Capitalism with Chinese Characteristics: Entrepreneurship and the State

Capitalism with Chinese Characteristics: Entrepreneurship and the State
Reviewed by Hugo Restall

Posted April 3, 2009

Beijing has responded to the global financial crisis with a $586 billion stimulus package skewed toward large-scale infrastructure projects, while also directing state-owned banks to extend credit to state-owned enterprises. The net effect will be to double down on an already investment-dependent, state-directed economy; some analysts predict fixed-capital investment will soon pass 50% of GDP.

CapitalismIf Yasheng Huang, a professor at MIT’s Sloan School of Management, is right, this will hurt China in the long run. He argues that by encouraging a high savings rate and channeling this capital to urban enterprises, the government has destroyed the rural entrepreneurship that initially lifted hundreds of millions out of poverty. Financial liberalization, deregulation and political reform are the keys to rebalancing the Chinese economy toward greater domestic consumption.

Some history is necessary to understand where Mr. Huang is coming from. After Deng Xiaoping rolled back Maoism, which diverted resources from the countryside in order promote heavy industry in the cities, rural residents were the first to benefit. Deng broke up the collective farms and allowed farmers to manage their own plots, leading to a surge in agricultural productivity. But the story doesn’t end there. In the 1980s, farmers also started small-scale manufacturing and service businesses, supplementing their incomes. Banks provided financing for these township and village enterprises, which were officially collectively owned but in fact were owned and run by entrepreneurs.

Around 1990, however, a new generation of technocratic leaders came to power and China changed its growth model. The central government embarked on industrial policy on a grand scale, again emphasizing urban industrialization. Shanghai, which was relatively neglected in the 1980s, came to the fore, along with other coastal cities. Rural access to credit dried up, and the TVEs faded away. Farmers migrated to the coast to find factory jobs.

The results were deceptive. Growth in GDP continued to be strong, so observers both within China and around the world hailed an economic “miracle.” Meanwhile growth in household income was slowing. This gap between GDP and income growth reflects the increasing share of wealth controlled by the government and the politically well-connected corporate elite, rather than workers and entrepreneurs.

Over the course of the 1990s, income inequality soared, social mobility slowed, and the health and education systems deteriorated. Property rights never enjoyed legal protection, but at least during the 1980s there was confidence that the reform trend was moving in favor of greater protection; over the last two decades, however, this reversed and corrupt local officials began to expropriate land and otherwise engage in rent-seeking activity.

Mr. Huang’s forte is explaining why China’s apparent strengths are actually symptoms of weakness. His last book, Selling China: Foreign Direct Investment in the Reform Era (Cambridge, 2003) showed that the 1990s explosion in foreign direct investment reflected the difficulty businesses have in working around the impediments government places in their way. The private sector may be the most efficient and fastest growing sector of the economy, but it is hampered by regulations and lack of access to lending from the state-owned banks. So entrepreneurs turn to foreign partners—whether real or created out of Chinese capital that is moved abroad and then brought back.

Likewise, China’s incredibly high savings rate is frequently attributed to the frugality of the Chinese people. Sometimes it is lamented that the rate is too high, which is supposedly due to the lack of a social safety net causing households to hold onto their income. In fact, Mr. Huang notes that Chinese households save less than their Indian counterparts; it is government and the corporate sector savings that turns China into a savings superpower. This suggests that consumption would increase if household income were to rise in line with GDP.

Could China go back to the 1980s model? In fact, one part of China never abandoned it. Zhejiang province, with its famously hard-driving business cities of Ningbo and Wenzhou, continued to encourage the development of private business through the 1990s. That makes it the perfect case study to juxtapose against neighboring Jiangsu province, which started out at the same level of development in 1990 but then followed the state-led, FDI-dependent approach. Zhejiang has pulled ahead not only in per capita income, but in a host of other social welfare measures.

More efficient allocation of capital is the key. During the 1980s, the Agricultural Bank of China and rural credit cooperatives villages lent freely to rural nonagricultural businesses, but in the 1990s state-directed credit went to agriculture in the countryside and industry in the cities. Another hallmark of the 1980s was the creation of “rural cooperative foundations,” essentially village banks that sold ownership shares and used the share capital to make loans. These and other informal banking institutions were stamped out in the 1990s, except in Zhejiang.

Comparisons like that between Zhejiang and Jiangsu are crucial because Chinese statistics are notoriously unreliable. Even tracking the relative performance of government-owned and private companies is impossible; plenty of companies that are nominally private are actually public, and vice versa. Mr. Huang uses more reliable data series like household surveys to tease out the truth. But in many cases he simply has to present a hypothesis and admit that the evidence to prove it does not exist.

This problem means that trying to characterize the post-1990 Chinese development strategy is a bit of a Rorschach Test. Conventional wisdom classifies it as a variant of the East Asian model pioneered by Japan. Other economists have hailed it as a new model that shows neoliberal prescriptions are misguided. After all, China seems to have succeeded without building a rule of law, property rights, democracy, the free flow of information and capital, etc. Economists have constructed elaborate models to show how this is possible.

Mr. Huang disagrees with both these views, essentially saying that to the extent reform succeeded in China it was due to an early “big bang” of laissez faire liberalization in the countryside, followed by a descent into Latin America-style crony capitalism. The good news is that over the last five years, under Communist Party General Secretary Hu Jintao and Premier Wen Jiabao, Beijing has focused on raising rural incomes. The bad news is that the policies designed to achieve this goal are still top-down administrative measures.

That isn’t surprising, since the Hu-Wen generation still comes from the same Soviet-style technocratic background as their predecessors. The financial crisis only makes it more difficult for them to trust that a liberalized banking sector can deliver growth. Perhaps China will have to wait for new leaders to come forward with the same breadth of vision and confidence in the Chinese people as Deng Xiaoping, Hu Yaobang and Zhao Ziyang, the progenitors of the 1980s renaissance. One can only hope that those future leaders are reading Mr. Huang’s work.

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