Chang-Tai Hsieh:	Thanks, thanks Steve for that generous introduction. I can't begin to tell you what a pleasure it is to be back here. The campus looks totally different from what I remember as a student, but I think from the number of students I spoke with this afternoon that spirit of [inaudible 00:00:25] still is the same I think as the spirit when I was a student when I was sitting in your chairs. 
	So, Steve really laid out the introduction of what I want to talk about. This is really a culmination of years of struggling of how to think about what has gone on in China. So, perhaps the way that I'll start is let me just start by moving back in time 15 years. This wasn't that long ago, and I'm going to start in the '98 year and just show you some data on what the Chinese economy looked like in 1998. 1998, at least for researchers, is important because that is the first year in which one could get access to a firm level of census level of Chinese firms. So it's really starting at that time that one can really being to understand what is happening in China. So let me just show you some of the facts. 1998 was that long ago, I was still in graduate school in 1998. And the way I want to think about it is if you look at the Chinese economy in 1998, nobody would have thought, at least certainly i did not think, that what would have happened in China ... In 1998 I certainly did not think that what eventually took place in China would happen.
	So if you look at the Chinese economy at the time, it was an economy that looked like it was in pretty desperate straights. It was dominated by state owned firms. Just to give you a number, 60% of employment and investments, this is from the firm level records, was by state owned firms. Private ownership was illegal for firms above a certain size, specifically firms that are above the size of 71 or higher workers as a prior firm you couldn't do it. So you had to find some other creative way of trying to grow if you want to run a business. These state owner firms that were dominant, they were largely these large inefficient money losing dinosaurs. So just to give you some of the numbers, the average state owned firm in that year lost an equivalent of about 8% value of the firm. They were never closed and they were kept live through massive infusions of cash from the state banking system. But obviously what that did is it basically just shifted the problem from the firms to the banks so then they were left with the banking system that was crippled with a very large portfolio of nonperforming loans.
	So the question then is ... One way in which you can begin to think about it is just ask yourself, suppose you were there in 1998 what would be the standard prescription? I would say that this is probably my best guess of what Steve's prescription would be and although he might not like it it's also true that this would be the standard prescription around the lunch table at [inaudible 00:03:41]. Would be just that what do you do when faced with this economic situation? The first thing you want to do is obviously it makes no sense to restrict private ownership to firms that are small. So the first thing you want to do, you want to remove the barriers that prevent private firms from growing. That seems to be a no brainer. 
	And the second thing that also seems to be a no brainer is what do you do with the large state owned sector? Well, some of these firms you think are pretty hopeless so the ones that are hopeless you just want to shut these firms down. But some of them you think that might have some hope of them making it, but he have a huge amount of evidence throughout history, and that is from all the countries of the world, that politicians typically do a very bad job at running firms. So what you want to do is that ... To the extend that these are firms that you can save, you want to save them off. You want to sell them off to people that have invested interest in trying to make these firms run well. So the question then is this what happened in China? Okay? 
	So the way I want to start this is to being to answer this question. I want to just go to that fabulous book that's out by Daron Acemoglu and Jim Robinson, I don't know whether it's on the syllabus of any class but it's a book called "Why Nations Fail" and it's a gutsy book, let me put it that way. It's essentially a book that has one story, one explanation for 3,000 years of world history. And if you think about that that's pretty gutsy, it's pretty gutsy to think that you could have one story that could explain everything that has happened in the world in the last 3,000 years. But what's lovely about the book, at least for me, is it walks you through some stories of what has happened in different regimes of the world and tries to tell this consistent story of when do states fail and when do states succeed. So what's lovely about that book is everything I know about the rise and fall about the Roman Empire comes from this book, which if any of you are scholars in the rise and fall of the Roman Empire I'm guessing that's going to be pretty sad. But there's a chapter on the rise and fall of the Roman Empire, there's a chapter on Venice I love the chapter on Venice, there's a chapter on the Mayans, there's a chapter on the Aztecs.
	So the book really walks you through world history. And then in chapter 17 or 18 of the book, they get to China. And they tell the follow story of China and this is a story that they got from the correspondence of the financial times in Shanghai, this guy called Richard McGreggor. And they tell the story of this one particular company called [inaudible 00:07:04]. It's actually an episode that's well known in China. So what is this firm? It's a private firm and this was a private firm that started in the early 1990s and this was a guy that ran a small steel plant, it was a relatively small steel plant. In the early 2000s he decided that he wanted to build the world's largest steel company, he thought that he could do it. He could have been crazy, but as long as it's his money why do I care? So what he did is he went to the local government of this small city called [inaudible 00:07:55], it's a small city up the Yhanghzi River from Shanghai and this is what McGreggor says about this guy he says as a low cost producer he thought that he could easily grab a profitable market share away from the relatively pampered state owned giants like Bau steel, 150 kilometers away down the Yhanghzi River near Shanghai. 
