It is only a matter of time, we are frequently told, that China will be the dominant economic power in Asia, if not the world. Just like in any other country, those best positioned in China to assess the future strengths and weaknesses of the nation’s economy are its people, especially its economic elites.
If that is the case, then the message is sobering indeed: China’s rich want to leave the country and take their wealth with them — a fact that has already led to a massive capital flight from the country and property booms in recipient economies such as the U.S. and Australia. One motivation driving the rush is the desire of some to protect ill-gotten gains. More broadly however, the reality is that Chinese elites feel far less confident about their country’s future prospects than outsiders realize, meaning their expectations of economic dominance are far from assured.
5.2 million people and counting
But first, let us consider: Who are the elites and who owns the wealth in China? The common assumption is of a large and cashed-up middle class comprising tens, if not hundreds, of millions of people, and that these middle classes are sufficiently wealthy to transfer some capital abroad.
Calling the economic elites in China “middle class” is not really accurate. The wealthiest 1% of urban households in China (about 2.1 million households, or 5.2 million people) have a combined net worth of about $4.5 trillion. When one traces their liquid assets such as cash, bank savings and holdings of stocks and bonds, the top 1% of urban households own around 30-50% of all such liquid assets in the country.
In addition, this group of the richest 1% of urban households is also estimated to own around 30% of all real estate assets in the country. In 2010, the combined value of all financial and real estate assets in China was about $10.5 trillion, according to China’s Bureau of Statistics. This means the richest 1% of households (2.1 million of the total of about 530 million households) own 40-50% of the country’s total real estate and financial assets.
Second, how do these elites view China’s future?
There is ample evidence to suggest they want “out.” Take Hurun Report, a leading private publishing and research group that tracks the behavior and attitudes of China’s richest people. In a 2014 survey of almost 1,000 Chinese each worth over $16 million, Hurun found that almost two-thirds had already made arrangements to leave the country permanently or are planning to do so. Astoundingly, the report estimated that one-third of China’s superrich have already left the country.
Interestingly, the U.S., which many Chinese believe is becoming yesterday’s superpower, remains the preferred destination. Of the 10,000 U.S. visas given out in 2014 under the American immigration program that grants permanent residency to major investors (requiring at least $500,000), 85% went to Chinese applicants. In a similar Australian program for business migration, Chinese made up 91% of the applicants last year.
Note that 90% of the 1,000 richest people tracked by the Hurun Report are either officials or members of the Chinese Communist Party. This should come as no surprise, as the importance of CCP connections for building up wealth quickly is well known. But it also means that those closest to privilege and power in the country are also among the most doubtful when it comes to their nation’s future.
Then consider the scale of capital flight as an indication of declining confidence in their country’s future. As is widely known, while China’s current, or trading, account is open, the capital account is largely closed, meaning there are significant restrictions on flows of capital in and out of the country. Current regulations allow individuals in China to move only $50,000 offshore each year. Exorbitant taxes are also generally imposed on the purchase of assets in foreign currencies, if such purchases are officially permitted and done by the book.
Beating the system
In response, Chinese citizens have become skillful at transferring large amounts of money out of the country. This is done through schemes such as “over-invoicing” of legitimate or false trading activity, which effectively means using a complicit trading company outside mainland China to exploit looser current account restrictions in order to shift money out of the country. Another way is to have financial services companies set up complicated schemes to bypass capital account controls. For example, a 2012 report by Global Financial Integrity suggested that about $3.79 trillion left China illegally through such over-invoicing of trade deals alone.
Moreover, it is generally the uber-rich — the top 1% of households — that have the means and connections to exploit these avenues to move their money out. Much of the money rushing into the Australian, U.S. and Canadian commercial and residential property markets from China is being funneled there as a result of intricately constructed schemes for the ultra-rich that have been running for a decade or so.
Chinese overtook Americans as the biggest buyers of foreign real estate in June 2013, with the value of sales to Chinese growing over 40% per year since 2012. Due to regulatory restrictions on the sale of existing residential properties to foreigners, almost a fifth of all sales of property not yet built in Australia are to Chinese buyers.
Such capital flight, driven by the ultra-rich, is truly alarming for Chinese authorities and is the key reason why Beijing will not consider a broad-based relaxation of capital controls. As Northwestern University professor Victor Shih has argued, if the wealthiest 1% of Chinese decided to reallocate 30% or more of their net worth outside the country — and surveys indicate this is entirely possible — at least $1 trillion would leave the country. In such a scenario, the People’s Bank of China would face the choice of flooding the domestic financial system with liquidity (and confronting the risks that such a policy carries), or having an illiquid financial system.
Consider as well what this says about the mistrust among Chinese elites toward their country’s own institutions, for example rule of law and guaranteed permanence of property rights. The problem is that these institutions are required if China is to join the approximately 30 or more nations that have escaped the “middle-income trap.” In Asia, only Japan, South Korea, Taiwan, Singapore, Australia and New Zealand have become advanced economies. All have very similar economic and political institutions.
China’s politically connected economic elites profoundly understand their country’s dilemma: Essenitially, further reform required for the next stage of economic development will require the CCP to release its grip on economic — and perhaps, eventually, political — power; and this could well lead to the dispossession of economic privileges afforded to well-connected party elites, if not present an existential threat to the party itself.
China may indeed overcome its challenges and join the exclusive ranks of high-income, advanced economies. But it seems a growing number of the country’s best, brightest and richest are not prepared to bet on that and instead simply want out.