Rough Seas Ahead for China

June 8th, 2011

Mao on the Yuan

Jonathan Rees/Flickr

Global Financial Integrity has been warning about illicit financial flows (IFFs) out of The People’s Republic of China for years. These outflows have ranged from an annual US$169 billion in 2000 to US$344 billion in 2008. Dev Kar, Lead Economist for GFI, notes trade mispricing, which is the practice of underpricing exports or overpricing imports in order to shift illegally capital abroad, is “the major channel for the transfer of illicit capital from China.” The country is also, by far, the largest transmitter of illicit financial flows in the developing world. And in case it’s not already obvious, let me clarify that these numbers are unbelievably large. For a point of comparison, the PRC’s stock of total external debt in 2008 was $378 billion, just slightly greater than its total illicit outflows in that year alone. In the same year China’s net inflows of foreign direct investment were US$147 billion, less than half of its total illicit outflows (note: I’m comparing a net figure to a gross one, there).

China has had an IFF problem for years, but as it would turn out, it’s not just confined to the black market. In fact, we are now seeing a so-called “rich drain,” which means that high net worth Chinese individuals are not only sending their money overseas, they’re looking to emigrate, as well. According to a recently published study by China Merchants Bank, The 2011 Private Wealth Report, at least 60% of Chinese citizens with at least 10 million yuan (US$1.53 million) are either “considering emigration through investment overseas or are already finalizing the process.” In fact, there has already been a 73% increase in Chinese investment immigrants to the United States in the last five years. Investment immigrants can gain eligibility for a U.S. immigrant visa by establishing a new commercial enterprise, investing at least one million dollars in high employment areas, or investing at least $500,000 in a “target employment area.”

Zhong Dajun, director of the Beijing Dajun Institute for Economic Observation, remarked in response: “We have been working hard to develop the economy in the past 30 years, but now these elite members of society are fleeing with the majority of the wealth. The loss may be even higher than all the foreign investment we have attracted.  It is as if, when the time of harvest comes, we find the fruits have all gone to others’ baskets.”

The Private Wealth Report, based on surveys and third-party data, found three (declared) reasons for the immigration: “a better education for their children, safety of personal wealth and a preparation for retirement.” Other pundits have argued the emigration is the result of Chinese government policy, which has abused private entrepreneurs or occurs on fears of corruption charges. A luxury jeweler, who was once based in the mainland but has since moved to Hong Kong, commented he is worried about “economic bubbles…amid reports of inflation and drops in housing prices.”

Gordon Chang, a reporter for Forbes, predicts that if Xi Jinping—China’s current Vice President—replaces Hu Jintao as China’s next President and Party leader as anticipated, the situation will get worse. Chang believes Xi and “his princelings…[will] use their new political clout to consolidate their grip on the economy.” The term “princeling” is a derogatory one used to refer to prominent descendants of senior communist officials who benefit from nepotism and cronyism. Chang, who is a self-described predictor of the political instability of China, believes Xi’s ascent to general secretary would mean “owners of private domestic enterprises will have even fewer opportunities than they do today.”

These signs should be big warning flags to the Chinese. Though there is no established relationship in the literature, it is likely that IFFs are correlated with emigration and are perhaps a leading indicator, which means they (IFFs) would come first and emigration would follow. The causes and effects of illicit financial flows (and emigration, for that matter) are not fully understood and vary widely by country, by year, or by transmitter. But I can say this for certain: they can both indicate economic problems and they can cause them. Either way, these signs point to rough seas ahead for the People’s Republic.

Written by Ann Hollingshead

Follow @FinTrCo