Mini-Bond Protests in Hong Kong: A Wake-up Call for Securities Law Enforcement in China

Last week, the Congressional-Executive Commission on China held a hearing on whether China is stable. I raised the following question:

“In Hong Kong, there has been real anger about the Lehman mini-bond fraud. These instruments were sold to investors in Hong Kong as secure, low-risk investments, but they were actually risky derivatives, and people lost a lot of money. This has led to popular protests in Hong Kong and demands for compensation through the political rather than the legal process. I'm wondering whether this could happen in China. With the fall of the stock market in Shanghai and some of the other financial issues -- money flowing out of China in record numbers -- if investors in the middle to upper middle class have lost a lot of money, will they be a source of instability, especially as there are many of them in Shanghai or Beijing? If they cannot pursue their claims in court but rather take them to the political process, will that be a problem?”

While fraud, especially insider trading, is widely believed to be rampant on the Shanghai and Shenzhen exchanges, I suspect the answer is, in general, "no". (I wouldn't be surprised to see an occasional organized protest, similar to the mag-lev protest in Shanghai, if an entire issuer goes under.)

Nevertheless, the PRC securities regulators should take the market drop and the implications thereof in Hong Kong as a wake-up call to vigorously enforce China’s nascent securities law regime. When markets are booming and everyone is making money, enforcement is easily overlooked. We saw this in the U.S. But now that the markets have dropped, enforcement is key to making sure that the markets will function properly when the money starts returning. Failing to do so could jeopardize the economic growth effects of the securities exchanges, which, in turn, would harm the ability of Chinese companies to raise capital and create jobs.

Moreover, justice is an important release valve for social pressure. Given that corruption and the popular sentiment against it are the gravest threats to stability in China (they serve as lighter fluid on the firewood of unemployment and/or inflation), breaking the corrupt practices in Chinese stock markets -- assuming rumors to be correct -- would be an important step towards further stabilizing the economic and political Chinese system. Given China's important role in the interconnected global economy, this is critical, for China and for the U.S.

China needs "tort reform with Chinese characteristics"

China has been faced with the problem of unsafe products and dangerous construction and environs for many years. The 2008 scandals over the collapse of school buildings following the Sichuan earthquake, lead in toy products, and melamine in milk have brought these issues to the fore.

I recently published a paper on the topic that looked at the development of Chinese tort law prior to these recent scandals. The paper analyzes the new tort laws and regulations issued between 2001 and 2004 and looks at the policy reasons behind their adoption. It then offers several policy recommendations:

- adoption of the Tort Law under consideration by the Chinese legislature,
- increased use of class actions in China,
- increased used of contingency fees for lawyers to help injured parties access justice, and
- renewed commitment for judicial independence by reorganizing the courts to be separate from local governments, looking to the Chinese military as a possible model.

"Tort Reform with Chinese Characteristics: Towards a 'Harmonious Society' in the People's Republic of China" can be accessed from the San Diego International Law Journal, volume 10 number 1, 2008, or on SSRN.

Congratulations China!

Congratulations to China for hosting an historic and exciting Olympics. This event should be understood in the context of the last 150 years of Chinese history, when China was attacked by Western powers repeatedly, was semi-colonized, had its treasures looted and burned, and suffered division, warlordism, the Japanese invasion, World War II, Mao's Communism, and more. Deng Xiaoping's Reform and Opening Policy has brought about amazing change in the lives of 1.3 billion people. Although much work remains to be done, today is a day to celebrate the enduring spirit of the Chinese people -- warm, welcoming, and even courageous. The Chinese people should be recognized for welcoming the world into Cultural China. Go Beijing 2008!

Justice and the Organization of Local Government

According to reports by CNN, a protest on Monday in a rural town in Guizhou Province, China was set off by the recent murder of a teenage girl and by the authorities' subsequent refusal to act against the suspects. Local townspeople believe the girl was raped and murdered by persons with close connections to the local government. Police have labeled the death a suicide, and when her uncle complained to the authorities about this conclusion, he was beaten and sent to the hospital. The incident drew enough popular outrage that the public set fires in front of the local public security bureau. Armed riot police now patrol the streets.

Reports indicate that corruption and intimidation and a correspondingly violent public reaction of this type are not unusual in rural China. The exact details of this incident are not and probably cannot be known under current conditions, but assuming the facts underlying the protest to be true, they highlight how the concentration of government power at the level of the local government can lead to abuses of power and thus to an inharmonious society. "Village emperors" who may be local industry leaders or government officials, dominate rural society in their respective localities through their formal and informal power over the levers of government and local industry, institutions which are often intimately (legally and not legally) intertwined. Local governments own and support businesses, and to secure such support, businesses take on local government officials as investors and partners. Should anything get in the way of either's interests, the village emperors have the levers of government and economic power at their disposal to remove -- fairly or unfairly, politely or impolitely -- the threat.

