According to Xinhua, the official news agency of the Chinese Communist party, Chen Liangyu, the Communist party secretary in Shanghai has been fired. The stated reason was that "Comrade Chen Liangyu has been involved in the misuse of social security funds by the Shanghai Bureau of Labor and Social Security." According to Xinhua, Mr Chen was accused of illegally enriching relatives, protecting staff who broke the law and "creating malign political influences".
The misuse of pension funds involved a $404m, the equivalent to one third of the pension fund’s assets loan to an unknown company, called Fuxi. Fuxi was connected to two senior Shanghai officials – Zhu Junyi, head of the pensions bureau, and Qin Yu, a former personal aide to Mr Chen. The loan allowed Fuxi to buy the toll road between Shanghai and Hangzhou.
The fact of the loan is not unusual. Most if not all loans in China are made because of connections to high officials within the Communist Party. The fact that the loan was being attacked and investigated is unusual. The reason is most likely that Mr Chen represents an attack by Hu Jintao, China’s president, against the allies of his predecessor Jiang Zemin, whose power base included many high ranking officials for Shanghai.
The point of this arrest for investors is that it illustrates the limits of guanxi in China. In a legal or relation-based systems like China, people cannot rely on the law, so they rely on relationships and connections, known in China as guanxi. These relationships usually have some connection with the Communist Party.
The problem with relation based systems is perfectly illustrated by the problems of Chen Liangyu and his colleagues. Power is ephemeral. You do not know who has it, how much they have and how long they will have it. After Deng retired, Jiang went after Deng’s associates who had allegedly been active in corrupt activities. Deng’s associates, like Jiang’s friends in Shanghai had undoubtedly been involved in questionable practices, but so has everyone else. The difference is that if your connection to power in China changes for any reason, so does the support for your investment or deal.
Unlike rule based systems, in China what exists now can change rapidly. Your contracts, corporate governance, terms of your investment anything associated with doing business in China can and will change overnight. The level of relation based system determines the levels of risk of investments in emerging markets.
Obviously, if risk increases, so will problems with sustainable economic growth. If your business and profits are dependent on your connections, your best move is to move fast while your connections are in good order. Any long term investment or strategic investment’s risk will increase to unacceptable levels. This increases speculation and eventually stagnation.
