Tuesday, April 19, 2011

The Wrong and Dangerous Narrative of Chinese Growth

The following quotations capture what is coming to be called the “Beijing Consensus,” namely the superiority of the Chinese model:

Report of Chinese Academy of Social Sciences:

“China’s success in the past 60 years, especially after the opening-up, has surpassed the achievements of Britain during the Industrial Revolution and the US progress in the 19th century.”

Thomas Friedman (New York Times):

“One party autocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages. That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century.”

George Soros (Speech in Paris):

“The world does need order, and that order needs maintenance. The idea that markets can correct their excesses turned out to be false. Perfect order and global governance are not realistic expectations. However, it is a sad fact that Western democracies provide less successful leadership than China.”

The growing consensus that China’s “socialism with a Chinese face” is superior to the “liberal” American model .is based on three stylized facts: 1) China is the world’s fastest growing economy, 2) China weathered the financial crisis better than others, 3) China is building a better infrastructure Hence the conclusion that the Chinese one-party state makes better economic decisions through an enlightened industrial policy executed by state enterprises.

Any claim that political decision making yields superior economic results must be greeted with natural skepticism. Past praise of Soviet planning, French Planification, and Japanese industrial policy was muted when confronted with long-term results.

If “enlightened” Chinese industrial policy is executed by state enterprises (or “national champions,” as they are called), they should be the engines of growth. Nothing is further from the truth. The state sector has been shrinking and must defend itself against further encroachments by the private sector just to hold its own.

The state sector is shrinking despite two major advantages:

First, Chinese banks, which are state owned, make 96 percent of their loans to state enterprises. Private companies get a miserly four percent. They must turn to informal lenders where they borrow at very high interest rates. China’s state banks have huge portfolios of toxic loans, while the unofficial private lending market prospers. All this against the backdrop of a country that has a gross saving rate of fifty percent.

Second, the private sector has grown despite the obstacles placed in its way by the state. Private companies can be put out of business at any time by authorities who watch over them “with one eye shut and one eye open.” That they continue to prosper and grow is a testament not to industrial policy, but to their ability to survive a hostile state policy. The success of China’s private enterprise is a monument to capitalism, definitely not to state industrial policy.

Chinese growth is accounted for by the private sector which operates outside of (and in spite of) state industrial policy.

State enterprises are estimated to earn a four percent return on capital versus a minimum of 14 percent for registered private companies. China’s inflation makes the state enterprises real rate of return negative! Unregistered private companies earn much more. They continue to grow despite borrowing in unofficial lending markets where the “Wenzhou rate” is at least 18 percent.

State enterprises accounted for almost all of GDP in the mid 1970s. They have now shrunk to some thirty percent. Rapid Chinese growth is therefore due to private companies. The state sector alone would have given China a modest rate of growth.

China, along with other Asian countries (who by the way do not use the Chinese model), emerged from the financial crisis of 2008-2010 less scathed than Western economies.
We forget that business cycles are a part of the free enterprise system. Keynes’ promise to end them did not pan out. One-party states can better promise stability than democratic market economies. Despite their inevitability, every business cycle is heralded as a “failure of capitalism.”

We have already forgotten that the current financial crisis followed upon what economists call “the Great Moderation” – a long period of growth and tranquility from the early 1980s to 2006. Unless we abandon our institutions, we will embark on another extended expansion, and the “failure of capitalism” will again be forgotten.

The worst time to draw conclusions about the superiority of one economic and political system over another is at the end of an economic downturn.

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