	So the way to think about what he was up against is in the early 2000s in China, the steel industry was dominated by state owned firms. So if you were going to enter into a market and if you turn out to be successful then the other guy is going to be hurt. And the other guy then is not going to be that happy with the fact that you want to take away some of his profits. As a mogul in Robinson's story is that consistently throughout world history what has happened when these kind of situations happen is that companies like Bau Steel manage to kill in some way. They may not kill, but they put tremendous barriers up to new firms that are threatening to take away their profits. But if you think about it, we think that it's precisely this process that drives economic growth. It's precisely this process in which Apple comes up with a new product and it looks like it's going to kill the Blackberry, it looks like Nokia is going to go to hell. And although the guys at Blackberry are not happy with this, although the guys at Nokia are not happy with this presumably the world is better off as a consequence of the introduction of the iPhone. Nobody talks about putting Steve Jobs in jail, at least not for this reason, you may want to put him in jail for other reasons.
	But what happened to this guy? This guy started to build in 2003, but the guys at Bau Steel were not happy and this was the largest and the most powerful state owned steel plant in China. So they were not happy, they put on pressure through the Chinese political system to try to get this firm shut down. So they were successful in doing so so orders came down from the Communist party to the banks to stop lending. The local party secretary of this town was fired and he was sent to supervise pig farms on the Russian border, which presumably he was not happy about being reassigned. And on top of that, they got this poor guy arrested and thrown in jail. So the poor guy spent 5 years in jail. So it seems clear, at least in this case, what was the real crime of this guy? And it seems clear that what was going on is an age old story. This is just a story we see that repeats itself again and again and again. And in this particular case this guy had the audacity to start a company that would compete with state sponsored companies. So it's pretty sensible on their part. 
	If you want to protect your profits, you can protect your profit that's coming out with a better product or you can do it by me copying your competitors. Both work in protecting your profits but one is good for welfare and the other method is not. But the story is that if you think about China within this broad sweep of world history, China is no different than other failed states. It's no different from this long history of states that have failed. That is, it is a state where vested interests are protected and entrepreneurs are blocked and that eventually the system is going to crumble. Let me just give you one more piece of evidence, because again this is sort of the same piece that Steve made. 
	Let's look at some indicators of the quality of the Chinese institutional environment. So, one of the things, I would say probably the only thing, that the world bank does that countries pay attention to is doing business indicators. The way to think about this is these are sort of like the country equivalent of the US news and world reports, they have all these flaws and then successful countries don't pay attention to them. But the countries that are ranked 50, that same way that a college is ranked 50, you can be sure that despite the fact that the college president says we don't care about this thing, he is watching this with an eagle eye. So, I have seen finance ministers jump when these indicators come out. So let's look at how China does in these measure. There's a summary statistic that's called the ease of doing business, it's essentially the weight average of all the different things that this survey measures. So, China is ranked 91 out of 180 countries in the world so it's about the same, in terms of doing business, as Guatemala and Zambia. And it's significantly below the Peruvians, which is ranked 43, and below the Mexicans, which is ranked 43. 
	A second indicator is the ease of entry. There's a typo it's not east, it's ease of entry. And there China ranks 151, which is actually lower than the Congo, the Congo is 150. And it's below the Iranians, which is 87. And the Pakistanis. So in China people talk, you go to China and there's this trimorphous tone of how many years is it going to take before China overtakes the US. Nobody talks about how many years is it going to take for China to overtake the Iranians or the Pakistanis or the Peruvians. But you can see the tension here because if you look at all the indicators and if I gave all this information to you and you didn't know that this was China, you would have been nodding your head and saying this country is in unadulterated economic disaster. But you know that from looking at the outcomes that this is a place that in the past 15 years there's been the kind of growth in the private sector that we haven't seen anywhere else in the world. So I won't insult your intelligence by showing you the numbers, but this is something that you know from just looking in your pockets. There's been this tremendous explosion of entry of new firms and there's been this tremendous growth of the private sector as well.
	So the first thing that has happened in China, on first order fact, there has been tremendous growth in the private sector. The second fact is what has happened to the state sector in China? Remember we talked about how the state sector was dominated by these large state owned dinosaurs? So ask the question, what does the Chinese state sector look like now? So you can ask were the state owned firms closed or privatized as we think that should have happened to these firms. And the answer is sort of, and I'll give you more details on what exactly happened, but it's still the case that we sort of know that there's still a very significant presence of the Chinese state in the economy. So there's lots of news accounts about ... This cover page in the business week last year is representative. There's a cover story about how can America beat Chinese state capitalism. 
