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Thursday, September 19, 2013

China: Yes, It’s Capitalism

The most growth happened where the State had the least power

Ronald Coase and Ning Wang, How China Became Capitalist. Palgrave Macmillan, 2013.

Ronald Coase, the Nobel Prize-winning economist who died on September 2, never retired. He was 97 years old in 2008 when he and Ning Wang, now an assistant professor at Arizona State University, began their book, How China Became Capitalist, published this year.

As David Henderson points out in his Coase biography, Coase never wasted time writing about trivialities; his reputation was made on the basis of two articles written 23 years apart. Like Coase’s other writings, the book is intellectually bold. And the topic—China—is of tremendous import. 

What we learn in How China Became Capitalist is quite different from conventional wisdom like that exemplified in a Wikipedia entry on China’s economy. To begin with, the title is “How China Became Capitalist.” It is not “How China Fostered State Capitalism” (to use the usual term for the country’s economic system). Nor is it “How Deng Xiaoping Created a Mixed Economy.”

More important, Coase and Wang argue that China became capitalist—and terrifically productive—largely in spite of efforts to build “state capitalism.” They write that China’s economy today is a “striking example of what Hayek has called ‘the unintended consequences of human action.’”

Leadership decisions made following Mao Zedong’s death in 1976 were indeed critical. But they were critical in unexpected ways. Deng Xiaoping is properly called the architect of China’s post-Mao economy, but his deliberate actions did not create the Chinese “miracle.” Rather, he and others ended the chaos of the Mao era and created an environment that allowed a market economy to develop on its own.

The process described in the book suggests a possible analogy with an action of the seventeenth-century Scottish parliament. Scotland, a backward country, instigated universal education in order to enable Presbyterian children to read scripture. An unintended consequence was to fertilize the ground for an intellectual revolution—the Scottish Enlightenment. Or perhaps there’s an analog in DARPA, the U.S. government agency that created a communications network for universities that ultimately became the worldwide Internet. In a similar way, actions by Deng and others enabled the Chinese economic miracle to occur, but not by the methods they adopted and not in the ways they designed.

By focusing reform efforts on State enterprises, China’s government largely ignored—and sometimes actively restrained—the sectors where economic growth actually took place. State-owned enterprises never became engines of growth; ultimately, many were privatized or closed. Meanwhile, the neglected areas thrived. “The most significant developments were to occur not at the core of the socialist economy but on its periphery, where state control was the weakest,” write Coase and Wang.

In fairness to Deng and his predecessor, Hua Guofeng, it should be said that at Mao’s death the country was so desolated by socialism and torn by chaos that basic steps were certainly helpful. For example, by the end of 1976, trade in commodities was restored (although the prices of most commodities were set by the central government until 1992); a little later, workers could get bonuses and differential pay (although their mobility was regulated); and then in a few cities, state-owned enterprises were allowed to decide what to produce (these were precursors of enterprise zones).

Changes were always couched in terms of “socialist modernization.” All leaders, it seems, were weighed down by a commitment to socialism. Everything had to be stated in terms of making socialism work; criticism of Mao and his legacy was muted at best, for Mao remained highly respected, even revered.

One historical fact was in the reformers’ favor—unlike the Soviets, Mao had always believed in decentralization; his favorite form of socialism was the local cooperative. In 1957, Mao had increased the independence of local governments and given them management of most state-owned enterprises.

Another beneficial factor was a Confucian tradition embodied in a saying that Mao had adopted—“seeking truths from facts.” That is, practical experience should inform ideology or theory. Citing that guideline, reformers could move away from the constraints of Maoism.

But the transformation of China, say Coase and Wang, came from the “disadvantaged and marginalized,” those people “on the fringe of government bureaucracy and excluded from state planning.”

In 1987, Deng himself expressed surprise at how much rural village industrial enterprises had grown, with output expanding by 20 percent a year. Their success, he said, had come “out of the blue.” In fact, although he didn’t say so, the central government had been actively hostile to them. They competed with the State-owned enterprises favored by the central government; thus they were the last to receive government-provided benefits such as loans.

It wasn’t just village enterprises, but also private farming, that fueled economic growth—even though private farming was prohibited until 1980. Well before that, unofficial non-state farming existed in many forms, from family plots to contracts between households and “production teams” (communal organizations). Ironically, when the State ended the ban and instituted the “house responsibility system,” it eliminated the vast variety of farming arrangements. By limiting farming to family control, it made economies of scale virtually impossible (an interesting governmental miscalculation).

There is a lot of detail in this book, and Coase and Wang have a number of subtle statements to make about institutional complexity and development while also giving a blow-by-blow account of the changes, deliberate and spontaneous, in the polity and economy of China.

I hope that this book will be read by China “experts.” Perhaps it will have an impact on economists’ understanding of economic growth comparable to the effect that Coase’s two seminal articles had on economics more broadly.

  • Jane Shaw is president of the Pope Center for Higher Education Policy.