Introduction
China appears to have come
through the world economic crisis better than many other countries. China's
admirers claim that, under China's "state capitalism," planners have
guided large state companies rationally and wisely through the rough seas of
the world economy. The Chinese Communist Party (CPC) plans, oversees, and
administers the interwoven network of state banks, airlines, railroads,
utilities, oil companies, and large manufacturers, all of which make up the
economy's "commanding heights" (to use Lenin's term). As Europe and
the United States slump, the CPC can speedily launch infrastructure projects or
shift millions of migrant workers from one locality to another. There is no
messy democracy to gum up the works. New York Times columnist
Thomas Friedman extols: "A one party system can just impose the
politically difficult but critically important policies needed to move a
society forward in the 21st century."1
But Ludwig von Mises in the 1920s and F. A. Hayek in the 1930s discredited
the idea that planners can manage an entire economy. Hayek pointed out that
central planners lack "the knowledge of the particular circumstances of
time and place."2 Because the planners do
not have the information that rests with hundreds of thousands of companies and
millions of consumers, planning fails, as it did spectacularly in the Soviet
Union. Interestingly, even socialist economist Robert Heilbroner admitted as
much.3 China is not an
exception. Its economic growth has occurred despite the
government's economic planning and because of its large,
dynamic private sector.
China's Economic Growth
As Figure 1 shows, China's
Gross Domestic Product grew from 1979 to the present at an average of slightly
over 8.5 percent per annum. Although Japan and the Four Tigers (Hong Kong,
Singapore, South Korea, and Taiwan) matched that growth rate at various points
in the past, more than thirty years of such high growth is unique. The CPC
would like us to believe its growth is due to its peculiar brand of socialism
with a Chinese face. In fact, what deserves credit is the entrepreneurship of
the Chinese people.
The Official Narrative
The Official Narrative
The official narrative of an
enlightened CPC echoes the "scientific planning" claims of the Soviet
Union. Defenders of the official narrative refer to the CPC as "more
enlightened" and "learning-minded" and claim that its major
mistakes (Great Leap Forward, Cultural Revolution) are things of the past.
Competing in the world economy is difficult, but the Chinese economy, they
claim, is guided by party leaders who are "highly intelligent, extremely
well educated, and have wide ranging experience." They are "some of
the most capable leaders in the world." Premature democracy is dangerous
because it "sacrifice[s] long-term economic development for short-term
political freedom, and therefore does not bring the greatest good to the
greatest number."4
Some economists buy the story that one-party rule enables poor countries to make tough decisions that "messy" democracies cannot.5 The most developed line of argument comes from Nobel laureate Eric Maskin and his Chinese co-authors, who cite regional competition among officials as the key to Chinese success.6 Instead of micromanaging the entire economy, they write, the CPC appoints and monitors the bosses who run its provinces, cities, and municipalities. Because of China's size, regions are often the equivalent of medium-sized countries. Regional mayors, governors, and local party bosses run relatively self-contained and self-sufficient regions. Nearly 70 percent of total government expenditure in China takes place at the sub-national level.7
The CPC, however, tightly
controls appointments, promotions, demotions and firings. Maskin et al. argue
that the CPC runs a tournament among regional bosses to promote those who
produce high growth rates, achieve low rates of unemployment, or attract
foreign direct investment.8 Indeed, empirical
studies show that promotions of Chinese regional officials depend on relative
growth and job creation.
This "efficient CPC"
narrative rings false on a number of accounts. Tales of lurid corruption and
excesses of princelings (children of the first-generation CPC leaders)9 belie the image of a
benevolent CPC. That still-poor China has more billionaires than any country
other than the United States raises additional suspicions.10 Political economists
have long demonstrated that "benevolent" dictatorships are torn apart
by principal-agent problems, greed, opportunistic behavior, and corruption. Why
would China be an exception?
Competition among regional
state and party leaders proved disastrous in the planned Soviet economy.
Competitors found that cheating was best way to win. At the end, the Soviet
economy generated more false information than even Hayek might have expected.
Chinese regional bosses have also learned to manipulate growth through public
investments or by simply cooking the books, as recent investigations of a
disgraced princeling revealed.11
Another sour note for China's
state capitalism is that China's weak property rights, corruption, and absence
of a rule of law and of economic freedom put China in league with some of the
worst countries in the world. China ranks 75th on Transparency International's
corruption index12 and 138th in the
Economic Freedom Index, right between Guyana and Syria.13 World experience shows
that poor institutions are inconsistent with growth. The Chinese state economy
is rife with such impediments to growth. Yet it grows. That is the puzzle.
China Has Grown Because of
Private Enterprises
China's private enterprise
reforms began first in agriculture in 1978 and spread from there. Agriculture
accounted for most of Chinese output and most of the labor force when Mao died
in 1976 and the reform period could begin. The freeing of agriculture from
collective farms is the most important untold part of the Chinese growth story.