	So what is this thing? What is Chinese state capitalism? Nobody talks about how can America beat Indian state capitalism or Mexican state capitalism. So let me just give you another statistic: If you look at the Fortune 500 list last year, so this is the list of the 500 largest companies in the world, there are 69 Chinese companies on this list. And 65 of them, by my counting, are state owned firms. So the largest Chinese firms are not private sector firms. The largest and the most successful, in terms of revenues and profits, are state owned firms. So I'm not making a welfare statement here, I'm just saying these are what the facts are. So in order to get some sense of what has happened to the Chinese state owned sector before going into ... 
	Let me just give you some more institutional details by just talking about one company which is our old friend the state owned steel company. So this was the company that was featured in the book. So what is this company? This is a company that it's original name was Bau San Steel, it's a company that's based in Shanghai. And in the mid-1990s it was your traditional state owned dinosaur. It employed 150,000 workers, it was losing, on average, about 1 billion US dollars every year, it was centrally controlled by the Chinese Ministry of Polergical Industry. So what happened to this firm? What happened is that the Central Planning Ministry was closed in 2000 and Bau San itself was legally closed in 1990. And then what happened at the same time is that a new company was created, it was called Bau San Company Limited and then all of the assets of the old state owned firm were transferred. So it's clear that the company was not closed, there was just a new legal entity was what was created to be the legal owner of the firm. And at the same time that this new firm was created, the firm was publicly listed. 
	And since the year 2000 this company has grown by leaps and bounds. So some of it is coming from handicapping its competitors so it's clear that that's an important part of what they do. But it seems like the company is no longer this old state owned dinosaur, it's this aggressive state owned firm. But the question is what is this firm? It's a publicly traded firm, so this might look and smell like privatization. We normally thing of this as a firm that is private. And then in the Chinese statistical data, because the firm is registered as a publicly traded firm it's listed in the data as being a private firm. And my guess is that he sophomore's endowment owns something of this firm. Maybe they don't know it, maybe they own it indirectly through a couple of hedge funds. But the question is was this firm privatized? And the answer is sort of, kind of. Because it's no longer this old central planning dinosaur. But let's dig deeper into the details of this firm. 
	If you look at the details of this firm, 25% of the equity of the firm is traded so if you're willing to spend a large amount of money the maximum number of shares of this company that you could by is 25% of the equity. So what that means is that you can never be the controlling shareholder of the firm. And 75% of the equity is held by this holding company called the Bau Steel group and the Bau Steel group itself is this holding company that also owns 6 or 7 large steel manufacturers and the Bau steel Group ... It's clear once you look at the details of this group that the chief executive of this group is directly appointed and evaluated by the central organization department of the Chinese Communist Party. So this is a very typical structure.
	So what is Chinese state capitalism? It's essentially firms like this, which is this weird mix of it's not quite a state owned firm but it's still a firm that ... These are typically firms that are publicly traded, these are firms that most of us own through our pension funds and through our endowment but it is still a firm where the chief executives ... That's the key control right over the firm. And if you know a little bit about China, the most powerful body in the Chinese bureaucracy is this body called the central organization department. You want to think about it as the personnel system of the Chinese Communist Party, they are the bodies that basically appoints seals of all the firms. They appoint all the governors and the party secretaries, they appoint the editors of every single newspaper, they appoint the presidents and the deans of every single university, so it's all part of this ... It's essentially this Soviet nomenclature system.
	But the question is ... I guess that's sort of not that surprising, but then the question is, again coming back to the previous one, we have a enormous amount of evidence that this type of governance system normally doesn't work that well. But the question is how can it be the case that you have a company where the CEO is appointed by the Communist Party's organizational department, how can it be the case that this company has seen the kind of performance that it has? So Bau Steel now is the 2nd largest steel manufacturer in world. And if you look at the 7 companies of this group, if you take them all together, they are clearly the largest steel manufacturers in the world. And it's not that they're only exploiting the [inaudible 00:25:15], this company is also a major exporter as well. 
	So all I'm doing is I'm just putting some more institutional flesh on the way that Steve posed the puzzle. So with all that, let me begin to lay out a story of the way I think one can begin to make some sense of this. And the way that I want to start is that I want to tell you 2 stories. The first story I want to tell you is about what happened in the aluminum market in China and this is really interesting because this is ... If you go back and you read the original series of articles in the Financial Times that Acemoglu and Robinson took their story about [inaudible 00:26:09] you're going to realize that those articles are not about [inaudible 00:26:16], the articles in the Financial Times where that story came out is actually about the aluminum market in China and it's a story about how this one particular private sector firm was able to make it in the aluminum market. 
