Wednesday, June 2, 2010

More on the Chinese economic growth model

Tyler Cowen's post highlighting the fact that 21 of the 22 Chinese corporations listed on the Fortune Global 500 list are controlled by its central government or state-run banks, has ignited an interesting debate (the remaining one is run by a local government) on the Chinese model of economic development.

Matthew Yglesias makes the point that the success of countries like China and France over a long enough time period, calls to question the prevailing neo-liberal policy consensus in the US, which would have consigned countries following these policies as basket-cases. Ezra Klein has this to say about China's success

"China's approach has been to marry market planning with state control. It brings in private companies and then uses the government's power to build the infrastructure they ask for. It lets private banks purchase up to 20 percent of state banks so that it gets private-sector expertise without relinquishing the public sector's control. It lets people buy shares of their financial institutions so it can get the oversight of the market, but it doesn't ever hand the market the reins. It uses the market to help plan, but it uses the state to act on those plans far faster and more decisively than the market ever could."

Tyler Cowen responds by attributing the success of China (and France) to a few specific characteristics. One, the high status associated with government bureaucrats means that it attracts the most talented individuals and thereby ensures that the government is manned by professionally competent individuals, atleast at the higher levels. Second, unlike the erstwhile Soviet Union, the Chinese government is dedicated towards the country's growth. Third, the Chinese government has ensured that its state-controlled enterprises compete (both among themselves and with multi-nationals) in a commercial environment. Fourth, "China is grabbing the low-hanging fruit by moving smart, hard-working individuals from rural jobs to highly productive jobs". However, this will invariably come up against the "you ought to shut down" constraint and the successes of state ownership "decays" with time. Finally, the overarching control exercised by the Communist Party ensures discipline to the inter-play of the market forces.

I am inclined to disagree with Tyler for the following point-to-point reasons

1. Bureaucrats enjoy very high prestige in India and entrance to the highest echelons of Indian bureaucracy are among the most prized of career options. Despite attracting the best and the brightest, its professional competence (over the life-cycle of a bureaucrat) is questionable. There are clearly other ingredients (uniquely Chinese or French) in the bureaucratic milieu that enables the bureaucracy to maintain high standards.

2. The claim that the Chinese government is committed to the country's growth is only a reaffirmation of the importance of the role of governments to a country's growth prospects.

3. The success of the Chinese government in creating competition among state-owned firms only clarifies that what is important is not who are competing (private or government firms), but that they are made to compete (and improve) and not collude (and stagnate). In fact, the deficiency of adequate level of competition among the big Wall Street firms was surely an important contributor to the recent spectacular failure of the financial markets. Competition is a function of government policies.

4. If there are enough low-hanging fruits to be grabbed for more than three decades, and it cannot be denied that the Chinese (and East Asian, in general) model has been overwhelmingly successful in grabbing them (more than any other), then bring it on! As the "constraints" start to kick in or the "decays" increase, the governments can calibrate their policies to suit the changing circumstances. And this is precisely what China appears to be doing.

5. The Great Recession and financial market meltdown that followed the bursting of the sub-prime bubble only highlights the disastrous consequences of the absence of adequate government control (read regulatory oversight) and the unfrettered play of market forces. If the Communist Party's iron-hand has had the effect of retaining strong government oversight and disciplining market forces, then it needs to be welcomed.

None of this is meant to defend the Chinese government. Far from it. In fact, the failures of the Chinese government are on a different scale and have highly disruptive long-term consequences - suppression of human rights, environmental devastation, rampant corruption, massive wastage (manifested in over-capacity and generous corporatee handouts and concessions), mis-allocation of resources across sectors (infrastructure spending against consumption), skewed regional development (hinterland Vs coast), disruptive and painful population transfers in the name of development etc. It is possible to contain many of these failings with a governance which is more open and democratic. However, it is undeniable that the Chinese government has been very conservative with its adherence to the norms of openness and democracy.

To its credit, China has benefitted from a government that has remained fairly close to the example of the Platonic "benevolent dictatorship". It is surely unrealistic to make national economic success dependent on such low probability variables (and history shows that such governments are outliers). Sure, the Chinese government has so far remained firmly committed towards achieving its growth objectives. But that can change any moment and in this uncertainty lies the great danger.

But at the other extreme, a full-fledged democracy, as the example of India shows, is likely to create policy paralysis and seriously constrain the growth path. So, in many respects, the gordian knot of being able to traverse the ideal middle-path, is to strike the right balance between open-ness (of a free-market) and discipline (of a strong government). In the real world, striking this balance becomes a formidable, even impossible, challenge. Either countries over-shoot on the side of open-ness (like India) or on the side of discipline (like China). On the balance of evidence so far (from across all of East Asia), the Chinese model concusively appears to be more successful than the India's approach.

In reply to Tyler's question about the desirability of other developing countries copying the Chinese model, I am (for the aforementioned reasons) inclined to argue that there are several important elements of it that are worthy of emulation, especially for countries with enough low-hanging fruits to be plucked. But the central ingredient that has held together the Chinese model - its reasonably disciplined and committed government - is not readily available elsewhere. In its absence, will the Chinese model deliver the desired results?

About the low hanging fruits, see this famous The Myth of Asia's Miracle article by Paul Krugman, which attributed its success to the simple process of adding inputs and shifting labor out of low-productivity sectors like farming into higher productivity sectors like factory labor. Matt Yglesias points to this and this.

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