July 29, 2012

The China Deal: Why China's economic success is fragile

Writing about web page http://ideas.repec.org/p/cge/warwcg/91.html

Why has China succeeded where Russia failed?

The explanation that is most widely shared is that the Chinese rulers kept political control and used it to reform the economy gradually. They pursued Deng Xiaoping's "four modernizations" (of agriculture, industry, defence, and science and technology) but rejected calls for the so-called "fifth modernization" (democracy). In the Soviet Union at the same time, in contrast, Mikhail Gorbachev abandoned the levers of totalitarian control. He allowed the Berlin Wall to be pushed over. The Soviet communist party imploded; insiders "stole the state." The Soviet Union collapsed and Russia entered a decade of near anarchy.

This explanation has obvious appeal but is incomplete on closer inspection. It is widely believed that the Soviet leaders did not try the China solution of gradual economic reform without political reform. The historical record shows, however, that this is untrue. Over a period of many years, while their system of one-party rule was completely intact, the Soviet leaders tried all the reforms that the Chinese communists followed to revitalize their economy. This included several experiments with a household responsibility system, the so-called zveno, in agriculture (1933, 1947, and 1966); a regional decentralization (from 1957 to 1965); and several rounds of public sector reform (beginning in 1965), culminating in new laws to reduce the compulsory obligations on state-owned enterprises, allowing them to supply the market directly at higher prices (1987), and to permit private enterprise (1988).

In other words, rash political reforms are not the factor that decided why communism failed in Russia. The collapse of Soviet rule came only after the gradual economic reform initiatives that worked in China failed in Russia.

We must look somewhere else, therefore, to explain China's success. In a survey of Communism and Modernization, I suggest that the answer must begin with China's capacity for continuous policy reform. To break out of relative poverty and catch up with the world technological leader, an economy must undergo continuous reform of its policies and instutions. Continuous policy reform is fragile. The reason for its fragility is that, as the economy undergoes successive stages of modernization, policy reform at each stage must infringe upon the vested interests formed in the previous stage. Where continuous reform becomes blocked (as in Italy, for example), the economy will lag and fall behind. From the 1970s, the Chinese economy institutionalized a capacity for continuous policy reform. This is what has enabled China's spectacular rise.

Continuous policy reform was a by-product of China's system of "regionally decentralized authoritarianism" (described by Xu 2011). This system set China's 31 provincial leaders to compete with each other economically and also gave them considerable freedom to choose how to do so. Those leaders who could make their provincial economy grow faster, if necessary by attracting labour from neighbouring provinces, would rise politically; the laggards would fall. Such incentives were very strong.

Deng Xiaoping allowed the provincial bosses to strike a "China deal" that created new space for private business to come out of the cold and thrive within market socialism. This opening of markets to private entrepreneurs, modest at first, became much more radical than the limited "deals" struck in the Soviet Union and Eastern Europe. Economic reforms under European communism gave legitimacy, at most, to low-powered, short-term profit-based incentives, insider lobbies, and shady sideline trading networks.

In China the main limit that was placed on market access was political: China's new business class must continuously demonstrate its loyalty to the one-party state. The best way to prove loyalty was through political and family connections to the regime. This raised the danger of the new business class exploiting their personal links to power to grow rich without economic effort. One answer, but an imperfect one as we see today, was to expose them to foreign competition. In fact, there was more product market competition in export markets than across China's internal provincial borders.

A crucial and completely accidental advantage on China's side was its size. The Chinese population was so large that its 31 provinces each formed an economic region with tens of millions of people -- the size of a large Western European country. In contrast, the Soviet Union decentralized economic management across a much larger number of much smaller provinces, averaging little more than a million people each. Unlike a Chinese province, the typical Soviet province was highly dependent on its neighbours. The danger was that a Soviet provincial boss could gain more by sabotaging his neighbours than by honest effort within his own limited sphere. In the Soviet Union regional rivalry turned out to carry high costs and few if any benefits.

If regional rivalry was not productive within the Soviet Union, why did it not work across Eastern Europe as a whole? After all, each East European country had considerable freedom to experiment with national economic models, and was more like a Chinese province in size and diversity than a Soviet province. Nonetheless, international competition did not work any better than interprovincial rivalry. Most likely, East European communist leaders had too much job security and tenure, did not depend on doing better than their neighbours to keep their jobs, could not be promoted to Moscow, and, even if they succeeded economically, could not build on success to attract labour from their neighbours because international borders, even within the communist brotherhood of nations, were rigidly sealed.

It may also have been a factor that East European and Soviet leaders just did not "get" continuous policy reform. They thought catching-up growth could be achieved by one-off reforms or interventions. It is also a good question whether Chinese leaders "got" continuous policy reform, or whether they stumbled across a design for it by accident.

Either way, the result was this: The recipe that happened to make communism work in China was tried and did not work in Europe. That raises a question of vast proportions: Will the same recipe continue to work in China's future?

Here we come back to the fragility of continuous policy reform. China's level of output per head has multiplied several times over the level of the 1970s. It must multiply several more times before China can approach the level of the world's richest countries. This is a very long haul. For China to maintain the continuity of policy reform over the distance is beyond unlikely. At some point, some coalition of interests is bound to form that will be strong enough to block it, at least for a time. At that time China's oligarchy must be willing to intervene on the side of movement, not stability. If not, the China deal will come unstuck.

References:

Harrison, Mark. 2012. Communism and Economic Modernization. CAGE Working Papers no. 92. University of Warwick. Repec handle http://ideas.repec.org/p/cge/warwcg/91.html.

Xu, Chenggang. 2011. The Fundamental Institutions of China's Reforms and Development. Journal of Economic Literature 49:4, pp. 1076-1151. Repec handle http://ideas.repec.org/a/aea/jeclit/v49y2011i4p1076-1151.html.


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Mark Harrison writes about economics, public policy, and international affairs. He is a Professor of Economics at the University of Warwick. He is also a research fellow of Warwick’s Centre on Competitive Advantage in the Global Economy, the Centre for Russian and East European Studies at the University of Birmingham, and the Hoover Institution on War, Revolution, and Peace at Stanford University.



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