	So the story is the following: The aluminum in the mid-2000s was like the Chinese industry. It was monopolized by state owned firms, in this case the aluminum market was monopolized by this company called the China Aluminum Corporation, Chinalco for short. And, again, the structure of this company is very much like the structure of Bau Steel. It's an old state owned firm, it was reorganized, it is now a publicly traded firm. And according to the article in the FT, the main assets, the one key resource that the China Aluminum Corporation had was that there were these set of rules put in place by the Chinese Central Government that the China Aluminum Corporation was the only company in China that was allowed to get access to the reserves of bagsai, which is the main mineral that one needs in order to produce aluminum. And on top of that, they were allowed to pay essentially close to nothing for the reserves of bagsai. So if you were a company that makes aluminum and you get your main input at almost 0, you're pretty much guaranteed a large profit regardless of how inefficient you are. So the key thing is that the reserves of bagsai in China is located in this particular place in Hunan Province in China.
	So what happened here? There was this private company called the East Hope Group, it's one of the earliest private companies in China. So the way to think about this company is that it's essentially the archer denial midlands of China, so it buys stuff from farmers and sells it to other farmers or it sells the material to food processors. So this company started in 1982 in the rural Sichuan Province and the first product was they were selling krill legs, and later the company expanded to pig feet, and then it expanded to chicken feet. So this was the bread and butter of the company. 
	The chief executive of this company is this character called [inaudible 00:29:31], if you've ever seen him or heard of him the guy is a character. He's currently the 6th richest person in China. There's this list that comes out in China every year of the 500 wealthiest people in China. People in Chine either they really want to be on the list or they're terrified of being on the list. This guy is a pretty wealthy guy. He first made his money selling pig feet and later in the early 2000s, about the same time that poor Mr. Die wanted to go into the steel industry, he decided that he wanted to go into aluminum. But the guy wasn't so very savvy, he knew exactly what he was up against. He knew that he was up against this powerful state owned monopoly. So when the FT interviewed him afterwards, after he was successful, he asked them what was the main obstacle that you had to deal with in order to start your company? This is what he said: "The first thing on my mind is I needed to make sure that my company did not become the next [inaudible 00:31:00]." So what happened to the other guy was very much present in his mind, he said it is a lesson for us all it was a tragedy. And this guy was a much savvier political operator. 
	So what did he do? If you look a little bit at the industry, it was clear to him that the main thing that he needed was access to bagsai. And he knew that the bagsai reserves were controlled by this local party bosses in this place in Hunan province. So he says, this is what he says he did, he went to the local party secretary in Hunan province and he knew that the local party secretary in Hunan province was not very happy with the deal the central government had cut with the China Aluminum Corporation because he was being forced to sell his holdings of bagsai at below market prices. So nobody exactly knows what kind of deal he reached but maybe it was something along the lines of I'll pay you market prices plus something extra if you'll give me access your reserves of bagsai. The China Aluminum Corporation were obviously aware this was going on so they fought the [inaudible 00:32:30] group and Mr. Lix every step of the way. In this case, the local party secretary was either strong enough or he had a high powered incentive to try to make this deal take place. 
	So they had a deal, it held up under the attack of the China Aluminum Corporation. [inaudible 00:33:04] Group started to sell aluminum in 2005 and it basically killed the China Aluminum Corporation. The China Aluminum Corporation used to have 98% of the share of the Chinese market and by 3 years its share of the market had dropped to 50%. So the China Aluminum Corporation was not happy about this deal but [inaudible 00:33:35] Group was happy and the local party secretary was happy as well. And the other thing that I find really intriguing about the story is that the boss of the local party secretary, that is the preventive party secretary of Hunan Province at the time, was ... Does anybody know who was the party secretary of Hunan Province 2002 through 2004? Who? The party secretary at the time was this guy called Mr. Lee Kuchang. And hopefully you guys know who he is. A few months ago he was named the Chinese premier so he's basically the second in command in China. 
	So if you think about what do we learn from this? The first thing is that the guy was rich because of the other business he ran. So when the centrally controlled state owned bank cut its credit, the guy had money so he was able to keep on going. But he says when he was asked what was the most important thing, this is what he told the reporter in the FT, he says, "Forgive me for being frank, but local officials, even corrupt ones, all need to have political achievements." Okay? 
	Let me get to case 2 ... The second story I want to tell is about General Motors in China. General Motors is the largest car manufacturer in China, last year sold about 2 million cars in Chine. And if you look at GM's annual report, at least from last year, profits from China accounted for 70% of profits of GM worldwide. So GM is losing billions of dollars in Germany, it's not making that much money in the US, most of its money is coming from its operations in China. So lets look at GM's operations in China.
