Princelings reign in the court of Chinese corruption

FT.com

Ping An, the Shenzhen-based insurance company, has always been portrayed as the underdog against the state-owned People's Insurance Company of China. To some extent that is a fair portrayal. But news reports that the support of premier Wen Jiabao contributed to Ping An's fortunes demonstrate that it might not be only the big, state-owned behemoths that depend on the largesse of party and government.

In China most successful entrepreneurs are as much a part of the system of personal relations as the sheltered government-owned enterprises, whose many perks include access to cheap loans from state banks, monopoly of resources, support for mergers at home and abroad, and the ability to go to the head of the queue for listing. For both kinds of company, political connections and political protection are a big part of the game. Indeed, if anything, such connections may be more important for private companies.

The need for such connections is at the heart of the corruption at the core of the Chinese system. That corruption has become so endemic that it suppresses competition, makes economic growth lower and more inequitable than it would otherwise be and threatens social stability. The fact that property rights cannot be taken for granted means capital flight has become an issue.

The most common form of protection for otherwise vulnerable entrepreneurs is an investment from one of the private equity groups in which the princelings figure prominently. The most well-known of these is New Horizon Capital, started in 2005 by the son of Wen, who was vice-premier at the time. While he is no longer running his investment company day to day, he still has links to it (and investors include many foreign banks).

Capital and a helping hand from the princelings can make a big difference, especially where rules are murky. The backer of one financial company, which is in the business of introducing those who need funds to those who have excess funds, frets that as this private firm grows bigger, the key to success is securing such backing. Otherwise, this person says, too much success can doom the enterprise and it can easily be found to have violated the rules.

From abroad, observers prefer to believe that this dynamic is purely domestic. But foreigners may also be affected. For one thing, they employ the princelings. Wen's daughter Lily worked for Lehman Brothers. Jiang Zemin's grandson Adrian worked for Goldman Sachs before joining one of the local private equity groups, Boyu. The daughter of Wang Yang, governor of Guangdong province, works for Deutsche Bank. The daughter of Chen Yuan, the head of China Development Bank who is himself the son of Chen Yun, one of the most venerable of the princelings, worked for Morgan Stanley before attending Harvard Business School.

If anything, investment banking, like private equity, has become far more political in its hiring than 20 years ago. Few of the first generation working for the foreigners were born with silver chopsticks in their mouths, as is currently the case.

As well as employing the princelings, foreign companies deploy them. When a foreign bank asked for a piece of the equity in a potash deal in southeast Asia, the Hong Kong private equity group it approached agreed – because "you don't say no to a princeling”, according to one executive at the fund.

Relationship hires are not always indefensible, although it would be naive to think family ties are never a factor. Many of the princelings have had the best education and therefore boast the qualifications to justify getting the job. It is easy to detect the hand of the well-connected at work when, in fact, it may not be. For example, some observers say Wen overruled regulators in personally approving TPG's sale of Shenzhen Development Bank to Ping An – something TPG denies.

Another downside to the princeling syndrome, although one that is harder to measure, is the fact that because intellectual property rights are less than sacred, many of China's best and brightest prefer to live abroad. Many of the most talented researchers and academics leave China for university campuses in the US. They say that unlike at Stanford or Yale, in China everything from promotions to research grants is often dispensed on the basis of party loyalty – which tends to mean ingratiating oneself with the right people.

Depressingly, these researchers and academics say it will be 50 years before the system changes.

Henny Sender is the Financial Times's chief financial correspondent.

Copyright The Financial Times Limited 2012.