China Is Pursuing Rhineland Capitalism, Not Cancelling Markets : Part 1 of a 2 Part Interview with Bert Hofman, Former World Bank Country Director for China


Bert Hofman, director of the East Asian Institute at the National University of Singapore and previously the World Bank’s Country Director for China, says that Beijing remains committed to the role of the market in the Chinese economy despite concerns over a recent actions by central government regulators.

China’s recent actions across a range of sectors including private education, fintech, e-commerce and online gaming have caused severe jitters for investors, as well as triggered speculation that President Xi Jinping is winding back the remit of free markets and stepping up the economic role of the state.

In an interview with China Banking News, Hofman said that while Xi has increased the influence of the state since assuming office, this does not signal a withdrawal from China’s commitment to the pivotal role played by markets.

“I think it’s the case without a question that China has become more statist under Xi,” said Hofman to China Banking News. “But has the pendulum completely swung and is everything now state-led and state-directed? I do not think so.”

“Even now – and definitely in the 19th Party Congress in 2017, the notion that the market plays a decisive role in the allocation of factors has been emphasised.”

Global Financial Crisis colours Xi Jinping’s views on the economy

Hofman said that a major influence on the outlook of Chinese political leaders has been the turmoil of free market economies since the turn of the century, and in particular the US sub-prime mortgage crisis which triggered a global crisis in 2008.

“Part of Xi’s fundamental thinking is that the market economy as it has been done in the West hasn’t worked out that well,” Hofman said.

“Looking at the Global Financial Crisis and its aftermath, and looking at the poor handling of the European debt crisis, Xi thinks that China did better with a more state-led model and the large presence of state-owned enterprises, that could be called to task in a crisis to make the investments and create the jobs that were needed.”

China’s recent regulatory interventions do not signal withdrawal from markets

Hofman said that while the latest round of regulatory interventions do not mark a wholesale withdrawal from the market as many speculate, but instead a stepping up of oversight and guidance by the state.

“Each of the major tech companies, including Ant Group, DiDi and Tencent, has been hit by regulatory interventions in quite a rough and ready way,” said Hofman. “This makes investors nervous, so it may have some consequences down the line. 

“While this has created a lot of stories saying that this is the end of the market in China and that a lot of the entrepreneurs will flee, I think China is simply defining the type of model it wants through its recent actions, and the role of the market that it wants. 

“Basically the message is that private entrepreneurs are great, but you still need to serve the objectives of the Chinese people.

“You still need to be socially responsible, and you still need to basically serve the objectives of the party which reflect the priorities of the Chinese people.”

Ant Group and DiDi interventions were expected

While observers have criticised the Chinese government for engaging in interventions that have been too arbitrary and abrupt, Hofman points out that in many cases these actions were warranted and should have been readily anticipated.

“In the case of the cancellation of the Ant Group IPO, to be fair the China Banking and Insurance Regulatory Commission (CBIRC) gave them ample warning beforehand,” he said.

“The regulators said to them that they were going to regulate this area, because your business model doesn’t work the way you say it works in your prospectus if we put these new regulatory measures in place. 

“With DiDi there was again an advance warning – the regulators said you have a data security issue you need to deal with, and DiDi thought that they could get away with it for some reason. 

“So they went ahead and did their IPO, and then they got caught a week later by the regulators.”

China’s current governance structure lends itself to abrupt and sweeping action

With regard to the sudden and sweeping nature of actions by Chinese authorities which have set markets on edge, Hofman points to the newness of some regulatory agencies as well as the nature of governance in China.

“China’s Cyberspace Administration is relatively new, the State Administration of Market Regulation is relatively new, and the whole idea of antimonopoly is relatively new, so it may have been a case of the of the market regulators asserting aggressively themselves once they saw an opportunity,” he said.

“The central government leadership is also usually is a little bit above the fray, and they don’t look at the day-to-day matters if there aren’t any problems – they think about big things and have study sessions on Marxism and on communication.

“But once an issue comes up on the radar screen, if you have Wang Qishan in the room while something is said about it, then things might turn around very fast, and I think that’s what has happened recently. 

“It’s the governance structure in China that makes for these relatively sudden turns – an example of this is what happened in Wuhan with the COVID-19 outbreak where a number of official and health officials tried to keep it relatively quiet and there were some local objectives that they wanted to pursue. 

