Factions and Finance in China: Elite Conflict and Inflation
by Victor Shih
Cambridge University Press, 264 pages, $85.00

China watchers often describe the battles in elite Chinese politics as a struggle between reformist and conservative camps. The reformist politicians favor more openness—greater democracy, more foreign investment—and conservative Communist Party stalwarts favor turning back the growing private sector and closing China off from influence of growing trade and openness. That simple framework led to the hopes that greeted Hu Jintao's elevation to the country's top post of Communist Party secretary-general in 2002. Hu was depicted as the leader of a new generation of cadres ready to accelerate the liberalization of China's controls on media, spur the private sector and usher in wide foreign access to China's vast markets.

While Chinese officials have continued to make steady, incremental progress on many of those issues, those hoping for breakthroughs have been largely disappointed. On the eve of the 17th Party Congress set for Oct. 15, many of the same observers see President Hu's ongoing consolidation of power by placing allies in top provincial posts and the possible naming of his own successor as another chance for a breakthrough.

In this forthcoming book, Northwestern University Professor Victor Shih presents a compelling alternate framework for a key slice of Chinese politics–economic and financial policy making. He argues that rather than a duel between conservatives and reformists, Chinese policy making represents a series of compromises between a “generalist” faction that derives support from local provincial authorities vying with a “technocrat” faction supported by central government bureaucrats seeking to consolidate control in Beijing.
Prof. Shih believes the generalist faction–headed by the Party's top leader–typically dominates. He seeks to dole out favors to provincial leaders he needs to back him in China's top ruling body, the Politburo. In the realm of economics and finance, that means giving financial support in the form of loans or tax preferences. For their part, the technocrat faction jealously guards the center's power over the economy and gains power by troubleshooting nationwide problems–such as rising prices.

In this way, local and central interests battle each other, shifting the balance of power between Beijing and the provinces. However, since the central bureaucrats lack a broad network of connections, Prof. Shih believes that they rarely threaten the generalist faction's overall control, but instead fight for broader powers within their narrow policy portfolio. This view varies significantly from the reformer-hardliner framework because it assumes that Chinese policy makers share broad agreement on key issues, such as the superiority of the market economy and benefits of gradual reform and opening of the economy to the outside.

The secrecy-cloaked world of Chinese politics makes it difficult to determine the appropriate model for understanding how Chinese politics work. Speeches by Chinese leaders distributed internally often vary significantly from those released publicly. Lower-level government officials are well-versed at touting the current policy line at forums and in interviews, even while debates rage internally. Media leaks can be punished harshly by powerful censors.

This makes Prof. Shih's decision to test his hypothesis in the realm of economic and financial policy making logical. Debates over economic policies are crucial to social stability and national well-being, while at the same time outcomes in economic policy making are more easily measured and tested than other policy spheres. In his analysis, he cites internal party documents and public speeches released through official media, but also employs bank-lending data to gauge the signals being sent by top leaders.

Prof. Shih posits that if the generalists are in the saddle they'll push for faster loan growth, especially in provinces led by the allies of the faction's leader. Once that loan growth begins to feed into inflation, party leaders sense a threat to social stability and hand control over to the technocrats, who rapidly clamp down on lending to stem soaring prices and boost their own power vis-à-vis local governments.

Prof. Shih presents a statistical model that aims to prove his theory, but the book comes to life when he launches into a narrative depicting the post-1978 struggles among China's political elite. This presents Deng Xiaoping as a relentless and impatient advocate of faster, decentralized growth that several times threatened to throw China into an inflationary spiral. At one point, Deng's lieutenant Zhao Ziyang is cited as arguing in favor of Latin American-style hyperinflation. Later, former Premier Zhu Rongji emerges as a crafty bureaucrat who exploits the Asian financial crisis to centralize control over state enterprises and banks at the expense of faster growth.

Prof. Shih ascribes neither of these two towering figures in Chinese financial policy with the visionary foresight that many observers attribute to them. Deng is normally hailed for the birth of Special Economic Zones and Mr. Zhu for negotiating China's entry into the World Trade Organization. Instead, he sees them both as shrewd political creatures, strengthening their hands by altering the balance of power between local and national interests.

How has China managed to navigate these conflicts in the highest ranks of power to achieve a strong track record on growth and price stability? Prof. Shih answers that the generalists, who maintain the upper hand, have ample incentive to turn power over to the bureaucrats in a time of crisis rather than risking a rival generalist faction overturning their predominance. That results in short spikes in inflation, but preserves a credible mechanism for dampening inflationary expectations. Once the crisis recedes, the generalist faction can again reclaim power and start unleashing resources for faster growth.

The book also proves particularly timely. The concurrent rising threat of inflation and a key Communist Party meeting scheduled for Oct. 15 puts policy makers at a crossroads. As Prof. Shih's model would predict, these conditions could lead to fissures in the alliance between President Hu and Premier Wen Jiabao.
Beijing technocrats, led by Premier Wen, are now warning that rising food prices risk threatening broader price instability and more importantly social stability—Chinese consumer inflation rose 6.5% in August, its highest monthly rate in over 10 years. Bureaucrats are hyping that danger, arguing for tighter controls on lending and investment by local governments. At the same time, President Hu needs to reward newly promoted provincial leaders with financial favors to garner their support to wield power over the Party apparatus.

As China's role in buoying the global economy continues to deepen, building a proper framework for understanding that push and pull in elite politics—and using those tools to foresee possible outcomes of Chinese policy becomes essential. Prof. Shih's work makes an important contribution to that effort.

Mr. Carew is a Beijing-based correspondent for Dow Jones Newswires.