Government involvement has been pro-market, says Zhu Ning of Tsinghua University

The Economist

By Zhu Ning

          This is a guest contribution to our debate: Should the West worry about the threat to liberal values posed by China's rise?

China has delivered some of the most outstanding economic growth the world has seen in the past half-century. Not only has it successfully increased its GDP per person more than 20-fold and lifted hundreds of millions of its citizens out of poverty since it launched its reform-and-opening policy some four decades ago, China has also managed to become a global leader in new technologies such as big data, artificial intelligence and mobile internet applications.

Now that China appears set to overtake the US as the largest economy in the world in the coming decade, it seems inevitable that more countries and global leaders will debate whether China has established a new model of economic development. They will ask whether this new model will challenge or even topple the traditional model of free-market economics, which hitherto has been widely regarded as the underpinning of economic growth elsewhere. China’s GDP per person is still below $12,000, which is commonly regarded as the minimum for a high-income country. But hardly anybody disputes that China has done a fantastic job with growing its economy.

It seems inevitable that more countries and global leaders will debate whether China has established a new model of economic development.

Some people attribute China’s success partly to its extensive geographical area and the homogeneity of its language, culture and values—assets which are conducive to forming a giant domestic market that can propel economic growth. However, this does not explain why China’s economy faced considerable challenges before the launch of the reform-and-opening policy in the late 1970s. Even though most agree that this policy has played a vital role in the delivery of China’s growth miracle, opinions diverge as to which aspects of the policy have proved most effective.

The prevailing view before 2000 was that China’s success mainly resulted from the encouragement it gave to market forces. Starting in the agricultural sector, the allocation of labour gradually became determined by the market rather than by government central-planners. This transition put the right people into the right jobs, unleashed entrepreneurial initiative and made workers more productive. After initial success with labour reform, other important inputs such as land and capital were also gradually exposed to market forces. This encouraged China’s economy to perform more like a market one.

More recently, however, especially in the wake of the global financial crisis in 2008, some have contended that China is unique in terms of the resourcefulness and determination of its government in the pursuit of economic growth. Somewhat controversially, one method used by the government to promote growth has been through the planning and guidance of industrial development. By designating certain industries as strategic and giving them priority in the allocation of resources, China has successfully established competitive advantages in many sectors. This has helped the growth of exports and the economy as a whole.

In addition, China has used counter-cyclical monetary and fiscal policies to provide much-needed capital whenever economic growth slows down and investment slumps. This has played a critical role in maintaining the speed of economic growth, as well as in reinforcing the confidence of investors in the government’s willingness to intervene in the market. So households and entrepreneurs have faith that growth will continue, which has encouraged capital formation.

Of course, some argue that such active interference by the state is neither unique to China, nor is it sustainable. Almost all countries in East Asia have followed, to varying degrees, the so called “East Asia model” established by Japan. This involves the use of government power to promote a nation’s competitive advantage, such as by helping labour-intensive industries at the outset of development and later using fiscal subsides to sustain fast economic growth and achieve global dominance.

Maybe China’s model does not pose a challenge. Rather, it may be in harmony with the free-market-based paradigm of neo-classical economics.

China’s growth before the global financial crisis of 2008 did bear some resemblance to the East Asian model. But China’s political system, including the way its civil service is run, sets it apart from countries such as Japan or South Korea. The performance of local government officials is assessed on the basis of the speed of economic growth within the officials’ jurisdiction. This gives officials a strong incentive to ensure that growth in their area is as fast as possible. This system is very effective in ensuring the implementation of the government’s “growth priority” policy nationwide.

Even though it is common among emerging economies for governments to intervene to ensure economic growth, China’s ability to make this work is probably unmatched elsewhere. Not only can the central government mobilise huge resources to boost growth and guide industrial development, it can also control prices in order to avoid inflation and asset bubbles. China’s financial system remains segregated from the rest of the global financial system, which has helped it to mitigate the impact of the financial tsunami resulting from the global crisis of 2008.

But it is critical to bear in mind that most of China’s economic policies during the past decades have been pro-market and pro-efficiency. If anything, China’s economic reforms have demonstrated the vitality of free-market liberalism. There is a growing body of research confirming that a pro-market environment at the local level has been instrumental in delivering economic growth, as well as in boosting the efficiency of companies, promoting consumption and reducing the risk of asset bubbles.

So maybe China’s model does not pose a challenge. Rather, it may be in harmony with the free-market-based paradigm of neo-classical economics. China’s government has proved that it can provide important and sometimes indispensable remedies when the market fails—an ability that economic theory had failed to predict it could master. With such involvement by the government, it is possible that economies elsewhere might perform better, even if they become less “free”. 

It could be argued that China’s success does not raise questions about the correctness of market-based economics, but only about the best way to perfect the market. It may be that China’s experience will eventually provide an answer to the hitherto unresolved question of how to ensure sustained high-quality growth while integrating more closely with the global economic and financial system and opening up domestic markets in service and financial industries.

Zhu Ning is the deputy dean at the National Institute of Financial Research at Tsinghua University and a professor at the Shanghai Advanced Institute of Finance. He is also a faculty fellow at Yale University’s International Center for Finance. He is the author of several books, including China’s Guaranteed Bubble (McGraw-Hill; 2016).