The economic costs of China's anti-graft campaign

Since Xi Jinping started China’s anti-corruption campaign more than 20 months ago, 33 minister or vice-minister-level officials have been arrested on corruption charges, including the vice-chairman of the central military commission, two members and three alternate members of the central committee of the Chinese communist party, one of the most powerful political organs in the country.

The party’s unprecedented anti-graft campaign has yielded some of the most sensational stories of the year. For example, when a deputy director in charge of coal industry reform from the National Energy Administration was busted in May, investigators found more than 100 million yuan in cash at his apartment.

According to a back of envelope calculation, his cash hoard would weigh about 1.15 tonnes. Investigators had to borrow 16 cash counting machines from a local bank to tally the total amount and four cash counting machines were burnt during the process.

When General Gu Junshan’s mini forbidden palace was raided in January this year, they found enough ill-gotten goods to load up four military trucks. The goods included a large boat replica, a wash basin and a statue of Mao, all made of solid gold. There was also hundreds of cases of Maotai, the poison of choice for Chinese elites.

Though the anti-corruption drive has been widely applauded by Chinese citizens, it has some serious side effects for the economy, especially at a time when growth is under much downward pressure.The impact is wide, ranging from the wholesale prices of sea cucumbers to the share prices of listed French luxury goods retailers.

At a macroeconomic level, President Xi’s drive to impose frugality on China’s luxury-loving officialdom acts almost like an austerity measure that leads to a substantial fiscal contraction. Lu Ting, a China economist from Bank of America Merrill Lynch believes Beijing’s anti-corruption campaign has heaved 1.8 per cent off the county’s GDP in 2012 or 937 billion yuan.

He has noticed that government departments and quasi-agencies such as research institutes have increased their savings considerably since the start of the anti-graft campaign. For example, the government saved 326 billion yuan more last year and the impact of the government’s fiscal contraction could be around 0.6 per cent of GDP.

Lu also explains that the anti-corruption drive is making officials and executives from state-owned enterprises reluctant to start new projects. “Even honest officials with clean hands might be discouraged from initiating new projects as they may be afraid of being perceived or even charged as being corrupt during the campaign.  Inaction might be viewed as the safest way for self-protection amid a political movement,” he said in an interview with Deutsche Welle.

If the impact on macro-economics is a bit of guesswork, the effects of anti-graft activities on many sectors are clear. For example, China’s restaurant sector has experienced the slowest growth rate for more than two decades and the high-end sector has been particularly bad, with negative growth for the first time in ten years. We are witnessing a funny situation where five star hotels are desperate to lose at least one of their stars.

It seems that German luxury car manufacturers will become the latest collateral damage to the campaign. Beijing has announced that it would slash spending on the country’s fleets of chauffeur-driven cars. According to one estimate, Beijing spends 300bn yuan a year on buying and maintaining government cars. The new austerity drive could halve that spending.

For people who travel regularly to China, you cannot miss numerous black Audis on the roads -- a lot of which are government cars. Audi sold nearly half a million cars in China in 2013, which accounted for about one third of the company’s global sales.  It is probable that Audi sales in China would drop in the coming years as the government tightens its belt.

Sales of luxury goods globally are also expected to grow slowly on the back of weaker demand in China, which account for about one third of global demand for luxury goods. Bain & Co predicts the local market will grow just two to four per cent, down from 20 per cent in 2012, as crackdown on conspicuous consumption drives shopping abroad.

It is quite telling that the retail price of Maotai, the favourite liquor of Chinese officials, has dipped below 1,000 yuan from 1,600 yuan a year ago. The wholesale price of  expensive seafood like abalone, sea cucumber and farm-raised soft shell turtle have all declined considerably, according to AMP Capital.

Graph for The economic costs of China's anti-graft campaign

Graph for The economic costs of China's anti-graft campaign

Patrick Ho, head of Asia Equities, told Australian investors: “One of the core problems post the three decades of growth in China comes from government corruption. The new leadership has shown ever-stronger effort to curb down the situation in China. The anti-corruption campaign has been more serious and has lasted longer than expected.”

“Many SOE executives and local government officials will be affected. This is positive for China in the long run, though may affect consumption and investment in the short run,” he said.

Though the crackdown has dampening effect on the Chinese economy in the short term, it has a large upside for the long-term growth prospects of the country if Beijing can build robust institutions to curb endemic corruption in China.