Lessons from the Chinese Economy

By R.M.B Senanayake

What sort of economy does China have? Many of our intellectuals still think of China as a Socialist or Communist economy. Professor Kumar David cxalls  it "State Capitalist". It is no longer a Socialist or Communist economy driven by central planning but an economy driven by market forces. China is not a democracy where the rulers are elected by the people and held accountable to them at periodic elections. But that refers to the polity not the economy.

China gave up the Communist type economy when Deng Xiaoping took power. In fact Communism prevails only in North Korea for even Cuba has gradually moved towards a capitalist economy.  But many Sri Lankan political leaders and intellectuals still believe in a Communist or Socialist economy where State enterprise dominates. President Mahinda Rajapaksa has vowed not to sell public sector assets to the private sector.

Is it State Capitalist?

Is China a State capitalist economy where growth is driven by the state enterprises?  Ronald Coase and Ning Wang, published a book about capitalism in China called "How China Became Capitalist". It concludes that China is indeed a capitalist country (not a "state capitalist" or "socialist market" country). More importantly, they argue that the Chinese economic miracle did not come about through the action of the state. In part, it came about through State inaction. As reviewer Jane Shaw points out, the title "How China Became Capitalist" is not "How China Fostered State Capitalism" (the usual term for the country’s economic system). Nor is it "How Deng Xiaoping Created a Mixed Economy." Coase and Wang argue that China became capitalist—and terrifically productive—largely in spite of efforts to build "state capitalism." They write that China’s economy today is a "striking example of what Hayek has called ``the unintended consequences of human action".

After Mao Zedong died in 1976, the country was in chaos from the Cultural Revolution. Some very basic, broad-based reforms were made, even before Deng came into power. Private farming was allowed within the family. Enterprises (virtually all state-owned) were allowed to pay workers differential wages instead of uniform wages (although workers’ mobility from one enterprise to another was restricted). Trade in basic commodities was restored (although most prices were still set centrally). 

When Deng took over, he recognized that the state-owned enterprises, the major source of goods and services, were abysmally unproductive and a huge drain on resources. He sought to change the incentives of these enterprises much as now proclaimed by the Treasury Secretary P.B. Jayasundera who has reportedly allowed SOEs (State Owned Enterprises) to retain their revenue instead of crediting it to the Consolidated Fund. China did the same. But the greater autonomy given to SOEs didn’t have much effect in China and is unlikely to make any effect in Sri Lanka public sector either. China ultimately privatized most of those enterprises or just closed them.

It is the other sectors such as farming families and village factories that broke loose and fueled the engine of growth for the next 30 years. In 1987, Deng expressed genuine surprise at how productive private farms had become.

The Chinese lesson is that reforms that open up competition may be better than any incentive-focused efforts. Competition is the best driver of growth in business enterprises. In China, reform meant that state-owned enterprises became more autonomous and were allowed to keep profits, but they still did not face market competition for resources or output.  So there was little pressure to improve efficiency. But the lavish support given to state-owned enterprises in China had an unusual benefit, says Coase and Wang, for it distracted the politicians from the real change going on under their noses—the local initiatives of villages and families.

 They also devote several pages to China’s higher education system, saying explicitly that China’s reforms to SOEs have not been extended to universities. "The fatal organizational flaw of Chinese universities is their lack of autonomy," they write. "The majority of Chinese universities remain primarily funded by the state and under the strict control of the Ministry of Education." Does this sound familiar? Yes it is the same malady in Sri Lanka’s university system. Will greater autonomy to the Universities help? Not really for it is the force of competition alone that will drive improvements. Of course greater autonomy is also needed for operational decision-making which must be invested not in politicians or remote control bureaucrats but in those engaged in the day to day functions.

One Chinese government policy was to increase the number of college graduates and it has done that. Coase and Wang say that in 1995 about five percent of 18-to-22-year olds were able to go to college; by 2007, the figure was 23 percent. But the results have not been happy for the education is based on outmoded syllabuses and teaches the students not to think but to memorize.

Newspaper articles show that university graduates in China are desperate for jobs that fit their qualifications; but the number of college graduates is out of line with the demands of their economy. More important, the Chinese are disturbed by the "Qian puzzle." Qian Xuesen, a prominent scientist who died in 2009, is known for asking, "Why have Chinese universities not produced a single world-class original thinker or innovative scientist since 1949?" Coase and Wang say the reason is that China does not have a marketplace for ideas. With its education system under government control and political influence, its incentives are to satisfy the wishes of bureaucrats, not explore and share ideas, the fundamental requirement of modern education.

Deng opens economy to foreign investment

The debate inside the Chinese Communist Party  on opening the economy to foreign investment started in 1977-78 shortly after the defeat of the so-called "gang of four" (arrested on October 6, 1976) who, after the death of Mao, were demanding a continuation of the "Cultural revolution"…Deng came to power in 1979. He made a specific appeal to the Chinese Diaspora, a community of 60 million in Taiwan, Thailand, Malaysia, Indonesia and even the USA to invest in China. He opened the Chinese economy to foreign investment and set up Special Economic Zones where they could operate freely. A large number of American and European foreign companies set up industries in China to take advantage of the cheap labor. These foreign enterprises exported the products of their factories to their home countries in USA and the West. China obtained much needed foreign exchange and also modern technology transfers (China was very backward then in production processes).

While Capitalism was thus firmly established in the Special Economic Zones the transformation of the rest of the Chinese economy to Capitalism and free market principles was a slow and contradictory process and is still on-going in adopting the macro-economic controls. The interest rate is to be de-regularized soon.

The first qualitative step came in the early 1980s when collective land worked by the communes was rented out on a long-term basis to peasant families and in the mid 1980s when price controls were removed from the bulk of goods and services. Agricultural production grew rapidly and foreign investment started pouring in. Living standards improved. Between 1980 and 1985 as many as 100 million television sets were sold. Between 1985 and 1990, fifty million washing machines and 40 million fridges were also sold. The sons and daughters of high-ranking bureaucrats started to study abroad, mainly in US and British universities. The first Stock Exchange was opened in Shenzen in 1988, with the second opening in Shanghai in 1990. In the meantime the massacre of Tian An Men took place where the army killed hundreds of youth and workers in Beijing on June 3-4, 1989. A part of the Communist Party apparatus asked Deng to slow down the opening up of China to capitalism in 1989.

After a year of debating the issue he rejected the calls of the party. He decided to open up all the coastal provinces and the capital Beijing to foreign investment. On the island of Pudong in Shanghai (500 square kilometers) plans were set up to create a new Manhattan, which was to become the most important commercial hub of China with four million square meters of skyscrapers built in a period of 10 years. Foreign investment in 1990 had reached six billion dollars and still continues.

Privatization of SOEs

The last serious attempt at any resistance to a Capitalist market economy was overcome between 1998 and 1999 when an official decision was taken to drastically reduce the weight of the state sector of the economy with mass layoffs and sackings, combined with a further opening up to foreign investment. State-run companies were turned upside down and inside out, with either the fusing of companies into one or the breaking up of others. The profitable sectors were separated from the loss-making ones. The former were privatized and the latter were left to rot. The top party officials and their families grabbed the lion’s share of the privatized SOEs. As a result of this process at least 70 million workers in the public sector lost their jobs and corruption crept in to the Party top layer.  The economy immediately became more productive and in 1993 GDP grew by 13.7%. Since then average annual growth has been 8% until last year when it fell to 7.5%.

With acknowledgment of the article

Subversive Lessons from China By Jane S. Shaw in the Freedman website
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