the crackdowns occur, we’re left with stories of high-profile “disappearances” and opaque police and judicial proceedings.
What is behind this dilemma? In the past two generations, China has grown into a massive urbanised market economy. Yet this economy is still largely built on personal ties, local reputations, and moral sanctions that are communal in origin. These kinds of dense social networks function best when a societal structure consists of a small, tightly knit group of relatives, friends, and acquaintances for whom frequent interactions are the norm. In the more interconnected 21st century, the communal approach — dependent as it is on informal constraints — limits the complex exchanges among unrelated partners that fuel growth.
In today’s China, more often than not, exchanges are now conducted outside of one’s small, trusted circle. Interactions among transacting parties are rarely repeated, and local knowledge of past behaviour is not effectively monitored. The traditional use of reputation as an effective form of social control is rendered hollow by scandal after scandal involving corporate, consumer, and political bribery and fraud.
The institutional evolution of any modern economy requires more than voluntary arrangements. The central government needs to establish a framework for an independent civil society, including the enforcement of property rights and a judiciary to protect the public from fraud and malfeasance — and, at the very least, to counterbalance the consolidation of state power. Without these, uncertainty will continue to limit healthy economic risk-taking or enthusiasm for complex exchanges.
To compensate for underperforming insurance and capital markets, state lenders step in as the primary providers of long-term investment—but this creates a capital shortage for private-sector investments in research and development. The underlying problem is that short of checks and balances, the Communist Party lacks the capacity to credibly commit to safeguarding the intellectual property rights of players within these markets.
The Party has acknowledged that there is not enough credit information to assess the risk profiles of market players. The government hopes to establish by 2020 a centrally managed “social credit” big-data system to house the business and social reputations of China’s 1.4 billion citizens. But the state has chosen to monopolise the dissemination of information and often acts alone as the reputation enforcer in society.
The Party has made some progress toward creating internal accountability. But outside the Party, accountability systems and self-monitoring among civic associations are virtually nonexistent. This central control over information and communication weakens civil society, leaving no independent institutions to serve as a buffer to monitor either the state or private actors.
The same trust deficit that affects China’s relationship domestically impairs trust with its most important trading partners: those that develop the technology China needs to become a high-income country. So far, technological advances have mostly come as free-rides on institutions developed elsewhere, from economies whose institutions better protect developers’ property rights — safeguarding incentives to invest time, resources, and energy into ideas and products. China’s domestic institutional capacity is unlikely to fill the gap.
China needs rule enforcement that is not strictly moral, but also encased in the institutional activism of a wide range of organisations and interests. It is illusory to try to substitute archaic, informal “social trust” systems whose legitimacy resides in the personal virtue of government officials.
As is the case domestically, China’s development as a technology power requires a multilateral framework until the time comes when its own domestic institutions can self-police. Up to now, there have been only a very few cases of foreign companies seeking judicial review within China to address copyright infringements. With judges selected by the Communist Party, foreign companies say they can’t expect fair outcomes.
Currently, there is insufficient international mediation when disputes arise. Stronger WTO rules, for example, on market access, technology transfers and IP protection would be a positive step until China transitions into a society in which good laws are the backbone of mutual trust.
In seeking international accord, China will recognise one of the great lessons of economic history: that independent institutions protective of property rights become more essential at each successive stage of development.