Agricultural reforms began
spontaneously from below, even before the "Reform" Party Congress of
1978 that installed reformer Deng Xiaping in power. A Chinese reform official
later admitted: "In fact, reform wasn't discussed. Reform wasn't listed on
the agenda, nor was it mentioned in the work reports."14 What became known as the
"contract responsibility system" was sparked spontaneously by
eighteen peasants from Xiaogang village in Anhui province. They secretly
divided communal land in November 1978 and agreed to farm their plots
individually, each contributing their share of the state quota. The state got
its due and the peasants kept what was left over. The peasants' separation of
their land from the collective farm was illegal, highly dangerous, and done
without the approval of regional officials. Why did they take the chance?
Kate Zhou explains that the
peasants had seen their parents and children die from starvation during the
1958-1961 famine of the Great Leap Forward. They understood they had to take
care of themselves. The contract responsibility system spread like wildfire
from village to village and from province to province, notably without
endorsement by or encouragement from regional or national authorities.15
As agricultural production
soared, Deng Xiaping and his CPC realized that they should not resist something
that was working. By 1982, more than 90 percent of rural dwellers worked under
the contract responsibility system, but they were allowed only one- to
three-year contracts on their land. It was only in 2003 that the state gave out
longer-term leases.16
The spontaneous reforms in
agriculture meant that new supplies of food products needed markets and that
markets needed infrastructure. Rural dwellers created a private trade network,
and, within one year, most state food stores were out of business. Rural entrepreneurs
then created new businesses, such as hotels, services, private restaurants, and
small-scale manufacturing, through the three Fs (friends, family and fools17). They bribed local officials
to register their companies as "township and village enterprises."
They created fake "red hat" enterprises, that is, private companies
masquerading as state companies, and sham collective enterprises, or they used
state enterprises to issue receipts and open bank accounts. Large private
manufacturing firms developed first in predominantly agricultural provinces.
China's largest agribusiness was founded by brothers who left the city to found
their company in rural Sichuan. Rural entrepreneurs built the largest
refrigeration and air-conditioning companies in China.
China at the Crossroads: State
Advance, Private Retreat?
China is, in fact, two
separate economies: the private and the state. The "private" economy
includes joint ventures with Hong Kong and Taiwanese entrepreneurs, medium and
small manufacturing and service businesses, food-processing plants, and just
about everything else. The most successful private enterprises are listed on
Chinese stock exchanges. Having shareholders gives added protection from
arbitrary state action. State officials think twice about alienating hundreds
of shareholders versus only a few owners. The private economy has operated in a
shadowy world of semi-legality and has had to survive on its own wits. It had
to wait until 2007 for the Chinese legislature to recognize the legitimacy of
private property.
The state sector of
"national champions," run by the CPC or by closely-connected persons,
is the second Chinese economy. There are more than 150,000 state-owned
enterprises after the weeding out of unprofitable state enterprises under the
policy of "grasping the big and letting go of the small," begun in
1998.18 They decided that the
government would control the biggest and most important companies but let the
smaller ones fend for themselves. These 150,000 companies account for only
three percent of the total number of state and private companies, but for more
than 90 percent of the market value of listed Chinese companies.
Many private enterprises
formally operate under the legal protection of state or collective enterprises.
Hence, it is difficult to calculate the shares of the state and private
economies. If we adopt the broadest definition, the state economy is, at most,
half.19 China today is split
roughly fifty-fifty between the state and private economies.
We lack exact calculations of
the relative rates of growth of the state and private economies, but the
private economy, with an average growth rate of nearly nine percent from 1980
to the present, has grown much faster than the state sector. In 1978, state
enterprises and rural communes produced all of China's GDP. By 2004, there were
more than three million private companies employing more than 47 million
workers.20 By 2011, there were 52
million private companies employing 160 million workers.21 Clearly, the major part
of China's growth has come from private initiative.
The private economy performs
better than the state economy. An OECD study finds that total factor
productivity of privately controlled enterprises is twice that of state-owned
enterprises.22 (Total factor
productivity is the amount of output for each unit of labor and capital input.)
Private companies earn higher profits, and state enterprises earn a four-
percent return on capital, versus much higher rates for private companies. 23 If state enterprises
average profit rates of four percent, then, whenever inflation exceeds four
percent, their real profit rate is negative. Private companies borrow in
private markets at rates up to 18 percent. They must earn profit rates above
that if they are to continue in business.24
Private-sector growth has
occurred despite many obstacles and disadvantages. CPC policy over the past two
decades is captured by the slogan, "The state advances, the private sector
retreats." A Chinese official characterizes this policy as "leaving
the private sector drinking the soup while the state enterprises are eating the
meat."25Discrimination against the
private sector is seen in its higher taxes, stricter regulation, and
bureaucratic meddling. State companies use their advantages to drive out
private competitors, as did the three state air carriers in driving seven of
eight private competitors out of the market.26 The most blatant form of
discrimination is practiced by the state banks, which make only four percent of
their loans to private businesses. Private businesses must borrow in unofficial
credit markets, which can be a criminal offense punished by long jail terms or
worse. 27
China's credit market is a
"political market," which lends on connections and government
intervention rather than commercial considerations. A nation's capital market
is a primary determinant of its economic performance. If scarce credit goes to
projects with low rates of return and higher-return projects are excluded,
economic growth and efficiency suffer. This is a universal rule of economics.
