17 February 2016

How China really went capitalist


Global inequality is a relatively recent phenomenon. For a large proportion of human existence, societies existed in what was accepted as ‘the natural state of mankind’ – where everyone was more or less equally impoverished. Feudalism, particularly in Western Europe, changed that to the extent that a handful of individuals achieved massive wealth and status gains whilst the remainder of the population stayed in a state of subsistence living.  Chronic inequality within societies was common. Since the onset of modern economic growth at the end of the eighteenth century, however, inter-country or inter-state inequality emerged. Following this, there have been countless attempts to understand what triggers prosperity in some places and what, by contrast, hinders the development of others.

In 2012, Daron Acemoglu and James Robinson published “Why Nations Fail”, a non-academic book summing up the results of their anterior research wherein they give their answer to the issue. Contrary to most of their predecessors, they focus on the political and legal framework in which people act. What really matters in their analysis, indeed, is “institutions”. In particular, according to Acemoglu and Robinson economies grow and thrive insofar there are enough economic incentives to produce and trade goods and services, which in turn require – in the long run – plural, representative and inclusive political institutions.

In today’s world, there is a country seeming to contradict such view: China. This is a country where an all-pervading single-party regime runs companies and stock markets; where there is neither freedom of expression nor freedom of press; where unlawful eminent domains are a daily occurrence; where any criticism of the government is merciless repressed. Yet this country has undergone a striking economic growth for the last 30 years, thereby challenging Acemoglu and Robinson’s line of reasoning.

Of course, it has happened many times in the past that cycles of dazzling economic growth coincided with authoritarian political regimes. Acemoglu and Robinson, however, vindicate their theory by arguing that those phenomena would not have lasted in the long run. The economic trajectory of the Soviet Union, in this regard, is a prime example of how this kind of growth tends to run out, sooner or later. Similarly, Acemoglu and Robinson believe that China cannot thrive – but it will rather collapse soon – unless it deeply reforms its political system.

This view is shared by many, but disregards a fundamental element of China. Under Mao and in the decades that followed his death, the Chinese government concentrated its efforts on enhancing its public companies. Such policies did not produce the desired result: growth remained weak, while the spectre of inflation loomed over the country. However, the game changer was smouldering beneath the ashes, far away from the eyes of Beijing, where small mixed public-private companies started to experience innovative forms of governance and farmers reintroduced private agriculture, despite the opposition of the central government. And that’s when institutions played a truly crucial role: private enterprises sprang spontaneously across China’s countryside and could have been nipped in the bud by the government, as well as by other natural and social circumstances.

Luckily, the local governments sustained (and the central government did not impede) such process, allegedly intended as a means of strengthening socialism by taking advantage of capitalism. The creation of special economic zones, where to experiment free market-oriented political and economic frameworks, followed the same line of reasoning. There then followed the phasing out of price controls, the privatisation of local businesses, and the pursuit of policies conducive to the increase of the inflow of foreign capital. As one of the Chinese leaders of the post-Mao era – Deng Xiaoping – pointed out, “if you open the window for fresh air, you have to expect some flies to blow in”. In the case in point, the principles of capitalism – and thus more inclusive economic institutions – were gradually affecting the whole economic system.

Although its current economic institutions are incomparably more inclusive than 30 years ago, China’s growth remains wedded to a political regime. Property rights are not sufficiently protected and unlawful eminent domains are a daily occurrence; labour mobility is highly regulated and political participation is close to zero; the Party is all-powerful and civil liberties are restricted to put it mildly. Consequently, the command of China’s government over economic institutions is such as to prevent creative destruction and thus a further growth.

However, the role of decentralisation in China’s transformation should not be underestimated. From an economic point of view, as we have seen, the turning point occurred at local level, thanks to the unchained development of millions of different entrepreneurial experiments, encouraged by regional governments without this being interpreted as a “contempt of Beijing”. The same applies to political institutions: the main difference between Chinese and Soviet institutions is the manner by which China is decentralised.

Unlike the Soviet Union, China has resolved the problem of incentives by implementing a high degree of institutional competition amongst regions. Subnational governments are assessed by Beijing based on their economic performance and other selected goals. In today’s China, regional and local governments are completely self-contained in their actions and do not have to report anything to the central government, insofar they fulfil the assessment criteria.

Obviously, China’s trials are far from over. What is truly missing – in all areas of Chinese society – is a marketplace of ideas. The education system, for instance, is entirely in the hands of the government, which controls both the organisational aspects and the study programmes. Critics of the regime are silenced and marginalised, or even eliminated. The Chinese leadership, in all likelihood, believes a free market in goods and services to be enough to legitimise its power, as it has been doing over the past few decades. Yet nothing could be further from the truth: the absence of a marketplace of ideas is directly responsible for the innovation deficit in science and technology, Achilles’ heel of China’s manufacturing sector, which in turn – together with State monopolies – reduces investments opportunities and jeopardizes economy’s competitiveness and dynamism.

One of the great merits of Acemoglu and Robinson, in this regard, is that they shrewdly avoid specifying the nature, number or “blend” of institutions needed in order to induce economic growth. Indeed, assessing institutions simply on the basis of their “inputs” (e.g. their implementation process, including the existence of political pluralism) or just according to uniquely Western criterions can be highly misleading. In the assessment of institutions, what ultimately counts is their “output”, that is, whether the system of incentives thereby created leads to the desired results across people; and the economic miracle performed by China’s private sector in the last 30 years is a prime example.

Paradoxically, in their analysis of China’s institutions, Acemoglu and Robinson result to be too hard on themselves. They focus on the role of Beijing, concluding that more inclusive political institutions are needed to keep China’s economy on a path of sustainable growth, while a more attentive reading of its history shows that their theory could actually match it. Again, the emergence of a marketplace of ideas and a political reform would actively contribute to free new creativity and entrepreneurship in China, cutting red tape and its costs and thus providing a breath of fresh air for its economy. However, believing that this necessarily coincides with the establishment of democracy is a rookie mistake we must certainly avoid.

Giacomo Lev Mannheimer is a Fellow at the Istituto Bruno Leoni.