	GM operates in China through a joint venture, so it's through a company called Shanghai GM. Shanghai GM is this company that is 49% owned by GM and 51% of this company is owned by this other company called the SAIC Motor Corporation. What is the SAIC Motor Corporation? This is a company that was a state owned firm. So it is a company that was very much like the China Aluminum Corporation or the Bau San Group with one important difference. The SAIC Corporation is not owned by the Chinese Central Government, it's owned by the local government of the city of Shanghai. So it's a company where the CEO is appointed by the party boss, really I mean party boss the way you want to thing about these guys these guys are really like mafia bosses. Think about Vito Corleone in the Godfather, this is what these guys are like. And this company was originally a state owned firm and it owns 51% of this joint venture with GM and it runs 2 other companies in Shanghai. It also owns another joint venture company, this time with Volkswagen and it also independently runs its own company as well. So think about this, GM is in business with another company that is essentially also its competitor because its partner also runs 2 other firms as well. 
	So what did GM do? So, again, if you talk with the executives of GM they currently view that their Chinese operation is their most successful venture. When I look at what they did, this is my interpretation of what they did, GM's business model, the way I would describe it, is that their model is to basically sell the worst possible cars that they can sell in the Chinese market at the highest possible price. So let me first just give you some of the facts and then we can think about why they were able to do this and what are the welfare implications.
	When this company started out about 2001, the first car that they sold was the Buick New Century. Let me show you a picture of their pride and joy, this is the Buick New Century. And it retailed in China at a price of $44,000 and this car went out of production in the US in 1992. And this for a long time was the best selling car in China. And you think about it from GM's point of view, what do they want to do? They want to make money. Businesses don't care about welfare, they care about their profits. So what they were up against was they were fully aware who their partner was. So they wanted to make money. Normally, when you want to make money you want to introduce the best possible products. You want to introduce the products that your customers want. So it's not that Chinese consumers are dumb. One of the most widely blogged about things in China is how expensive cars are in China. It's not that they're not aware that GM is selling them a total dog. 
	They're totally aware, but the fact is that the owner of this company is the local government of the city of Shanghai and the main thing that the local government of Shanghai cares about are the profits of the firm. The nature of the regime is such that if consumers complain about the fact that they only have access to bad cars, it's a political system that for obvious reasons that doesn't quite matter. But also from GM's point of view, they were fully aware that their partner was also their competitor. So they want to make money and they other thing they also wanted to make sure, they wanted to make sure that their partner never learns to make a car that everybody in their sane mind would buy. So they wanted to make sure that the cars that their partner learns how to make are cars that if the were in a free competitive market they would never be able to sell. So that's the way I think about what GM's strategy was.
	So the second car that GM introduced in the Chinese market ... The Buick was sort of their Cadillac so they needed a car that was smaller and cheaper, so they looked around the world in all their subsidies and they asked what is a mid-sized car that nobody in their sane mind would buy? And they found this car in their German subsidy [inaudible 00:42:28] and this is their subsidy that is going bankrupt. So the second car that they introduced was this car. So this is a picture of the [inaudible 00:42:42], not sure whether this is East or West Germany it looks like East Germany. And this was GM's adaptation of the car. So they basically just took the blueprints of this car, they transferred it to China, and they set up the factory, and they rebranded this car as a Buick and this retailed for $35,000. So when you look at this number, it's clear who the losers are. It's obviously Chinese consumers that are the losers from this strategy. Yeah? [inaudible 00:43:25] This was in 2003. 
	So before they lose hope, the really interesting story comes from their 3rd car. They just continued their strategy so they needed a car that was slightly smaller, so, again, they looked around the world and they asked what crappy car can we bring to Chinese consumers. And they found it in their Korean subsidiary [inaudible 00:44:01], so they took the design of this car it's a really small car I'll show you a picture in a minute. And their plan was to rebrand this car as a Chevrolet Spark, as their entry level car and they were going to sell it for $25,000. Now what happens is that ... They were in this process, but before they were ready to sell ... 
	So roughly 6 months before they were ready to start selling this car they were shocked that some other Chinese company that they had no idea what this company was started to sell exactly the same car. This other company started to sell exactly the same car, this company called Cherry and they called this car the Cherry QQ. So what is this company and what is this car? Well let me show you a picture of the 2. So this is a picture of the 2 cars side by side. One of them is a GM car, the Chevrolet Spark that's this car, and this is the Cherry car. And there's these funny stories of the GM engineers, they bought a sample of the car, they opened the car up and they realized that it was identical it was the exact same car. They could take out the pistons from the Cherry car and they could just put the pistons ... You can see there some small differences the headlights are slightly different, so there's some local ingenuity there involved in the making.