China appears to squander a great deal of its huge household savings on roads
and bridges to nowhere, opera houses in towns with no opera, and empty
high-speed trains.
As I write this piece, China's
National Party Congress is poised to select new leaders to run the party and
state for the next decade. Such a selection process reveals factional rifts
within the party. One important such rift is between those who favor further
reform and those who yearn for the glorious revolutionary days of Mao.
The World Bank and the
Development Research Center, an influential Chinese government think tank,
jointly submitted its "China 2030" report recommending new reforms.28 They propose that China scale
back the state economy, suggesting that the state limit itself to policy making
and oversight and not intervene in the affairs of state enterprises.
State-owned companies should be run by professional asset managers and should
be privatized and broken up if they hold monopoly power. The "China
2030" report warns that powerful domestic interests will oppose reform,
but implementation of the reforms will provide vital improvements in economic
performance.
The CPC is, therefore, at a
crossroads. To date, it has played the "leading role" in politics,
economics, and civic life. If people are allowed to make their own decisions in
relatively free markets, the CPC will lose much of its leading role. The control
of economic resources is what gives party leaders power and personal wealth. An
authority on Chinese finance characterizes credit markets as a "bountiful
source of political resources.... [T]he enormous pool of savings in the banking
sector made it an indispensible policy and political instrument."29
The CPC must decide whether it
wants control or economic performance. Economic growth, emanating largely from
the private economy, has allowed the CPC to delay this decision. How it decides
will affect political and economic performance for the coming decades. As the Economist writes:
"China is often held up as an object lesson in state-directed capitalism.
Yet its economic dynamism owes much to those outside the government's
embrace."30
The remarkable feature of
China is that despite the private sector's disadvantages in credit markets, it
has advanced and outgrown the privileged state sector. Perhaps, one day, we
will see what it can accomplish on a level playing field.
Footnotes
2. F. A. Hayek, "The Use of
Knowledge in Society,"American Economic Review, 35, no. 4 (September 1945),
519-30.
3. Robert Heilbroner, "Socialism," in David R. Henderson,
ed., The Concise Encyclopedia of Economics. Indianapolis: Liberty
Fund, 2008.
4. All quotes in this paragraph are
from "China
'Best Served' With CPC at the Helm,". China Daily,
June 6, 2011 (Interview with Robert Lawrence Kuhn).
5. Michael Spence, The
Next convergence: the Future of Economic Growth in a Multispeed World (New
York: Farrar, Straus and Giroux, 2011).
6. Eric Maskin, Yingyi Qian, and
Chenggang Xu (2000), "Incentives, Information, and Organizational
Form." Review of Economic Studies, April 2000, 67(2), pp.
359-78.
7. Chenggang Xu, "The
Fundamental Institutions of China's Reforms and Development," Journal
of Economic Literature 2011, 49:4, 1076-1151
8. Barry Naughton, and Dali L.
Yang (eds.), Holding China Together: Diversity and National Integration
in the Post-Deng Era (New York: Cambridge University Press, 2004).
11. "Brother
of Fallen Chinese Politician Resigns Lucrative Business Role," New York Times,
April 25, 2012.
15. Kate Zhou, How the
Farmers Changed China: Power of the People (Boulder, CO: Westview
Press, 1996).
16. Paul Gregory and Kate Zhou,
"How China Won and Russia Lost: Two Dissimilar Economic Paths," Policy
Review, No. 158, December 1, 2009.
17. This is a term that venture
capitalists use to refer to three types of early investors.
18. "We Are the
Champions," The Economist, March 18, 2004.
19. Andrew Szamosszegi and Cole
Kyle, "An
Analysis of State-owned Enterprises and State Capitalism in China," U.S.-China Economic and
Security Review Commission, October 26, 2011. PDF file.
21. Statistical Yearbook of China
(English edition). 2011.
22. Szamosszegi and Kyle, 123.
23. "Entrepreneurship in
China: Let a million flowers bloom," The Economist, March 10,
2011.
24. Qiao Liu and Alan Siu,
"Institutions, Financial Development, and Corporate Investment: Evidence
from an Implied Return on Capital in China," Hong Kong Institute of
Economics and Business Strategy, December 2006
25. Patrick Chonanec, "China
State Enterprises Advance, Private Sector Retreats,"Forbes.com, August 31, 2010
26. Michael Wines, "China
Fortifies State Businesses to Fuel Growth," New York Times,
August 29, 2010.
27. "When Fund Raising is a
Crime," Economist, April 16, 2011, 69.
28. Bob Davis, "Blueprint of
China Reforms: Leaves Role of Party Vague," Wall Street Journal,
February 28, 2012.
29. Victor Shih, Factions
and Finance in China (New York: Cambridge University Press, 2008), 191
30. "Entrepreneurship in
China: Let a million flowers bloom," The Economist, March 10,
2011.
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