China Research

PRC 1.0 was China under Mao and during this period China adopted the planned market economic model and got a dictatorial leadership model, with catastrophic consequences. The fingers of the state reached everywhere and involved the most intimate details of private lives. With the bad experience of the cultural revolution and after the death of chairman Mao, the party decided that it would never like to go back to a one man dictatorship and instead established a collective leadership model.

PRC 2.0 lasted the next 30+ years and had the task of rebuilding China. During this period, the most important goal was to get all the basics in place: infrastructure, industry, private enterprise, a legal system, a middle class, education. etc. During this period China made huge domestic investments and received large foreign investments. The cheap labour and the establishment of production in China by foreign enterprises lead to a booming export industry. All this is well known.

Perhaps less well known is that the state has taken its hands off the micro management of its population. No longer wants the state to approve marriages, pregnancies, nor does it any longer allocate work and housing to people. There are, however, still some restrictions left in the society such as the Hukou registration restrictions or incomplete access to social security. But on the whole the Chinese people have much more freedom over their lives than at the end of PRC 1.0.

When entering PRC 3.0, the state again has to take steps towards micro management – not of individuals, but of industry. In the period of PRC 2.0 when China was in a build-up phase it was still to a large extent the skills of the planners that build China. The mentality was often that the government knew best – also in matters that normally are better left to the market or to the citizens to solve. As the Chinese economy became increasingly complex, the ability of politicians to make correct resource allocation and decisions or to engage themselves in micro management of industry became more difficult by the day.

By mid PRC 2.0, former president Hu and former prime minister Wen seem to have realized the need for deepened reform and to let the markets handle more of the resource allocation. Possible attempts to lead the development in the right direction were distorted by the Lehman Brothers crash and the ensuing global financial and economic crises. A gigantic stimulus package ensured that China could reduce the negative impact from falling export revenues and lower foreign investments. The world also took comfort in China as the locomotive of the global economy. The problem, however, is that the still ongoing problems of the free market economies and the considered success of the state capitalistic system of China cemented the belief among many Chinese politicians and officials that their system – with politically decided allocations and detailed control – was in fact an optimal governance model.

At the onset of PRC 3.0, the new government should realize that there is no other way forward than deepened market reform and less government involvement in resource allocation. The big challenge now is to also let ministries, bureaus, administration and individual officials to understand that the private industry and the society as a whole need to function in an efficient and creative. Instead of setting detailed standards, regulations and laws, the government needs to start setting goals and targets. It should design systems to follow whether these goals and targets were really met or not – but the government must not determine all the solutions to reach these goals.

In my view, this would be a big step, may be comparable to the start of PRC 2.0 – and it needs to be done. If it will be done, China will experience major efficiency improvements and new creative forces will emerge. I do hope the government is ready to take this crucial step…

Mats Harborn
Executive Director, Scania China Strategic Centre, Chairman Swedish Chamber of Commerce in China

Back to Start Page

Last year, economists Daron Acemoglu and James Robinson published their ground-breaking analysis of the crucial role that institutions play in determining economic development. One of the boldest and most controversial claims made in Why Nations Fail: The Origins of Power, Prosperity, and Poverty is that the Chinese economy will stumble badly, leading to sharply lower growth. The authors don’t put a fixed date on when this event will occur, but they are not talking simply about growth slowing from the 8–10 per cent range to the 4–6 per cent range (something that most economists believe is inevitable as an economy matures). Instead, Acemoglu and Robinson contend that China is in for the type of economic stagnation that the Soviet Union experienced before its collapse or that Japan has been experiencing since the early 1990s.

What do the authors base this claim on? They have two closely related insights. The first is that institutions are important for economic growth, and the second is that the degree to which a country develops sound institutions depends on the political system that evolves in a country over time. Bad institutions are a result of political systems that generate huge financial gains for the elite members of society at the expense of everyone else.

The contrast between North and South Korea also illustrates the effect that political and economic institutions have on economic development. South Korea has what the authors refer to as “inclusive” political and economic institutions that attempt to distribute power evenly in society and try not favour one group over another. Political power rests with a broad range of interest groups. South Koreans have access to proper education and are permitted to own property, start a business, or obtain a mortgage. This contrasts sharply with the extractive political and economic institutions in North Korea that narrowly concentrate political power and that force people to toil mainly for the benefit of the country’s ruler and a small segment of society with ties to the ruling party.

China certainly has extractive institutions. The country still does not have well-defined property rights and it remains a communist dictatorship. Stories in the media about sudden expropriations of farmers’ land by government to build a factory or make way for a dam are still common. The farmers who are displaced have little recourse in these situations.

The authors cite the arrest of Dai Guofang by Chinese leaders in 2003 as evidence of the serious flaw in China’s institutions. Dai’s crime was to start up a low-cost steel company that could compete with Communist Party-sponsored operations. The ruling party in China won’t permit companies with crucial links to the Communist Party to fail even if they are inefficient and lose money. And because the Chinese government will not permit these inefficient companies to fail, the economic system in China will never innovate to the degree essential to generate sustainable economic growth. Eventually growth will grind to a halt as the productivity gains realized by massive numbers of people moving from rural to urban parts of the country start to wane.

Critics of the authors’ views on China point out that for over three decades the Chinese economic model, which combines some elements of a market economy with extractive political institutions that protect the interests of the Communist Party, has generated rapid economic growth and lifted millions of people out of poverty. There is no reason why this can’t continue, they argue, although it is widely agreed that more modest growth will eventually occur in China.

The authors agree that it is possible for a country to attain high economic growth with extractive political institutions for a long period of time—but not indefinitely. They point out that the former Soviet Union’s economy initially experienced rapid growth despite having weak institutions that protected the interests of Communist Party members at the expense of the rest of society. In fact, between 1928 and 1960, national income in Russia grew by an average of 6 per cent per year.

In 1956, then-Soviet leader Nikita Khrushchev cited the rapid economic growth in his country and boasted to Western powers that “We will bury you!” Soviet leaders were able to engineer high economic growth by undertaking a massive program of industrialization. However, a lack of economic incentives and innovation in the Soviet system meant that economic growth couldn’t be sustained once the shifting of resources from rural to urban areas of the Soviet Union had been completed. A similar fate awaits China, according to the authors of Why Nations Fail.

It is possible that China could still avoid that fate if its leaders gradually introduce democratic reforms that lead to the more inclusive political institutions the authors say are crucial for long-term economic growth. Perhaps Chinese leaders will eventually follow the South Korean model, in which a dictatorship initially implemented economic reforms that resulted in surging economic growth. That was gradually followed by reforms, which eventually led to a successful democracy taking hold in South Korea. Skeptics correctly point out that, to date, the Chinese Communist Party has given no indication that it intends to reform itself out of existence. However, the country does have new leadership, and we should soon have a clearer idea about the path that China will follow.

Sources: Daron Acemoglu and James Robinson, Why Nations Fail: The Origins of Power, Prosperity, and Poverty (New York: Random House, 2012); Francis Fukuyama, “Acemoglu and Robinson on Why Nations Fail,” The American Interest (March 26, 2012).

Kip Beckman
Principal Economist, World Outlook Forecasting and Economic Analysis, The Conference Board of Canada, Ottawa

Back to Start Page