Because of the unitary organization of the Chinese government, the local population has little ability to check the behavior of these well-connected individuals. When incidents of abuse of power occur, complaints to the police at best fall on deaf ears and at worse on the ears of the agents of the tormentors themselves, leading to the kinds of beating and public intimidation seemingly evident in the Guizhou incident of late. China presently implements a system of hierarchical oversight as local authorities are overseen by provincial authorities who are overseen by central authorities. Chinese history presents many examples of local populaces appealing to higher authorities to correct injustices and malfeasances by local authorities. Unfortunately, recent history suggests that this system of oversight may not be enough.

Certainly, the standard "democracy and human rights" prescriptions would be helpful here. A free press able to cover incidents of local government misbehavior and elections where the public could vote malfeasant local officials out of office would go a long way towards preventing the abuses that lead to these kinds of social disturbances. Fortunately, China is already moving in the direction of a press that plays an greater oversight role in society, at least vis-a-vis local government. Although it has not yet expanded local democratic processes, it would seem that such a development is only a matter of time.

However, in the meantime and generally, China should consider whether additional steps may be necessary and helpful. In particular, whether a small adjustment to the organization of its courts and prosecutorial offices would be helpful in checking abusive potential of rural local governments. Quite simply, China should consider separating the management, budgets and personnel authority for the courts and the prosecutors from local government and placing those organs into a separate bureaucratic unit managed vertically, similar to how the military is organizationally distinct from the rest of the Chinese government. Providing for institutional checks and balances is precisely why police in the U.S. generally are under the management and budgetary authority of a city while district attorneys and courts are generally under the management and budgetary authority of a county or state. Such a reform would limit local influence on courts and prosecutors and thus permit those authorities to take action when the kinds of abuses in the Guizhou case occur at the hands of local police and local government authorities. Although not a guarantee of good behavior in every situation, at least the leadership of courts and prosecutorial authorities would not be directly indebted or accountable to the persons most frequently held by the public to be responsible for the abuses in question.

China could implement such a reform relatively simply and with little disruption to CCP governance or policy. Separating the courts and the prosecutors management, budgets and personnel from local government would simply mean that tax revenues from the locality directed to those agencies would have to be funneled upwards and then back down through centralized budgeting. Although personnel would be affected in that public security personnel could no longer be so easily dispatched to the courts or the prosecutors, this would be an improvement in the sense that the position of the procurate and the courts would be raised, making it easier for them to oversee the public security authorities. Finally, reorganizing the management of the courts and procurate would not in any way effect the political or policy directions of those agencies; it would simply mean that a different set of CCP officials would manage them from above rather than from the local level.

From 1949 to 1978, the CCP moved towards an increasingly unitary state structure. It unified the management and control of government agencies, industry, land, social welfare, and all aspects of life. Since 1979, however, China has recognized the value of separating institutions and has permitted farmers to tend separate plots and industries to separate from government control. China's central authorities may now wish to consider whether a reorganization of its courts and prosecutorial systems may be advantageous to the provision of justice to a seemingly impatient public, justice being a necessary ingredient of a harmonious society.

Heaven hears through the ears of the people, Heaven sees through the eyes of the people

Hong Kong Chief Executive Donald Tsang put his foot in his mouth yesterday, suggesting that when democracy is taken "to the extreme, and you have a cultural revolution, for instance, in China. When people take everything into his own hands, then you cannot govern the place."

Excuse me? Sure, when people have a mass revolution, you can't "govern the place," but that has nothing to do with democracy. I can see how a illiterate peasant in rural China might misunderstand the Chinese translation for democracy -- literally, "mastery by the people" -- for mass revolt, but Donald Tsang has no such excuse. A well-trained civil servant under British governance, Mr. Tsang knows exactly what democracy is about -- the orderly rule of the people through laws and procedures. In fact, democracy can be, perhaps unfortunately, all too conservative and anti-change. It is nothing like the quasi-civil war and self-hating chaos of the PRC Cultural Revolution.

Mr. Tsang's comments are revealing, not of his personal thinking, but rather of what he has heard from his colonial rulers in Beijing. Ever since Deng Xiaoping took power, China's leaders have been obsessed -- rightly, perhaps -- with not repeating the chaos of the Cultural Revolution, in particular, the attacks unleased on the Party and government bureaucracy by Mao's Red Guard. Today's leaders came of age under Deng's tutelage and embody those same underlying concerns. Assuming their caution towards democracy is based on some genuine public conern (rather than with a desire to retain the perks of authoritarian power), they fear democracy because they incorrectly believe that it is more likely to lead to the chaos of the Cultural Revolution. (In Hong Kong, opposition democracy is also fueled by tycoons who fear harm to their economic interests. They wouldn't want the people voting for politicians who promised a minimum wage or strengthened labor rights.)