	So clearly GM's strategy was leaking, but this is exactly what you would expect a market to do. They were selling bad cars at monopoly prices and what you would expect the market to do is try to cut into these profits and the lower prices for consumers. So the reason GM was able to do it was because of who their partner was. Their partner was essentially the party secretary of the city of Shanghai, who also cared about the profits and generally didn't give a damn about consumer welfare in the city of Shanghai. So the party boss of Shanghai was very happy with this arrangement until it hit into this problem. So what is this company? Where did GM face competition from?
	So now let's dig into this other company, Cherry. So this is a company that's based in this obscure city called Woo Hoo, it's a city of about 600,000 people so it's a small city by Chinese standards based in [inaudible 00:47:08] province. So before Cherry came in it was a pretty poor place. This company was essentially started by 3 engineers that worked at the state owned firm called First Outer Works. And this company by the mid 1990s was going bankrupt, like lots of state owned firms, so these guys decided that they had no future in this state owned firm and they wanted to take their skills and their knowledge and start their own car company. So you want to start a car company, you obviously need lots of things. You need a license, you need land, you need capital, in the US we would try to find a venture capitalist to try to provide the seed financing that we need. Obviously that's not what these guys did. What they did is that they basically went to the party secretary of the city of Woo Hoo in 1996 and it's clear to the party secretary of this small city thought that these guys were like manna from heaven because it was a poor place. He was seeing that other cities around him were getting rich and he thought that this was his chance to try to make it.
	There's a quote I found from a Chinese newspaper in which he says something along the lines of, "You let me take care of the licenses and the land, you just focus on getting some cars built here and then I will take care of everything." And this was important because you needed to have a license from the central government in order to build cars. The city of Woo Hoo and Cherry did not have the license, so the party boss of Woo Hoo told these guys don't worry about that I'm going to take care of that for you. So by some mechanism he did it. So these 3 guys needed an assembly plant so they went and they found a car factory that was shut down in Spain, they disassembled a factory, shipped it to China, and the first car that they made was a clone of the Volkswagen Jetta. The clone didn't sell that well. The second care they made was the clone of the Chevrolet Spark and that car actually ended up being a best seller in China. But the GM guys can't complain that guys because the Chevrolet Spark was in itself just a clone of the [inaudible 00:50:14] car. 
	So what is this company? What's key about this? So it's clear that these guys did not approach the party secretary of Shanghai and it's pretty clear why because they know that their main competitor is essentially the party secretary of Shanghai. It's that guy and that particular local party organization that's going to get the profits and the glory if the car industry is successful. So they went to this other city that they thought was going to be more receptive, that had high powered incentives to get this done. So what is this ... Let's look at more of the details of this company. Cherry is actually legally registered, if you look at the data and you look at the registration of this company, it is registered as a state owned firm. The majority shareholder of the firm is the local government of the city of Woo Hoo. So in the data this company appears as a state owned firm, but this company is now the largest exporter of cars from China. So this company now has 10% of the market shared in Chile, it has 15% of the share of the market in Bolivia, it has 5% of the share in Mexico, and it has 0% of the market share in Shanghai.
	So you can ask the question, is this company really a state owned firm? Or GM, it is legally registered as a foreign firm. So in all of our data, GM is counted as a private firm. But if you look at the behavior of these 2 firms, which firm is the state owned firm that lives off rents and which firm is the firm that lives off trying to meet the needs of its customers. So really I think if you look at the behavior of the firm I think really the way you want to look at it is Cherry, despite the fact that it's legally registered as a state owned firm, really is a Chinese private firm. Now, the local government of the city of Woo Hoo owns 55% of the firm, but maybe one way you can think about it as mafia blood money, or maybe you want to think of it as the equity stake of the venture capitalist if you want to use terrible terms to think about the company. 
	But the company did get created and it's not just that bur basically everything that the company needed in the city was done. They got the credit that they needed, the roads were built, they got the land that they needed to set up the plant. And I'll come back to this later, the land was all expropriated from the local farmers. But that's the process by which these things take place. So they had the power, they had the roads, they had the credit, they had the land. So they got the basics quickly in terms of what they needed and it is now the most successful "private" car company in China. And it's clear that what was key here ... So if you want to start to think about what was key in this case, what generated the competition in this case? It's the fact that Cherry had options. It was not forced to go to the party secretary of Shanghai. There were essentially lots of other places that they could go to and each one of these guys, it seemed for whatever reason, they had high powered incentives to get this deal done. 