“When it hit the radar screen of the leadership of the State Council and the Politburo standing committee however, action was taken very forcefully at the end of January, and within a week the whole country was placed under lockdown.”

Ant Group targeted over competition with state-owned banks and risk issues

China has cracked down heavily on Jack Ma’s business empire, with the shelving of the Ant Group IPO that was originally scheduled for November last year, as well as a heavy antitrust penalty for e-commerce platform Alibaba in April this year.

In the case of Ant Group, Hofman says that regulators were predisposed to intervene given how its business model affected the operations of the big state-owned banks.

“Ant Group was eating the established state bank’s business for lunch, so I think that these interests played a role, especially when it came to lending operations,” he said.

“Ant Group’s business model was that they use the data that came from their payment services for Alibaba to find good credits and then to basically intermediate the credit and package it up for sale to banks. 

“They took most of the margin, but they also did most of the work, and did so in a very different way from the way normal banks do, by using algorithms based on the big data that they acquired on the payments side of the business. 

“This is a transformation that took place over the past decade, and I tend to think that this is a very good innovation, as it gave tremendous access to financial services to people that wouldn’t even get into the door of a bank. 

“Of course it did make the life of state banks a lot more difficult, so there were interest groups that wanted to clamp down on Ant Group.”

Ant Group’s business model was also a source of risk concern, given that its particular brand of credit intermediation had the potential to create the same issues that led to the sub-prime mortgage crisis in the US.

“Ant Group only took very small risk on their own balance sheet,” said Hofman. “They only kept 2 – 3% of the risk and sold the rest to the banks, while the regulations now state that for every loan you originate you need at least 30% on your balance sheet.

“So the motivation for regulatory action was not entirely out of the blue, if you recall that the separation of the origination of credits and servicing of the credit was a big problem in the sub-prime mortgage crisis in the US. 

“They were all kinds of originators of loans, but they sold them to banks or they did it on behalf of banks, while the banks therefore didn’t have the contacts and the information to tackle any problems coming up in the mortgage market. 

“This is a big risk, and whether Chinese regulators have solved this risk remains to be seen. In any case it makes the Ant Group business model less attractive.”

Is China pursuing a Rhineland model of capitalism?

Hofman points out that the latest round of regulatory action in China does not in essence mark a radical departure from standard practice for the market economies of the modern era, whose governments all regulate economic activity to reflect social values and priorities.

“The market is not something abstract that is God-given – the market is shaped by societal values,” he said. “This is not Xi Jinping speaking, but Adam Smith speaking in The Theory of Moral Sentiments, which he wrote before The Wealth of Nations, and is all about the framework within which a market can operate. 

“There’s no such thing as a market economy as something that is abstract and the same everywhere – the market economy in Germany is something totally different from the market economy in the United States, and the market economy in France.

“Why is this? Because these societies are different and their values are different – societies around the world shape the market and they regulate the market accordingly.”

Instead of withdrawing from the free market, Hofman instead sees the Chinese Communist Party as pursuing something akin to the Rhineland model of capitalism, which involves the regulation of markets and the maintenance of fair competition, in tandem with the implementation of social welfare policies.

“In the old days people used to talk about the third way, or the Rhineland model of capitalism with a stakeholder economy,” Hofman said.

“This was not US capitalism and it was not socialism – it was something in between. Having seen some of these things and read Chinese Communist Party documents, I think this is what’s happening. 

“This is was they are trying to do and yes it does involve more state.”

China shift its development focus since 2010’s

The pursuit of Rhineland capitalism entails greater emphasis upon social welfare and fairness, which is a shift that has become more pronounced in China since the middle of last decade.

“Since 2015 there’s much less emphasis on growth and efficiency, and much more talk about national security, stability and social fairness,” said Hofman.

“Liu He, China’s key economic architect, talks about social fairness and national security as being key drivers of future development model. That’s very different from maximising growth which for thirty years or forty years was the case in the China.

“You see these societal values change and that has implications for what you do as a regulator and as a state in the economy. 

“So the balance is clearly shifting. Where exactly it is going is hard to say, but to say that everything is anti-market would be an incorrect judgement.”