Chinese capitalism and its future

Photo Michel Aglietta / Professor of Economics, Paris Ouest University, Scientific Adviser, Groupama Asset Management / March 1st, 2013

Between planned economy and privatization, Chinese capitalism is trailblazing its original path. What will the next twenty years be like? To form an idea, we must go over the course of reforms that have been carried out so far, while taking the full measure of a major phenomenon, which should encompass 300 million more people within a few years: urbanization.

ParisTech Review – At the end of 2012, China changed its leaders and announced reforms for the period running up to 2020. These aim to establish a new growth regime. Is this a strategic move?

Michel Aglietta – This reform is in line with the very deep transformations that the socialist revolution introduced in China in the 1950s. But before going further, let us formulate three posits. First, reform must be considered in the long term. It is a process that goes far beyond the political will of leaders. They too are driven by a groundswell of transformation of productive structures and institutions. These structures and institutions interact with each other, in a dynamic that feeds on its own contradictions; falling in line, as a matter of fact, with the Chinese way of thinking, a thought based on relation and movement, which is very different from the culture of equilibrium to which we are accustomed in the West.

Then, we have to embrace the fact that China has been a market economy for a long time already, which incidentally proves, as Fernand Braudel so well described it, that capitalism and market economy are not the same thing.

Lastly, we must remember the country’s historic journey. China had been at the forefront of technology until the sixteenth century and was the world’s largest economy in 1820. Then it declined for more than a century. In 1950, after the fall of the empire, the Japanese invasion and the civil war, living standards in the country were twice as low as Africa’s.

According to your last book, communist Mao is the one who introduced capitalism in China…

That paradox is only apparent. The strategic planning implemented by Mao was indeed the trigger because it mobilized the rural masses around a massive industrial project for the first time in the country’s history – even though an initiative like the Grand Leap Forward was a dramatic failure. But it was the Party, under Mao, who laid the ground for industrialism and a mass education system. It introduced the basic health care bringing it even to the most back country areas: as a result, there was a boom in life expectancy. Agricultural research increased the productivity of rice cultivation. And all this in complete autarky, given that external openness didn’t take place until the early 70’s with Nixon’s trip.

Technological advances followed because China was henceforth able to import fertilizers and a few machines, which led, at the end of the 70s, to a boom in agricultural productivity. An agricultural surplus began to appear, besides the required amount imposed by State planning for distribution to cities. Deng Xiaoping decided to allow farmers to sell this surplus, by themselves, for themselves. Thus Deng Xiaoping immediately improved the revenues of a huge mass of peasants, bestowing considerable legitimacy to his reforms between 1978 and 1985.

Let us go back to the roots of Chinese capitalism. Why hasn’t the country performed its industrial revolution in the nineteenth century, along with its Western competitors?

The European industrialization was the result of the concentration of capital by the landed, merchant, colonial and financial gentry, and of concentration of labor by the proletarianization of peasants driven from their land. If this primitive accumulation didn’t take place under the Empire, it is because the country’s institutions didn’t allow for it. Imperial China was a two-tier society. At the bottom were rural families attached to their land because they were owners, whose population growth absorbed all surplus of agricultural productivity. At the top was the imperial State, along with the bureaucracy of mandarins, which drew its legitimacy from providing public goods – e.g. canals, dykes, roads, grain silos – that ensured the well-being of the population.

Merchants didn’t constitute a social class, given that the State derived its income from taxation of agricultural production, not from borrowing. Bureaucracy was meritocratic as opposed to hereditary: social mobility could thus happen upward or downward. A feudal aristocracy or financial bourgeoisie, in the European style, could therefore not appear. The ultimate goal was harmony, not growth; the Empire led no conquest or colonization wars, and had no outside rivals. Finally, there was no primogeniture therefore inheritance was not liable to concentrate. As long as these structures were maintained, it was impossible to accumulate capital outside of the State to exercise power over the State. After the Opium Wars in 18839-1842, no attempt at industrialization has given any result whatsoever. If markets and parliamentary democracy were sufficient, as is believed in the West, to launch capitalism, it would have happened in 1911 when the Empire fell. In 1913, the country had its two Houses, modeled on the United States bicameral system.

Mao led the revolution in 1949, but “reforms” waited until his demise thirty years later. What were their different phases?

