So, Just How Capitalist is China?

♠ Posted by Emmanuel in , at 4/30/2008 01:26:00 AM
I came across this interesting paper by MIT economist Yasheng Huang via Andy Mukherjee over at Bloomberg. In it, Huang tackles the question, "Just How Capitalist is China?" and comes up with a novel explanation about China's path to development. The paper summarizes the key points of his forthcoming book, "Capitalism with Chinese Characteristics." It is a fairly ambitious work that has the potential to upend some current thinking about the rise of China. Let us begin with a peek at the introduction and the main findings from the paper linked to above. Truly, it is beyond debate that the country has grown by leaps and bounds. Yet, the exact mechanisms by which it has done so, especially in terms of economic governance, remains subject to much debate that isn't likely to quiet down anytime soon. Nevertheless, the description of the research methods used by Huang make it sound like he has done fairly extensive historical and archival work towards giving us better clues:

Since 1978, the Chinese economy has grown phenomenally. This is not in dispute. By exactly what mechanisms has China managed to grow so fast? There is more room for debate on this question. The near-consensus view—or the view that has achieved the greatest traction—among economists is that China has grown by relying on unique, context-specific local institutional innovations, such as ownership by the local state of township and village enterprises (TVEs), decentralization, and selective financial controls. The conventional mechanisms of growth, such as private ownership, property rights security, financial liberalization and reforms of political institutions, are not central components of China’s growth story.

Much of the economic research on the Chinese reforms revolves around the following question, “Given the manifest inefficiencies in the Chinese economy, how do we explain its growth?” The answer, often backed up by formal, mathematical models, is that seemingly inefficient policies, practices and institutions—such as public ownership of TVEs and financial controls—perform underlying efficient functions in the specific context of China. The approach is typically inferential—i.e., these efficient functions of observably inefficient forms are inferred from China’s excellent economic performance.

This book takes a different and factual approach. It starts with the following set of questions, “Were TVEs really publicly-owned? Did China implement financial reforms prior to or concurrently with the initial economic takeoff in the early 1980s?” The research is based on detailed archival examinations of policy, bureaucratic and bank documents as well as several waves of household and private-sector firm surveys. The qualitative and quantitative data span the period from 1979 to 2006. As an illustration of the factual density of this book, I have examined thousands of pages of memoranda, directives, operating manuals, rules of personnel evaluations issued by the presidents of China’s central bank, all the major commercial banks, rural credit cooperatives, etc.

These documents are contained in a 22 volume compilation of bank documents, which, while available at Harvard and in Hong Kong, have never been examined by a Western academic. I have also gone to the raw database on TVEs established by the Ministry of Agriculture. Ministry of Agriculture was in charge of collecting data on TVEs and its data have finer ownership breakdowns than the TVE data available in China Statistical Yearbooks. Based on this body of research, here are the main findings:

--Explicitly private entrepreneurship in the non-farm sectors developed vigorously and rapidly in rural China during the 1980s;
--Financial reforms, again in the rural areas, were substantial in the 1980s and the Chinese banking system channeled a surprisingly high level of credits to the private sector in the 1980s;
--Conventional property rights security was—and still is—problematic but the security of the proprietor—the person holding the property—increased substantially at the very onset of the economic reforms;
--The Chinese policy makers in the early 1980s strongly, directly and self-consciously projected policy credibility and predictability;
--The political system, although absent of the normal institutional constraints associated with good governance, became directionally liberal early during the reform era.

Next up are excerpts from what I consider as the highly intriguing part of his explanation: small-scale and mostly private industries in rural areas have more recently been given far less attention than large-scale and mostly state-owned industries in large Chinese cities. Hence, the widening inequality gap between urban and rural areas:
Capitalism with Chinese characteristics is a function of a political balance between two Chinas—the entrepreneurial, market-driven rural China vis-à-vis the state-led and oligarchic urban China. In the 1980s, rural China gained the upper hand but in the 1990s, urban China gained the upper hand. Although China made notable progress in the 1990s in terms of FDI liberalization and reforms of SOEs, this book assigns greater weight to the rural developments in determining the overall character and the pace of China’s transition to capitalism. When and where rural China has the upper hand, Chinese capitalism is entrepreneurial, politically-independent and vibrantly competitive in its conduct and virtuous in its effects. When and where urban China has the upper hand, Chinese capitalism is tending toward oligarchy and political dependency on the state and it is corrupt.

Most economists judge China’s economic performance by its GDP data. While decadal differences in China’s GDP growth are fairly small, the economic and social implications of a more entrepreneurial version of capitalism in the 1980s and the one closer to oligarchic capitalism in the 1990s in fact differed enormously. There are substantial and real welfare consequences:

--Although GDP growth was rapid during both the 1980s and 1990s, household income growth was much faster in the 1980s;
--The share of labor income to GDP was rising in the 1980s but declining in the 1990s;
--Several studies on TFP converged on the finding that TFP growth since the late 1990s has either slowed down from the earlier period or has completely collapsed;
--The majority of the much-touted poverty reduction occurred during the short 8 years of the entrepreneurial era (1980-1988) rather than during the long 13 years of the state-led era (1989-2002);
--Income disparities worsened substantially in the 1990s, while they initially improved in the 1980s;
--Governance problems, such as land grabs and corruption, intensified greatly in the 1990s;
--In the rural areas, heavy taxation was accompanied by the withdrawal and rising costs of basic government services;
--A development that has garnered almost no attention in the West is that between 2000-2005 the number of the adult illiterate Chinese increased by 30 million, reversing decades of trend developments;
--The way the Chinese measure adult illiteracy implies that all of this increase was a product of the rural basic education in the 1990s and this adverse development coincided closely in timing with the intensification of urban bias in the policy model.