China © Brand X/SuperStock

Extra7/18/2007 12:01 AM ET

Broken China: A dysfunctional nation

Beijing can't clean up the environment, rein in stock speculation or police its companies. Here's why the country's problems could keep it from becoming the next superpower.

By BusinessWeek

When the bureaucratic machinery of China rolls into action, it is a sight to behold.

A mayor announces a plan to reclaim hundreds of acres from the sea and build a massive industrial complex.

A few years later, busy factories and roads stretch as far as the eye can see, families are living in thousands of new apartments and 10,000 workers have launched phase two (see " '4 Manhattans a year' ").

This is the side of China that awes the outside world.

The country's extraordinary ability to mobilize people and capital to accomplish daunting feats in record time is the reason it has averaged annual growth of 9.5% for three decades. It is why China is an export juggernaut in everything from T-shirts to TVs, has the world's fastest-growing consumer market (see "Keeping Up With the Wangs") and has amassed enough wealth to snap up South American mineral reserves, IBM Corp.'s (IBM, news, msgs) personal-computer division and a big stake in private-equity company Blackstone Group (BX, news, msgs).

Will Beijing complete all of the stadiums, expressways and hotels in time for the 2008 Summer Olympics? Count on it. It's also a decent bet China will achieve its goal of winning the most gold medals.

Why, then, is it so hard for this same government to crack down on exporters of dangerously tainted seafood, toothpaste and medicine despite years of warnings by local and foreign experts?

The relentless headlines about unsafe products from China reveal a scary truth: Probe even a little into the Chinese economic miracle, and glaring administrative failures abound. Product safety is just one aspect of Beijing's inability to enforce needed regulation in everything from manufacturing and the environment to copyrights and the capital markets.

The same Communist Party apparatus so proficient at censoring the Internet can't keep peddlers in the heart of Beijing from selling knock-off Callaway golf clubs and fake iPods despite solemn promises to Washington since the early 1990s about enforcing intellectual-property rights. Shanghai's stock exchange may be one of the world's hottest and may boast a state-of-the-art paperless trading system. But it was a casino when it opened in 1990 with eight listings, and after years of flaccid regulation, it's an even bigger casino with 1,118 (see "China's Olympian stock-market sprint").

Beijing proclaims all sorts of green initiatives, yet heavily polluting new factories and coal power plants keep going up (see "How long can China pollute for free?"). The party has talked for decades about building a social safety net, yet as the working population ages, the government isn't investing nearly enough to head off looming crises in health care, education and pensions. China spends more than Japan on research and development, according to the Organization for Economic Cooperation and Development, but its record of innovation is underwhelming.

Economy is at 'a critical point'

China observers dismiss these flaws as the growing pains of a nation making a breathtakingly fast transition from a command economy to a free market. But it's becoming clearer that these and other structural problems aren't being addressed.

The same policies that have been so successful at boosting the gross domestic product by developing export industries and public-works projects, it turns out, undermine initiatives that might move China's economy to a higher level. In its pursuit of growth at all costs, China has skimped on investments needed to provide basic, affordable health care and the regulatory machinery that can enforce environmental, safety and corporate governance regulations nationwide.

Video on MSN Money

China © Lawrence Manning/Corbis
Not made in China
Taking the "made in China" out of one's life is harder than it sounds. Sara Bongiorni documents her family's attempt in her a recently published book.

Solving these shortcomings will require a massive shift of the resources that are now being plowed into capital projects. Though Beijing would like to cool the economy (see "The China Syndrome"), however, it is wary of doing anything that would slow the high growth needed to generate jobs for the millions of youths pouring into the work force each year, especially with a pivotal leadership conference scheduled in the fall.

"China's economic-development model was based on the simple concept of expansion of production," says economist Chen Xiushan of People's University in Beijing. "This model has reached a critical point."

A more intractable problem is China's power structure itself. Although Beijing holds a monopoly on politics, local Communist Party officials enjoy wide latitude over social and economic affairs. They also have huge professional and financial incentives to spur GDP growth, which they often do by ignoring regulations or lavishing companies with perks.

Continued: Reform looks unlikely

 1 | 2 | 3 | 4 | next >

Rate this Article

Click on one of the stars below to rate this article from 1 (lowest) to 5 (highest). LowHigh