Socialism with Chinese characteristics–i.e., capitalism

Sometime in the late Seventies, the Politburo of the People’s Republic of China, led by Deng Xiaoping, decided that central planning had to be abandoned as the tool shaping the economic progress of their country.  Deng concluded that it should be replaced by the Asian Economic Development Model.  Why?

The Politburo felt it had no other economic choice.  Despite the negative effects of the Great Leap Forward and the subsequent Cultural Revolution, China had become too big and complex for central planning to be effective (if it ever was, even in a small and simple economy).  The Politburo also saw the gradual deterioration of the Soviet Union and didn’t want to follow in its footsteps.  In contrast, the examples of Japan, Korea, Singapore and Hong Kong all showed that the Development Model worked.

The PRC was very careful to distinguish between relatively free-wheeling, capitalist-style economic development, on the one hand, and the popular political consensus and personal freedoms that typically underpinned it, on the other.   In the Chinese view, it was “yes” to the first, “no” to the second.  This became known as “Socialism with Chinese Characteristics” (an acquaintance of mine who became quite well-known as an economist in China used to prepare two cover pages for all reports:  for mainland clients, the cover read “Socialism with Chinese Characteristics”;  for Hong Kong clients it read “Capitalism…”).

It took years for the outside world to understand how fundamental a change the Chinese economy was undergoing.  It may be that at first the PRC wasn’t very clear in communicating what it was doing.  It could also be that at first no one believed them.  Also, during the first half of the Eighties world investor attention was focussed on the handover of Hong Kong to China in 1997 and the political/economic dislocations that that might entail.

China’s unique issues

China had three problems specific to it that it needed to solve:

1.  The vast majority of its industrial output came from state-owned enterprises (SOEs).  True, the SOEs kept a lot of people employed.  But they were deeply unprofitable, and their output was,by and large, so low-quality that no one inside or outside of China wanted it.

2.  China needed a way to continually create a huge number of jobs.  Several million new graduates would be entering the workforce for the first time each year.  Millions more would be leaving rural agricultural areas to search for work in the cities.  Absorbing these workers into SOEs would be compounding an already serious problem and flushing more money down the drain.  In fact, any hope of revamping the SOEs would entail the layoff of still more millions of workers each year.  In total, the PRC could find itself generating 7-8 million new job-seekers annually, with no effective means of creating new jobs for them.  This is a recipe for potentially explosive social unrest, the greatest fear of any member of the ruling elite.

3.  Through the Great Leap Forward and the Cultural revolution, China had “re-educated” out of existence a generation of businessmen, professional managers and teachers.  So it had a real need for technology transfer.

The tail wagging the dog

What makes the Chinese economic experience truly unusual is the country’s gigantic physical size and population.  This has two related consequences for the rest of the world:

1.  The first step in the Asian development process has been to offer cheap labor power in return for technology transfer.  This is a transfer of wealth from the developing country to the buyer, which is a good thing.  But it also, directly or indirectly, disrupts low-end manufacturing activity in the markets where the output is sold.  In most other Asian cases, the  developing country is relatively small or reaches full employment relatively quickly.   So the pressure on low-end manufacturing in developed countries is either transitory or not that large.

In China’s case however, the most important continuing need is to create employment.  Almost 50% of the population is still working in agriculture.  Last year, the country had over five million university graduates.   And layoffs from SOEs were maybe 700,000.  So even after thirty years traveling on the capitalist road, China still needs labor-intensive manufacturing (done in the interior rather on the east coast, maybe, but labor-intensive manufacturing, nevertheless).  This has put lasting pressure on labor-intensive manufacturing elsewhere, with no letup in sight.

2.  The focus on exports has generated an immense trade surplus with the rest of the world for China.  During the early part of this decade economists seemed to agree that investing this surplus in government securities in the US and Europe had puched long-term interest rates 100 basis points lower than they would have been otherwise.

What could change?

In contrast to the last generation, the current leadership of China has been concentrating for several years on developing the western part of the country, which has so far not enjoyed the prosperity of the cities on the eastern seaboard.   This change of emphasis has preceded by only a few years the first signs (in 2007) that eastern China is beginning to run short of manufacturing labor.  As the recession ends and world demand for toys and garments picks up again, it’s likely that the locus of this labor-intensive manufacturing will gradually farther west.

In order for this to happen, large government investments in infrastructure, especially transport, but also power and water, will be needed.  Also, as the wealthier eastern part of the country continues to prosper, it’s possible that an increasing portion of China’s labor-intensive product output will be used domestically rather than exported.  The combination of increased imports of raw materials and lower exports would slow the rise China’s trade surplus.  This could have two negative effects for he US economy–high world prices for industrial raw materials, and a diminished Chinese appetite for Treasury bonds, implying long-term interest rates here could eventually move closer  to the levels of the Nineties, rather than the lower levels we have become used to during this decade.