	So what is the story then? This is McGreggor's story so this is, again, the correspondent for the FT. So this is the way in which he describes the Chinese system and I think that he is right on in terms of what is the model. So, again, just want to be clear, we're not saying anything about welfare so far. Think of this as a positive story of what's gone on in China in the last 15 or so years. So the first part to think about is that, this is what he says, "Local party secretaries have dictatorial powers and are a dangerous enemy for anyone who takes them on under his controls." They way you want think about it is that you essentially have local party secretaries that are essentially local mafia bosses and they control absolutely everything. They control the courts, they control the media, they control credit, they control land. So it's essentially a mafia boss with essentially no checks. He can lock up practitioners and any other activists who challenge you, prevent rivals from advancing within the local government through control over appointments. So this by itself seems like a recipe for economic disaster. Normally because so far this describes Stalin, seems like a recipe for disaster. 
	But then he starts to add this nuance, "When it comes to the economy, however, these same powers make the local party secretary a ruthless competitor. You want a business license? The locality will assign someone to do the walking and talking for you. Want a building permit? They'll give you one with money back guarantees. Unhappy about the dirty creek passing through the site? They'll offer to build a small lake for you." And also what's unsaid is that it's also ... You want to think about pollution in China? It's coming from exactly this mechanism. You want to dump as much waste as you want into the local river? No problem, go right ahead. It's exactly this same institutional set up. "They'll help you find architects and builders and recruit workers for a reasonable fee. They sell their cheap electricity and sell their parts and entertainment, sell their easy transportation, sell their water supply, sell their glorious history, and even sell how gook looking their girls are." So lots of party secretaries have actually done this, have tried to advertise to Taiwanese firms and Korean firms how good looking the women are. 
	So he goes on to say, "Each locality operates like a standalone economy. Localities prompt investment, strong arm banks for finance, and often hold shares in the businesses themselves. They'll operate much like a company might. At the same time the local party's overwhelming powers within it's own borders effectively make each district its own separate jurisdiction with direct control over the courts and over local regulations governing business activities." 
	But the other part is that these same powers, there's no reason why these same powers are going to be used to create wealth. You could very easily use the same powers to try to extract wealth, to do what the Bau Steel company tried to do. You could use exactly the same powers to do what General Motors tried to do in Shanghai. So what McGreggor doesn't say, which is what I think is key, is that on top of this you also have this system where there are options. It's a big country, you don't only have 1 local mafia boss you have 3,000 of them. And I think that my sense is that that really has been the saving grace of China, at least in the story of the car industry that's what seemed to indicate. In terms of GM, the commercial goal of selling more GM Buick's and Chevrolet's in China becomes a political and economic campaign to enhance the power and the might of the city of Shanghai. Think of it as Shanghai, Inc. where the Communist Party secretary is the chairman and the CEO. And what's key is that it's not just Shanghai, Inc., it's Shanghai, Inc. and Beijing, Inc. and Woo Han, Inc. and on and on. So read the news accounts that have come out in the last year about what the party boss of the city of [inaudible 00:59:44] was doing, the guy who was just brought down Mr. [inaudible 00:59:51]. 
	When I read those stories it just seems to me that this guy was so typical. That the party secretary of Shanghai behaves in exactly the same way, he does exactly the same thing. The thing which many people don't appreciate is that the 2 cities that he was the party secretary of, these are cities that when he was the party secretary experienced 20% growth per year.
	Really when you think about China, it's a system where American businessmen love China. They're in love with it because they basically get everything they want for free. But it's a system that totally screws over people and resources of production that don't have options. So poor farmers get screwed, political enemies get screwed. But you want to think, the world is the world with shades of gray. So let me just show you a picture to think about the welfare consequences of this. This is a picture of the city of Shanghai in 1990, so it wasn't that long ago I think I was still a student here at the time. So if you've ever been to Shanghai this is the Huangpu River, this is the traditional downtown, the place along the river, you can't quite see, is the famous Bund. And this place across the river was mostly farmland and small factories at the time. So keep this picture in mind and let me show you a picture of exactly the same place now. This is exactly the same place now. So this area, what is that? This is the Pudong district, this was all farmland 30 years ago. This is the only part of Shanghai with building restrictions, almost everything is new.
	So this seems like a massive creation of wealth, but now you want to ask the question how did this process take place. So the first thing is that you need to reallocate property right over land. So all this stuff used to be farm land, so normally you would expect the market process you go to the farmers and say I want to build 30 skyscrapers on your farm, will you sell me that farm? And what do you think the farmer is going to say? The farmer is going to say yes if you offer me a high enough price. And if the farmer is smart enough they're going to realize that the value of farmland when used as farmland is much less than the value of land when used to build 100 story skyscrapers. What happened in China was there was none of this market process. What happened was that every single farmer in the Pudong district was essentially expropriated. The party boss, the same guy who runs GM Shanghai, went to the farmers or sent his agents and said we need this land. We're going to offer you the market price and we're going to offer you these apartments in the suburbs of Shanghai. So lots of these guys were not happy with this but ultimately you're dealing with the party boss of the city of Shanghai so resistance was useless, so they all sold.
