The Chinese recipe for growth, and slowdown?

To understand the reasons for the Chinese slowdown, it is important to revisit the reasons for China’s economic success. In this article, Alexandra de Mingo McAllister attempts to provide a comprehensive understanding of China’s journey uptil now.

In Yingyi Qian’s paper on “How reform worked in China”, he analyzes how the Chinese economy blew mainstream economists’ expectations in the twenty-two year period from 1978 until the end of the twentieth century. China entered a process of economic development departing from a state with poor, over-populated state, short of skilled human capital and natural resources, and with a hostile attitude towards international markets and steadfast reform. When Deng Xiaoping came into power in 1978, he enacted the Four Modernizations, goals which were set to develop agriculture, industry, military, and science and technology in the state.

At the start of Deng’s Modernization Programme in 1978, Coca Cola was admitted into the Chinese market/Source:

This was the transitional period in which China went from a planned/command based economy, where decisions regarding allocation of resources are made by a centralized government, to a market based economy where privately owned businesses with unrestricted decision making capability are the price setters.
Qian highlights that what makes China a unique example of drastic economic development in such a short time period is the fact that the reforms succeeded without complete liberalization, without democratization, and without privatization. This phenomenon could be due to a very unusual degree of unanimity among those bearing the power of decision-making regarding what policy changes to implement in the transition towards a market economy. The indisputable recipe for such a transition had been unquestioned until China proved it wrong. Democratization until then was thought of as a primordial base to be followed by stabilization, liberalization, and privatization.
Two objectives need to be fulfilled simultaneously in order to succeed in economic development; improvement of economic efficiency by increasing incentives for competition while making the reforms appealing to all- the mass labor force and the policy makers in power. Given the culture of Communism that sets China apart from other world powers, what is noteworthy is its seemingly admirable coexistence and balance between a conservative traditional political regime and a liberal economic character.

The Chinese government acted on five key reforms during this time period. The first, the “dual-track” method reform was done with the aim of attaining market liberalization. The aim of this was to utilize the pre-existing planned prices and rations which would have been hard to change through policy, and allowing the production of many industrial goods above the planned quantities and planned prices at the price set by market forces. The second reform was a result of an innovative method of business ownership that provided a midpoint between private and state ownership. One of the most successful examples of this is the Township-Village Enterprises (TVEs). In a period with unsafe private ownership rights and given the lack of entrepreneurial freedom of public ownership, this non-standard ownership form served as China’s most growth enabling power until the mid 1990s.

The third reform aimed at making fiscal federalism more productive. This was aimed at increasing the incentives for local governments to promote business under its jurisdiction, thus aiming at regional growth versus centralized development. This was extremely vital given the territorial vastness of the Chinese economy and its natural endowment of a large population. The fourth incentive aimed at the financial protection of private incentives given the absence of the rule of law. Economies like Switzerland are pioneers in such policies, aiming at limiting the knowledge of the government regarding financial interactions, given that it benefits from higher revenues from increasing returns on interest rates and capital flows. The last incentive is the only one which Qian labels as a failure. Large-scale state-owned enterprises (SOEs); despite reforms on SOEs no economic efficiency has been obtained that creates sufficient incentives.

Qian states that contrary to popular believe, China’s economic development has taken place not just in coastal and urbanized areas of the economy, but all over. Furthermore, FDI and remittances, he defends, are not the key responsible factors for the experienced economic development. It must be noted that China devoted vast amounts of financial resources and tailored policy in order to strengthen its human capital and technology. It has been successful in this and has managed to shift large proportions of its labor force from low skill labor occupations, to high skilled jobs.

Dani Rodrik delineates a taxonomy of economic growth in his paper on determinants of economic development. He pins three key determinant factors along which an economy will develop; geography, integration, and institutions. Furthermore, he adds a second dimension of classification between endogenous, partly endogenous, and exogenous. In the exogenous category lies geography alone. It is by fate that one economy is endowed with a certain geographical position in the globe, whether closer or further away from the equator, landlocked or surrounded by a navigable body of water, etc. Partly endogenous are integration and institutions. Integration refers to the benefits and costs of an economy’s participation in international trade and its market size relative to the global market. ‘Institutions’ refer to legal and governmental bodies that play a role in determining the economic performance of the state. Finally, in the endogenous category lie factors of endowment, productivity, and lastly, income.

In the case of China, its geographical location seems to have more averse qualities than adverse. It covers a vast territory of the globe and has varied climates. It has throughout history pioneered with important international sea ports that have enabled trans-oceanic low cost bulk trade. It has been able to diversify in trade due to its vast natural endowments. The main geographical set back is that much of China’s territory is desertic. Trade was enabled through the liberalization of the economy and the opening up to international trade, while concentrating in developing quality and price competitiveness. Institutions were developed, as stated in Qian’s work, in order to cater to the needs of a competitive market driven economy. China developed its most notorious factor of endowment, the large labor force, in order to diversify in skills and promote competitive higher education that will produce skilled workers to develop technological industries that are financially high yielding. Investment in education was a key promoter of internal labor competitiveness, which by default results in international competitiveness.

At the time in which Yingyi Qian conducted his research it was 2002, and since then the world economy has taken unpredicted turns, along with which the Chinese economy has also proven many of the over positivistic expectations wrong. An example of this was Qian’s expected succession of China to the EU and USA as a leading world economic power by the year 2015 ceteris paribus.

It is argued that Chinese economic growth has been in the stage of diminishing returns since the end of the first decade of the twenty-first century. Paul Krugman defends a skeptical opinion on the Chinese method of growth in his article in The New York Times, “Hitting China’s Wall”. He defends that inevitably, the Chinese method of growth is unsustainable given the small levels of household consumption offset by high investment on securitization of future investment. Until now wages have been kept unnaturally low due to the vast supply of cheap labor, however, as previously mentioned, the labor factor of endowment is slowly being depleted and gradual socioeconomic openness and civic development is resulting in a gradual increase in wages which until now was one of the main enablers of such sharp economic growth.

Chinese policy makers correctly devised appropriate transitional institutional methods for the needs at the time of the post Cultural Revolution. This along with good timing and a cooperative society resulted in the rapid growth that intimidated the rest of the world. Nonetheless, the same political rigidity that allowed for fast decision making and policy implementation, is the obstacle that might be holding China from entering the next and more determining stage of growth, that which could set the economy on the final path to the status of a ‘developed economy’. One of the characteristics of a planned economy is the individual freedom that is given up in return for stability and predictability. China has managed to find that a happy medium until now in its path to economic growth.

However, as much as the Chinese political regime is a reflection of the society, it might have reached a generational point in which the more skilled and outward looking younger section of the labor force is demanding higher standards of living that are parallel to those in other developed economies, and thus reaching that natural point of diminishing returns.

Alexandra de Mingo McAllister is a Master’s student of Diplomacy, Law and Business at the Jindal School of International Affairs, Delhi.


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