Is China ready to jump tomorrow to a fully democratic system? Given the economic insecurity still present in many parts of China and the unfamiliarity by local government officials with how such a system should work, probably not. Intra-party democracy would be a step forward. But ultimately, China's leaders must set out a roadmap to a constitutional democracy, encompassing constitutional human rights, the rule of law, an independent judiciary, a free press, and elections for the President, the National People's Congress, and provincial and municipal leaders. Otherwise, instability and "taking matters into their own hands" is a far greater risk. As China's many dynasties knew, "the Heaven hears through the ears of the people, Heaven sees through the eyes of the people." (Mencius). And revolution is what you get when you suppress popular sentiment through authoritarian policies. Democracy is the release valve which allows people to vent their dissatisfaction with their leaders. The U.S. has existed as a stable, growing power for almost three hundred years, during which time China saw, depending on how you count, somewhere arguably seven revolutions -- the Taiping Heavenly Kingdom, the Boxer Revolt, Sun Yat-sen's Republican Revolution, the KMT Northern Expedition under Chiang Kaishek, Mao's Communist Revolution, Mao's Cultural Revolution, and arguably the Tiananmen Square protests. So in which system is it more likely for the place to be ungovernable?

Mr. Tsang's comments sad reflections of his inability to stand up for any sense of factual and historical reality. Going forward, he should -- and can -- do better. Hong Kong knows what democracy is, and is ready, tomorrow, to implement it fully, with no cultural revolution required.

Confucian Liberalism

This weekend in the Hong Kong, the pan-democrats are holding a rally. Counter to the rally is a celebration of Confucius by the Hong Kong Confucian Academy. It has been asserted that the celebration has been organized by the so-called “Beijing loyalists” counter to the rally in order to hold up Confucian “harmony” as an alternative to the democrats’ liberalism. Whether this is an accurate characterization of the planning is not important. What matters is the impression that Confucianism can be presented as opposed to democratic liberalism. Any honest reading of the Confucian texts would reveal that, quite simply, it cannot.

The teachings of Confucius and Mencius are constructed around pointed criticism of rulers. Although history turned the tables on Confucius and Mencius when government leaders used their philosophy downward to call for better ministers and ultimately better subjects, the heart of their philosophy is upwards focused –– a call for better leaders to create better government. Moreover, it is a misinterpretation of Confucianism to say that harmony was its highest value. In fact, Confucius talked about humanity 仁 (ren), civility 礼 (li), and justice 义 (yi), and made little mention of harmony 和 (he). A dynamic vision of humanity 仁 (ren) that transformed leaders was the core of Mencian thinking. The Doctrine of the Mean focused more on harmony in its depiction of how sincerity and the middle way will enable humans to transcend their earthly place and form a union with Heaven, 天人合一 (tian ren he yi), but this harmony was not juxtaposed against criticism and free debate. In fact, sincerity was the core characteristic that would grant a person the transformative power to create the union with Heaven, Human, and Earth. Nor were the other Confucian books or even the later Confucian thinkers particularly enamoured with harmony.

The closest Confucianism comes to calling for a “harmonious society” is in Confucius’s descriptions of the five relationships. Confucius sees sensitive human relations as core expressions of humanity (ren) and as keys to leading a fully human life. However, harmony is not necessarily at the core of any of them, and in fact can be contrary to their highest fulfillment. Take values such as respect 孝 (xiao) between parent and child and loyalty 忠 (zhong) between ruler and minister, which seem hierarchical and authoritarian. In fact, the greatest loyalty and respect only can be demonstrated when one has the courage to disagree, perhaps saving a parent or ruler (in the modern day, the public) from a bad decision. Hence the Confucians placed great emphasis on remonstrating the king, which both Confucius and Mencius did, albeit to little avail.

Liberal Confucianism recognizes the core of Confucian thought is a call for better leaders and a better society. It is not the politics of “harmony”, be that good or bad. Nevertheless, Confucian Liberalism recognizes that free speech, accountable government, rule of law, and open elections are universal values that should be seen as continuations of the great Confucian tradition. If Confucius and Mencius were in Hong Kong in 2007, which event would they attend? With little doubt, they would be at the pan-democrat rally.

Loyal Hong Kong

The term "Beijing loyalist" is often used in the newspaper here to describe politicians who cast votes thought to please Beijing. While that raises a number of issues that I'm not going to discuss, I'd like to pick on the language. While I appreciate that the phrase “Beijing loyalist” is not necessarily used as a compliment, it nevertheless carries the suggestion that others are not loyal. Perhaps, but I doubt it. Hong Kong is far too concerned about positioning itself to do business with China to want to go the way of Singapore. Granted, China is perenially concerned about break-up, but one country-two systems already in effect ought to mean that Hong Kongers can have opinions that conform or not with leaders in Beijing and yet remain “loyal” to the China the nation. Ironically, the source of this linguistic problem isn't Beijing; it's with critics here that in using it actually demean themselves.