From 1978 to 1994, the first phase was that of the dual way: planning remained in place but the market developed on the fringes, starting with agriculture. In China, everything begins with agriculture. The second phase started in 1994 with the main purpose of resolving the contradictions of the first. The State took over control of budget. Strong institutional structures were set up that did not exist: a central bank, a reform of public companies with privatization; and more than anything else, the restrictions on the prices of industrial goods were lifted. However, the regime didn’t go as far as lifting restrictions on the prices of factors of production, which were and are still strongly administered. All this resulted in two growth factors: firstly the expansion of urban real estate market, which was privatized, as had been the case in Western countries, with a bubble phenomenon. Secondly, international openness, which guided the growth towards a very rapid process of capital accumulation, due in particular to the massive inflow of foreign direct investment destined to exports. And if China did rather well at absorbing the Asian crisis of the late 90’s, it is thanks to the installation of a true Chinese macroeconomy, which did not exist in the 80’s.

Reform initially contributed to enriching the countryside. What of the cities?

In urban areas however, Deng Xiaoping’s reforms posed many more problems. He wanted to repeat his idea of introducing a dose of freedom with State-owned companies, but those were nothing else than government departments. There was no difference between department and company. In 1985, Deng Xiaoping launched the reform of “business responsibility”, giving way to the legal autonomy of companies. But it did not work because minds were not ready and leaders remained the same. Their collusion with local government leaders, especially those belonging to the party – the latter remaining within companies – remained unchanged. So, when banks began to loan freely, loans were in fact policy-related, lacking frame and without limits whatsoever, since there was neither a central bank nor a monetary policy. The result was a gigantic inflation. This was the underlying reason for the Tiananmen Square tragedy in 1989. Prices skyrocketed while wages, which were administered, were not evolving at the same pace. Urban real wages collapsed. These social tensions, reflecting the reform’s internal contradictions, then propagated within the Party.

In the absence of a Western style democracy and rule of law, Chinese capitalism was able to start but will it be able to progress long?

Since it does not derive from ballots, the legitimacy of political power in China fundamentally depends on the welfare of civil society. China is a country where dynasties have been overthrown by purely popular uprisings, without the intervention of any political party. There is a real test of power by civil society and if it is not integrated by mediating institutions, it degenerates into violence. The Communist Party is fully aware of that. Each year, there are tens of thousands of small uprisings in China against local potentates or against companies simply because these relationships are not formalized enough by means of a contract. Since 2007, contract law has made considerable progress, but it is not enforced enough to this day. In particular, a highly developed labor legislation exists but it has been put on the backburner due to the huge problem posed by the recovery plan of 2008. Pressured to produce, private companies have continued to hire without contracts. Yet this is theoretically a requisite.

Inherited from the legalistic tradition, law does exist in China, but the Communist Party is wary of it. It rejects the idea that a political force can be born outside the Party, using the power of judges as a shield, for example, a bank lobby. If “democracy” is ever to develop, it can only do so within the Party, among its 84 million members. This will have to be achieved by a renewal of officials and the progressive inclusion of the middle class.

In the perpetual reform imposed by China on its economy, what was the part played by the country’s accession to the World Trade Organization?

Combined with foreign investment and with a huge U.S. deficit, entry into the WTO in 2001 triggered both a growth of 10% per year until 2007, and most notably a very intensive accumulation of capital. Along it came a reduction in the share of consumption in the GDP, a strong rural exodus to the eastern cities – all within full “demographic dividend” (1990-2010), that is to say, in a phase where fertility has already declined but where the population has not yet begun to age. This phenomenon greatly expanded the young working population, which allowed the country to move into excess of labor supply and to offer low and stable wages to internal migrants, thus guaranteeing high profitability for businesses. The offset was an income distribution whose impact on households turned out to be adverse, especially regarding the 200 million migrants are not entitled to the urban “hukou”, a residence permit that gives access to social services.

In 2008, the financial crisis triggered by the American subprime credits contaminated the whole world. Was China hit hard?

The internal contradictions of the growth regime became more acute in the wake of the financial crisis created by the western world. At its peak in the fall of 2008, the crisis caused a collapse of international trade. To maintain employment – a sine qua non of social stability and thus of the regime’s very survival – China had to come up with a massive stimulus plan with great urgency, which a posteriori turned out to be largely oversized. This plan resulted in considerable debt that stacked on top of debt contracted for the previous growth front. China absorbed the crisis rather well, but it came with a price: in 2010, inflation caused social tensions typical of transition phases in China, which changed the political balance within the Communist Party and eventually ended up with new leadership in 2012.

Is the Chinese economy backed by a sound financial system or is bad debt accumulating in opacity?

