The cost of anti-corruption

Former top general Xu Caihou has become the highest-ranking Chinese official to be felled in president Xi's anti-corruption campaign. According to state-run news agency Xinhua, the 71-year-old - who retired in late 2012 from the decision-making Politburo - is accused of accepting bribes, both personally and through family members.

With dozens of officials at or above ministerial level being investigated, some analysts argue that the anti-corruption campaign is also a vehicle of settling political scores and putting Xi's own men and reform-minded bureaucrats into key positions across the Communist Party.

But whatever the reason behind it may be, the campaign's increasing momentum is also having an impact on the Chinese economy. Lu Ting, a Hong Kong-based economist at Bank of America Merrill Lynch, says in a DW interview the corruption crackdown is dis-incentivizing some officials from starting new projects and instilling fear on others of being perceived or charged as corrupt.

DW: How is Xi Jinping's anti-corruption campaign impacting the Chinese economy?

Lu Ting: President Xi announced a crackdown on corruption shortly after he took office in November 2012. The CPC Central Committee put forward its eight-point rule in December 2012 to improve the government's working style by reducing extravagance and bureaucracy. Since then a number of anti-graft and anti-extravagance measures have been introduced at both the central and local levels, covering areas such as travel, government vehicles, official dinners and special privileges.

The main channel of economic impact from the anti-corruption campaign was slumping luxury consumption in 2013, while the channel in 2014 has been the slowing fixed asset investment (FAI) growth due to inaction of local government officials and executives of state-owned enterprises either because they are in fear of corruption charges or because they are not financially motivated.

The impact of anti-corruption and anti-extravagance campaigns on consumption is straightforward, but why could FAI be affected?

First, the room for potential corruption might be greatly squeezed as a result of the anti-graft campaign, so some officials are dis-incentivized from starting new projects. Second, 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.

What sectors are among the most affected and why?

High-end retail, catering, hotels and travel industries are mostly affected by the campaigns. This is because an important part of the drive is aimed at anti-extravagance. Regulations have been introduced to ban the use of luxury cars, eliminate lavish gifts for officials, stop the use of public funds to organize galas and limit the expense on travel and hotels.

Do you have any figures as to how much the campaign is costing GDP growth every year?

We have estimated the impact of fiscal contraction as a consequence of Beijing's anti-corruption campaign on China's GDP growth by looking at the growth of fiscal deposits - bank deposits of all government and quasi-government agencies. We estimate the direct impact could be around one percentage point of GDP.

Since the spring of 2013, government deposit growth surged from the negative territory to as high as 28.3 percent at the end of February 2014. Quasi government deposits quickened to 23.6 percent year on year at the end of February 2014, while fiscal revenue growth dropped to just around 10 percent and nominal GDP growth was even below 10 percent.

How did you calculate these figures?

We here provide a back-of-the-envelope estimate. For the government, we just assume that there is no need to increase deposits faster than economic growth, so the benchmark is just the 10 percent or so nominal GDP growth in 2013. Based on this method, we estimate fiscal contraction as a result of rising government savings in 2013 was around RMB326 billions (or about 63 basis points in 2012). After adjusting to inflation, impact of the government's fiscal contraction could be around 60 basis points on annual real GDP growth.

For quasi-government agencies such as schools and government research institutions, all public media including TV stations and newspapers, the appropriate benchmark might be growth of overall deposits at 13.8 percent in 2013. Using this method, the fiscal contraction of weak quasi-government consumption was at RMB937 billion in 2013 - or 180bp of GDP in 2012.

This is a big number and we don't want to make too big calls as some of the quasi-government agencies might be fully out of the control of the government. In this regard, we can perhaps assume the actual fiscal contraction impact of those quasi-government agencies is around 90bp on real annual GDP growth - assuming close to half of those agencies are out of government control and factoring in some CPI inflation.

Are you saying that China's economy partly depends on corruption to grow?

Though in the short run corruption could grease the wheels of commerce, sustained growth would be sabotaged by rampant graft as corrupt officials generate an increasing amount of red tape for rent seeking.

What can China do to expand GDP growth without corruption?

To reduce the impact of the contractionary fiscal policy as a result of the anti-corruption campaign, we think the Chinese government should spend the extra government savings on welfare projects such as social housing and health care, and infrastructure projects, especially in the western region of China.

Lu Ting is a Hong Kong-based economist at Bank of America Merrill Lynch.