China: From Mao’s Failure to Partial Economic Reform to…?

Today, October 1, is the 70th anniversary of communists seizing power in China.

Given the horrible consequences of Mao’s rule, including tens of millions of deaths from famine and tyranny, this tweet from President Trump seems rather inappropriate.

Congratulations to President Xi and the Chinese people on the 70th Anniversary of the People’s Republic of China!

— Donald J. Trump (@realDonaldTrump) October 1, 2019

That being said, it’s also worth pointing that today’s China is far better than Mao’s China.

Simply stated, it’s no longer a communist nation, at least in the sense that there’s been a decent amount of economic liberalization (starting in a small village in 1979).

China is now ranked #113 by Economic Freedom of the World. That’s definitely not anything to cheer about, but its score of 6.42 is way higher than the 3.59 of 1980.

And, for what it’s worth, China is currently ranked higher than Kuwait (#114), Brazil (#120), Ukraine (#135), and Pakistan (#136). And none of those are considered communist nations.

This isn’t merely my opinion.

In an article for Project Syndicate, Zhang Jun explains that a shift toward capitalism – even if only partial – explains what China has enjoyed impressive growth.

The rise of China is widely attributed to its state capitalism, whereby the government, endowed with huge assets, can pursue a wide-ranging industrial policy and intervene to mitigate risks. Accordingly, China owes its success, first and foremost, to the government’s “control” over the entire economy. This explanation is fundamentally wrong. …China is using its long-term planning and robust implementation capacity not to entrench state capitalism, but rather to advance economic liberalization and structural reform. It is this long-term strategy – which has remained unswerving, despite some stumbles and short-term deviations – that lies at the heart of the country’s decades-long run of rapid economic growth. …this process of economic liberalization and structural reform is also uniquely Chinese, insofar as it has emphasized local-level competition and experimentation… The result is a kind of de facto fiscal federalism – and a powerful driver of economic transformation. …China has traveled far along the path of reform and opening up. But it should not underestimate the challenges ahead, let alone forget how it got this far in the first place.

You won’t be surprised to learn that Crazy Bernie hasn’t learned from this experience.

Here are some excerpts from a column in the Wall Street Journal by Joshua Muravchik.

Sen. Bernie Sanders’s praise for the government of China should raise eyebrows… In an interview last month with the Hill, Mr. Sanders…asserted that “what we have to say about China, in fairness to China and its leadership, is . . . they have made more progress in addressing extreme poverty than any country in the history of civilization.” …Mr. Sanders’s comment about China has a basis in fact. According to the World Bank, 88% of Chinese lived on less than $1.90 a day in 1981. Today less than 1% do. (These figures are in 2011 dollars, adjusted for purchasing power parity.) Yet that success didn’t come from socialism. It’s a product of China’s move away from socialism. And it came at the cost—at least by Mr. Sanders’s usual lights—of heightened inequality. …Mr. Sanders urges a “political revolution” and a “wholesale transformation of our society” from capitalism to socialism—the reverse of what China did 40 years ago. …Yet Mr. Sanders’s accurate observation about China’s record in ending poverty ought to give him pause. Mao Zedong’s China was the apotheosis of class warfare…and shared poverty (except Mao himself, who lived like royalty with a few of his cohorts). …the core difference between socialism, which focuses on how to distribute wealth, and capitalism, which is concerned primarily with how to produce it. China’s experience teaches anew that the latter is more important than the former, for the poor as well as the rich.

But what about the future? Is China on a reform trajectory?

There’s no way to answer that question with any certainty, but there are some worrisome signs.

Here’s a tweet from a journalist for the Economist (hopefully he has more sense than some of his colleagues). It shows a shift toward more state-driven investment.

Regression of China's economy towards more of a state-led model continues. In the decade before Xi's presidency, growth of private-sector investment outstripped that of state investment 90% of the time. Since 2015, state has been on top 75% of the time. (1/2) pic.twitter.com/tl5hghuj2G

— Simon Rabinovitch (@S_Rabinovitch) September 16, 2019

I’m not sure if we’re seeing a trend of a blip.

But I am sure that much more reform is needed. One area is the “hukou” system, which Leo Austin describes in an article for CapX.

China has had a ‘hukou’ (or similar) household registration system…, which identifies and determines the rightful home of each individual, the place where they enjoy state education and medical services. If you are very lucky this is Beijing, Shanghai, Guangzhou or Shenzhen. …But for most people it is a rural county. …It is very difficult for the children of rural migrants to graduate from an urban school… The hukou system has led to a long history of wage suppression in China. Compared to its Asian neighbours, wages in China have historically been much lower than they should be at the same level of GDP. …People weren’t free to move to where the best jobs were. The huge state enterprises in their hometowns provided free education and free medical services, but they didn’t have to compete for workers and they didn’t have to pay the best wages. …If you look at consumption as a share of GDP and compare China to the other Asian Tigers, by 2016 China was consuming 20% less than Japan and 30% less than Korea did at the same level of development.

And China also is being held back by the politicized allocation of capital.

Resources go to the wrong people. State owned enterprises represent maybe a third of GDP in China today, but they still received around 82% of all the corporate bank loans in 2018, at least in the legal banking system. The money is not invested wisely. According to the Nikkei Asian Review, for the nearly 300 non-financial state owned enterprises (SOE) listed in China, returns on equity fell by half in the loose-money boom years between 2007 and 2017. Over the same period, the return on equity for comparable US and European companies rose – ending more than double the level of Chinese SOEs. All this has a serious impact on productivity – as Conference Board research shows, China’s Total Factor Productivity for the period 2013 to 2018 was negative.  In most economies, productivity improvements drive GDP growth every year in the absence of population or capital growth. In China, productivity was a drag on growth… China cannot be a true competitor to the US until it allows merit and innovation to allocate capital and rewards. An economy built on wage suppression and state investment can be large, but it cannot be competitive in the long-term. …Unless the state retreats, it may yet bankrupt the country.

My two cents is that state-directed investment is a big problem, and it is an indirect cause of bad trade relations with the rest of the world.

Let’s wrap up with a look at the history of economic freedom in China.

As you can see, there was a big improvement from 1980-2000, then very incremental improvements this century.

The good news is that China continues to move in the right direction.

The bad news is that the pace of reform is very slow.

And the big worry is that China’s score could move in the wrong direction. Especially with policies that exacerbate the nation’s debt problem.

P.S. What happens with Hong Kong is a wild card. Hopefully, Beijing will resist any temptation to intervene.

P.P.S. China definitely needs to ignore the horrible advice it’s getting from the IMF and OECD. It should also ignore the New York Times.

P.P.P.S. If nothing else, China shows us why policy makers should focus on growth rather than equality.