Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: China’s 19th Party Congress, vaccine diplomacy, insider trading from home, and a look at the Microsoft antitrust case.
What to Expect from China’s 19th Party Congress
Entering the fifth plenum of the 19th Party Congress next week, the Chinese Communist Party (CCP) has much to celebrate: Beijing appears to have emerged from the COVID-19 pandemic with less scarring than its international competitors. The International Monetary Fund reports that China will be the only major economy to grow this year, thanks in large part to a surge in exports of personal-protective equipment and other manufactured goods.
Yet Beijing’s short-run successes have deepened structural economic imbalances that will likely handicap its long-run economic goals. For years, the Chinese leadership has attempted to transition from an export-driven manufacturing economy to a domestic-demand-driven service economy. After its last Party Congress, the CCP released a five-year plan emphasizing domestic consumption and entrepreneurship as the pillars of sustainable economic growth.
Those reform efforts have seen limited success: Household consumption remains below 40 percent, far lower than the 60 percent average in the developed world. Meanwhile, the Chinese economy remains overleveraged, with an overall debt-to-GDP ratio as high as those in advanced economies. The recent surge in exports, while a boon to GDP growth, also reveals an economy that has failed to gain sustainable footing.
Chinese president Xi Jinping is now advocating “dual circulation,” described as “a new development pattern that takes domestic circulation as the main body with domestic and international circulation reinforcing each other.” In a July speech, Xi said that trade tensions and slow global growth meant that China would need to modernize “the domestic industrial and supply chains, vigorously promote technological innovation, accelerate research on key core technologies, and create new advantages for future development.”
It sounds a lot like what Chinese policymakers have been saying for the past decade. In 2007, Premier Wen Jiabao acknowledged structural weaknesses in the then-booming Chinese economy, describing it as “unbalanced, unstable, uncoordinated, and unsustainable.” After the 2008 financial crisis, CCP rhetoric focused on harnessing its burgeoning middle class to ween itself off exports.
12 years later, the Chinese economy is yet more unbalanced, unstable, uncoordinated, and unsustainable. The forthcoming five-year plan will call for reforms to boost consumption and entrepreneurship, but if recent history is any indication, it won’t usher in meaningful structural changes.
Around the Web
The Financial Times reports on China’s coronavirus diplomacy: “China is promising preferential access to its Covid-19 vaccines to countries across Asia, Africa and Latin America, as Beijing uses inoculations as a new tool to bolster its ties with nations neglected by the US.” Over the past few months, Beijing has raced to produce a vaccine, beginning clinical trials well before other countries in a risky bid to score a diplomatic victory.
After a years-long legal battle, the Justice Department reached an $8.34 billion settlement with Purdue Pharma, the producer of OxyContin. The Wall Street Journal points out that the sum is “largely symbolic: Because the company’s assets fall well short of $8 billion, it will pay $225 million and the federal government is expected to cede most of the rest to allow more money to flow to states, counties and Native American tribes.”
Remote work may have led to a spike in securities fraud. Bloomberg’s Elisa Martinuzzi: “Banks are suddenly having to grapple with an explosion of interactions taking place away from their direct oversight. From Zoom to Skype to WhatsApp, bankers are often encouraged by clients to connect on platforms that are hard to vet.”
In a 2001 paper, NYU economist Nicholas Economides evaluated the antitrust case against Microsoft brought by the Justice Department in the 1990s. He found that the proposed breakup would lead to higher prices and have little effect on long-run market share in operating systems:
DOJ’s two-way breakup plan was premised on the hope that an autonomous applications company would create a new operating system to compete with Windows. But more than 70,000 applications run on Windows, creating what the government calls “the applications barrier to entry” in the operating-system market. However capable the new applications company, it still wouldn’t be able to single-handedly create a successful rival operating system. Separately, even with a new applications company’s support, Microsoft’s biggest operating-system competitor, Linux, is unlikely to become a serious desktop threat to Windows.
In my opinion, the breakup as proposed by the government and imposed by the District Court will have detrimental effects. First, the breakup is likely to result in higher prices. If DOJ is correct and Microsoft kept its OS prices low so that it can exercise its monopoly power in the adjacent browser market, the post-breakup Baby Bill that inherits the operating systems will have no incentive to keep the price low. The OS Baby Bill will no longer have the incentive to disadvantage any applications companies. Thus, if DOJ’s theories are correct, the OS Baby Bill will now exercise the monopoly power it has and raise the price of the operating system to the detriment of consumers. If DOJ is correct and Microsoft has significant monopoly power because of the “applications barrier to entry,” higher prices will be the direct result of the breakup. Second, as explained earlier, the breakup is likely to eliminate the efficiencies that make Microsoft a flexible and formidable competitor.
The breakup is likely to temporarily eliminate the incentive for interference from OSs to applications and vice versa. Of course, the same could have been accomplished by conduct restrictions without the cost and the disruption of the breakup. Moreover, the District Court did not impose permanent restrictions on the post-breakup functions of the companies. The OS and the applications Baby Bills may enter into each other’s business soon after the breakup. It is very likely that a few years after the breakup, one of the resulting companies will dominate both markets.
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