China possesses effective institutions in 2013: the Central Bank and the regulatory commission, the CBRC, both being efficient and powerful. It has the power – this is essential – to exempt banks from the negative influence of regional governments. The country successfully addressed the issue of political loans which had exploded during the 80’s and early 90’s. It acted in 1998 and in 2003 in two ways: recapitalizing banks and creating “bad banks”. Since then, in addition, the CBRC has adopted the very demanding Basel III prudential capitalization criteria, while other countries, like the United States, refuse to enforce them.

The financial system cannot be that clean!

The real problem comes from “shadow banking”, that is to say from financial vehicles used to finance real estate. For now, the government has managed to avoid bubble bursting, thanks to very strict rules: for its first acquisition, a household has the right to borrow long under the condition that it makes a significant personal downpayment. For any subsequent acquisitions, you get no credit. There’s a ban on buying three properties. Prices have stabilized in large cities, without collapsing, because at the same time, there is a strong social program to ensure that a sufficient number of constructions are available.

By 2030, what should be the next critical milestones?

The prices of factors of production remain to be liberalized: labor, capital, rural land and energy. It is much more difficult to achieve than for market goods because competition is not the same. The labor market is evolving through demographic change. Companies will face a crucial choice: either adapt to rapid wage increases in the eastern regions and be forced to move upmarket to increase their productivity, or maintain their momentum but then be forced to migrate inward. Capital market must be completely transformed: for State enterprises, interest rates are far too low compared to the rate of growth, which has allowed for accumulation, but at the same time, it is much too high for private SMEs which find great difficulties to thrive. Finally, gas and electricity are too cheap. Getting prices right is of the essence as well as a market taking CO2 emissions into consideration.

Precisely, what will mark the next two decades is urbanization.

About 300 million Chinese will migrate to cities that do not exist yet. The national megaproject is to build 200 cities of between one and five million habitats. Cities of the future, low-carbon cities. Therefore railway lines are mandatory. Multipolar cities must be built, such as Chongqing, to avoid spreading, which is a disaster for transport and therefore for the environment. A multipolar city contains sub-cities and rural areas. Each sub-city must specialize in a productive sector. Some will be industrial, some will focus on agribusiness. Each will be self-contained enough that there is no commuting between them. You must be able to live in the sub-city you work. Those are not dormitory towns. All this requires ambitious planning, resting on experiments, such as the one which is underway in 2013 in Sichuan.

Migration to cities is a major economic issue. It is associated with a significant increase in productivity, generally in the order of a factor of one to five. It also goes hand in hand with the development of services. In this respect there is still much to do, and it bears insisting on one point: the issue of privatization is crucial. In 2013, there are 110,000 State-owned companies left in China. Often they have a monopoly even though the sector is neither strategic nor significant at the macroeconomic level by maintaining employment for instance. In culture or sport, considerable efficiency and consumption gains can be achieved through privatization. In health, creating private practice alongside public hospitals could lead to cost reductions and important service improvements. Nowadays, planners only want two sorts of SOCs: on the one hand, cutting-edge multinationals in strategic sectors such as nanotechnology, new materials and all the environmental technologies that are prerequisites for the new growth. On the other hand, businesses that are pivotal for the regional economy. Everything else should be privatized.

Is planning a panacea in a modern economy?

Westerners are deprived of the means to act on behalf of the dogma of market efficiency. The Chinese government has retained, through economic planning, control of financial flows and of monetary policy, as well as the ability to implement a long-term strategic vision: to be on par, within twenty years, with the technological boundaries currently occupied by the West, advancing the environment, substituting exports with domestic consumption, reducing social inequalities, planning sustainable urbanization by means of urban concentration and the electric car.

Isn’t there a risk that all these efforts may be undone by brutal aging from 2020 onwards?

That kind of impact should not be overestimated. Until 2020, the working population will remain high, although there will be fewer young people between ages 15 and 24 (the first “Lewis turning point”, this moment in economic history where the workforce available in a given region ceases to be virtually unlimited). But the reduction of the workforce’s weight will be gradual, and start from a high level. Moreover, the Chinese have plenty of leeway: to react, they can reform at will. After all, retirement takes place at age 56. In urban surroundings, where jobs are less strenuous, such an age limit can be raised. And the participation of women in the labor force is still modest. Finally, the one-child policy will be loosened.


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  • Chronicle of a Decline Foretold: Has China Reached the Lewis Turning Point? (M. Das, P. N'Diaye, IMF Working Paper, Jan. 2013)
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