April 1, 2010

China can change and China does change

The structural conditions for a financial crisis are abundantly present in China today. There is a weak financial system, an overvalued stock market, a deteriorating social foundation and an underdeveloped indigenous corporate sector. Compared with Southeast Asia, China is poorer and the effects of a financial crisis will be grave.

When this ominous prediction, found on page 290 of Yashen Huang’s Capitalism with Chinese Characteristics was read to a friend, he asked if this was not said some ten years ago. Perhaps he had Gordon C Chang’s The Coming Collapse of China in mind. He said that it sounded as inevitable as death, but with the same uncertainty in predicting its arrival.

This observation is no reflection on Mr Huang’s wonderful work. It merely represents the struggle that economic and social historians face in trying to fit China into familiar historical frameworks. The strength of Mr Huang’s book is the tremendous amount of original work behind it. The insights are rich and useful. Subtle humour pervades. His lack of respect for reputation and willingness to name people for their misconceptions and wrong diagnoses are borne out of his commendable intellectual convictions, hard work and honesty.

He divides China’s post-reform period (starting in 1979) into three periods. The first is the golden period of reforms that essentially lasted until the Tiananmen Square protests but somehow resumed and lasted until 1994. This was the period when directional liberalism was amply evident in China.

Mr Huang contrasts directional liberalism from institutional liberalism, which is what most western liberal democracies are. Chinese reformers in the 1980s did not go so far as to institutionalise liberal reforms in politics and economics. But the direction of change was unmistakeable and the shift, soon after the end of the Cultural Revolution, was so significant and sincere that it was enough to unleash rural entrepreneurship, boost rural household income, business income and lift health and educational standards in rural China. There was liberalisation of finance as well. Rural credit and access to credit expanded. If India under Nehru experienced a slow ascent up the Marxian Mountain in the 1950’s and 60’s, China since 1979 was marked by a slow and steady descent from the same mountain.

In the 1990s, after the Tiananmen Square student protests, everything changed. It was state-led crony capitalism with accent on investment, foreign direct investment (FDI) and heavy state control of the economy. The power, reach and influence of State-owned Enterprises (SOEs) expanded. The indigenous private sector shrunk and capacity building stunted. China’s restructuring of the SOEs was more symbolic than substantive. There might not have been private stripping of public assets as was the case in Russia but there was public stripping of private assets. China’s GDP grew but people’s incomes did not. Income inequality widened. Access to finance was curtailed and innovations in rural credit delivery were rolled back. In fact, illiteracy in China expanded between 2000 and 2005 as a result of the policies followed in the 1990s.

The book does not attempt a political economy explanation of the changes to the policy orientation in the 1990s and their reversal in the new millennium. In fact, Mr Huang notes that the policy platform unveiled at the Seventeenth Party Congress in 2007 was the most liberal and progressive since the Thirteenth Party Congress some twenty years earlier. The emphasis that the current leadership has placed on rural education, healthcare and rural incomes suggests that they have their priorities right again. The economic report of Premier Wen Jiabao to the National People’s Congress in March 2010 repeatedly emphasises ‘opening up’ and grassroots democracy.

It is important to realise that, in crucial aspects, China has not followed the famed East Asian model. Mr Huang provides many examples to show that while state intervention was high in East Asia, the interventions were market conforming. Foreign direct investment played a very small role in the export performance of East Asian nations in the 1970s and 1980s except in the case of Singapore. Mr Huang believes that the role of the state investment in China puts it closer to Latin America than to East Asia.

One similarity is that both East Asia and Latin America opted for exchange rate management, as has China. Both regions endured major crises because of this. China has avoided one so far. China has managed to keep its nominal exchange rate undervalued and real exchange rate from becoming too uncompetitive. It has not allowed labour unions and wage bargaining, as wages are a key component of costs and inflation. It has price curbs on many utilities and services. Thus, the party’s grip on power, economy and society remains strong.

Command capitalism could be worse than command socialism as income and wealth inequalities under capitalism are too visible for the poor to ignore. The paradox with command capitalism is that as long as there is nominal economic growth, most of the distortions it causes would remain manageable and some may even fade away. At the same time, its persistence and spread would derail growth and much else.

Which tendency would prevail eventually is really a matter of guesswork. It is easier for historians to explain them after the fact rather than for futurologists to predict. That is why the book wisely refrains from doing so. Nonetheless, with these caveats well in place, readers would have benefited from his insights on this all-important question.

What does this book hold for India? Plenty. In fact, there are reasons to believe that the current UPA government, in office in India since 2004, has been pursuing policies that represent the worst of the 1980s and 1990s practices of China. In rural India, it is likely that the government’s distributive programmes are increasing dependency rather than unleashing rural entrepreneurship. In urban India, the government is emphasizing FDI and faster GDP growth without undertaking economic liberalisation. “FDI does not put the country on a high-growth trajectory but once a country grows fast, FDI will come to the country regardless of its infrastructures” (p 268).

To achieve sustained high growth, India does not need its government to spend but to find more ways to get out of the way and be accountable for what it does and where it spends. Even the South Korean dictator Park Chung-Hee would visit his cabinet ministers to discuss goals and strategies for the upcoming year and follow up with a performance check one year later. Those who failed more than 80 per cent of the targets would be fired on the spot. He would meet business people only in large groups in which they acted as representatives of their industries than as representatives of their firms.

On governance and accountability, China of the 1980s shows the way for India and for many other nations. The mayor of Wuhan not only apologised to a private entrepreneur for having wrongly arrested him but also personally delivered the court’s verdict and the 600 yuan that the government had confiscated.

In Wenzhou, in a similar situation, the local government released all the imprisoned private entrepreneurs and restituted their assets for having arrested them earlier for allegedly manufacturing inferior electric transformers. Not only that, the government published the decision in local newspapers explaining why it had erred.

The signalling effect of these two events cannot be underestimated. In Mr Huang’s words:

In an unconstrained political system, that the policymakers were willing to let peasants experiment and to trust them to come up with right solutions is nothing short of extraordinary. This political economy dynamics is the single most important feature of the decade of the 1980s. (In contrast), the Chinese authorities in the 1990s responded to the rising problems caused by financial centralisation with more financial centralisation. May be there is no such thing as an ideology-free policy approach. Being pragmatic is an ideology in and of itself.

To the extent that China has had a more recent experience of good and hands-off governance, it seems to have an edge over India. To the extent that it was able to apply the principles of laissez faire economics where it mattered—in agriculture, in rural China—it has also displayed original thinking in economic development compared to the statist and confused application of the principles of free-market economy in the West.

Hence, despite its cautious message, Capitalism with Chinese Characteristics leaves the reader with the impression that, for all its faults, the Chinese leadership is capable of both original thinking and course correction. Something for existing and aspiring superpowers to think about.

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