	So this is something that has happened everywhere in China. It's happened everywhere, every single jurisdiction through this process. So this is something that has been well reported in the media. The other thing that has happened is that the same thing has happened to the urban residents. So all the guys that used to live here, the same thing happened to them. The party secretary, or essentially the Shanghai housing bureau sent their agents and said we want this apartment building. Some of them fought, essentially they all gave in eventually. So this area was entirely built, all of this, all of Shanghai was built on expropriated land. 
	So you can think about why were they able to do this? It's absolute political power of the party secretary. You can ask what are the welfare consequences of this? It could have been the case ... This process ended up being like "land reform" under Mugabe in Zimbabwe. And clearly some of that did take place. A lot of the land was handed over at below market prices to cronies of the party secretary. But it also seems that for a lot of this land, the marginal product of the new use of the land is higher than the marginal product of the land which they were being used before. So that transformation of the reallocation of resources from the years when the marginal product is low to one where the marginal product is higher, that is an integral part of the process. It has happened by and large in China. It has not happened in a place like India, say. So this process for anybody that has spent time in almost any country in Africa, I think it's pretty clear that it's really really hard to generate this kind of a transformation. But normally if the value of my land goes up then I get the rent. In this case it's the party boss that gets the rent.
	Do I have 5 minutes or am I completely out of time, Steve? [inaudible 01:09:56] Okay, so let me just spend 2 more minutes. I was going to talk about state owned firms, I didn't quite get there. But let me just spend 30 seconds talking about state owned firms. The way to think about what happened to the state owned firms is that they basically grafted on this particular strategy of having local competition to how the restructured the large state owned firms. So basically the way in which the state owned firms were group is that these large state owned firms they were basically split up into 3 or 4 companies. 
	So if you look at ... Let me just give you an example. If you look at the Chinese oil sector there are basically 3 main companies in the Chinese oil company and 50 years ago this was one company. But it's part of this process. They were split up into 3 and these 3 companies now ... The chief executives are ranked relative to each other. If you look at the steel sector, there are 5 major state owned firm that are in the sector and they're all pretty ferocious competitors of each other. So 3 of these companies are owned by the Chinese central government, that's our old friend the Bau steel group, there are 2 other companies the Woo Steel group and the An Steel group. And there are 2 locally owned firms, what I mean locally is they're owned by Chinese local governments. I'll skip the data. 
	So let me just conclude. How do you want to think about this? The way I make sense of this is why does China look so funny? Why does China have these really funny localities to each other? And I think the way that you want to think about it is that it's this underlying tension. The underlying tension of there are these 2 goals. The first goal is this terror of losing political power. The first imperative was that they wanted to make sure that nothing like Tenement evert happened again, so the first thing they did was strengthen essentially the Leninist structure of the party. But they also wanted to have wealth. So they were trying to figure out a way in which they could get both things. So in terms of what they did to the private sector, it was clear that having a dynamic private sector is the key to wealth. But then that runs into a political constraint and the political constraint that it runs into is that if you have a large and prosperous private sector these guys are going to be politically powerful and you wanted to make sure that if you had rich guys who are politically powerful, these guys have to be under your thumb.
	So the private sector in this case is under the thumb of the bosses of the Communist Chinese Party and the Communist Party bosses are held in check through market competition and also through a series I didn't get to talk about, internal controls by the central organization department. And also by some weak external controls. In terms of thinking about what happened to the state owned firms, it's really the same dynamic at play. It is privatization of the large state owned firms was never ever ever one the table. It was never on the table because it's clear that ... It's the same logic that the problem with privatizing large state owned firms is that these guys are potentially not going to be under your political control. 
	But they also want to have efficient state owned firms so the best way I've heard this described, this is Hank Paulson's description of the Chinese system. Hank Paulson was the US Secretary of Treasure and he was also the CEO of Goldman-Saks that basically brought also Chinese state owned firms to the market. So the way that he describes it it, "I finally realized what the Chinese Communist Party wants is that they want to have a marriage of the Communist Party and Goldman-Saks." And I think that's a very apt way of thinking about what the goal is. If you think about it, if you can do that, if you have wealth and power, that is actually a pretty powerful combination. I do fear, i don't have time to talk about it, that it's a very distortional system and it's not likely to succeed in the future. But I'll stop there.