More Chinese pragmatism

I am an optimist about China.  Some commenters mistakenly assume I am a China booster.  Actually, I don’t at all like the authoritarian nature of their political system or the gross inefficiencies of their economic system.  There’s nothing for us to emulate.

I’m an optimist because each time I visit China (and I plan to return this summer) I see dramatic changes.  Yes, it’s repressive and wasteful, but far less so than a few decades earlier.  And as this important story in the new issue of The Economist shows, the reforms roll onward relentlessly:

INFORMAL lending is rampant in China. Although some private banks like Minsheng do lend to small enterprises, the official banks that dominate Chinese banking prefer to lend to well-connected state firms. Many Chinese entrepreneurs have been forced to turn to shadow banks. . . .

At the end of March officials announced that Wenzhou, a dynamic city in Zhejiang, would be named a “special financial zone” in which two pilot schemes will be introduced. First, informal moneylenders will be encouraged to register as private lending institutions free to operate with the blessing of the state. Second, private citizens in Wenzhou will be allowed to invest up to $3m each directly in non-bank entities abroad, without the need for a formal government intermediary.

These moves are welcome. Legitimising black-market finance could accelerate economic growth by deepening the pool of capital available to the country’s cash-starved entrepreneurs. Michael Werner of Sanford C. Bernstein, an investment bank, also points out that such a reform would help by giving legal remedy in case of default. At the moment, there is none. During last year’s crunch in Wenzhou, for example, some bankrupt bosses simply boarded up their factories and fled town.

The move to allow direct overseas investment is also a promising step towards opening up China’s capital account. At the moment mainland residents can legally move only a pittance abroad in any given year. If the pilot scheme is expanded, the opening could help ease upward pressure on property prices by offering punters another way to seek high returns. Frederic Neumann of HSBC thinks allowing money to flow abroad could ease the “financial repression” of low interest rates for savers.

Tantalisingly, Wen Jiabao, the prime minister, this week declared that the “monopoly” grip of state-run banks must be broken, and hinted that the reforms in Zhejiang would be expanded nationally if successful. Officials also almost tripled the amount of foreign investment allowed in China’s capital markets, to $80 billion.

Chinese market reforms began in rural Anhui during 1979.  But the urban reforms began in the 1980s in Wenzhou, which is China’s most entrepreneurial city.  The Chinese government tends to try new policies on a small scale before rolling them out nationwide.  Often the reforms simply legalize what is already occurring.  That was true of the move away from communes in the late 1970s and early 1980s, and it’s true of the current banking reforms.  But legalization is very important, as it puts business people in a much less precarious position, especially in a country where prosecution for economic crimes can be politically motivated.


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23 Responses to “More Chinese pragmatism”

  1. Gravatar of happyjuggler0 happyjuggler0
    13. April 2012 at 08:58

    Benjamin Cole writes:

    Can a centrally planned economy work, if done intelligently and supported by an accommodative central bank?

    Too many people take a snapshot of China today and look at that snapshot to try to deduce what is causing China to have very high rates of GDP growth. They see central planning, indeed far more central planning than in the US for example (although we are regressing towards that foolishness each year), and they assume that that is the reason China is growing. It doesn’t explain why China had a dismal economy under Mao’s much more comprehensive central planning however.

    This is like looking at a marathon runner who has 200 pounds of rocks in a backpack, and is barely moving forward. He then takes 120 pounds worth of rocks out of his backpack, leaving 80 pounds that he is carrying. Then his pace accelerates tremendously, and people take a snapshot him. They take note of his increased rate of speed that he has achieved, and note that his acceleration is higher than the other runners achieved since the time he dumped 120 pounds off his back. They then conclude that having 80 pounds of rocks on your back seems to be the best way to run at a faster pace than before, while ignoring all the runners who are far ahead of him in the race, and who outpaced him when he had 200 pounds on his back.

    China’s economy isn’t succeeding because it has central planning (excepting the central bank accommodating, not causing, high growth), it is succeeding because more and more it has less central planning than before, and instead has more dispersed planning than before. China is succeeding today because it has removed many burdens from the “backs” of Chinese entrepreneurs and multinationals. This success has occurred in spite of the fact that there still remain too much central planning getting in the way of those who are actually responsible for creating new wealth (i.e. increased GDP) in China.

  2. Gravatar of Cthorm Cthorm
    13. April 2012 at 11:09

    “The Chinese government tends to try new policies on a small scale before rolling them out nationwide. Often the reforms simply legalize what is already occurring.”

    That’s something I wish we’d emulate.

  3. Gravatar of Benjamin Cole Benjamin Cole
    13. April 2012 at 11:38

    Again, I am surprised Scott Sumner does not mention that China’s central bank “has a revealed preference for growth” according to the Hong Kong Monetary Authority.

    In other words, rather make a fetish out of low inflation rates, the Chinese central bank is concern about pointing enough money to fund aggressive growth.

    It raises an interesting question: Can a centrally planned economy work, if done intelligently and supported by an accommodative central bank?

    Russia was deeply corrupt, and pre-Internet, and addicted to vodka. Making decisions is hard in that environment, or getting state capitalism to work. We can gloat and predict collapse, and it happened.

    Let’s assume China is moderately corrupt, but leaders have generally good information, and the population has work ethics and only minor drinking problems. And a central bank geared to growth.

    The China model is a lot different from the Russian model, and showing more signs of flexibility.

    Thailand now exports more to China than the USA, and the gap is widening every year. Guess who has more and more influence in Thailand?

    We do have our aircraft carriers, sullenly conducting war games off of China’s coast. They do not reap much in the way of economic advantages. And for military advantage, they are very vulnerable, probably sunk easily by Chinese submarines.

    Something tells me that China will blow us away (economically) without a shot being fired.

  4. Gravatar of Cthorm Cthorm
    13. April 2012 at 12:18

    Interesting points Ben. I have wondered something similar about China.

    I’m married to a cultural psychologist, and she was involved with lots of research on the tangible effects of ‘Western’ and ‘Eastern’ cultural norms (Eastern meaning broadly Confucian). It turns out that their values are starkly different. Eastern values place enormous weight on harmony, family, and hierarchy. What does that mean for the application of Classical Economics onto an Eastern society?

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. April 2012 at 14:03

    Nothing to do with China, but Tom Maguire of Just One Minute reminds of a proposed 2009 bet by Greg Mankiw that Paul Krugman looks wise to have ignored;

    http://justoneminute.typepad.com/main/2012/04/no-wager-left-behind.html

    ‘Team Obama says that real GDP in 2013 will be 15.6 percent above real GDP in 2008. (That number comes from compounding their predicted growth rates for these five years.) So, Paul, are you willing to wager that the economy will meet or exceed this benchmark? I am not much of a gambler, but that is a bet I would be happy to take the other side of (even as I hope to lose, for the sake of the economy).’

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. April 2012 at 14:11

    ‘INFORMAL lending is rampant in China. Although some private banks like Minsheng do lend to small enterprises, the official banks that dominate Chinese banking prefer to lend to well-connected state firms. Many Chinese entrepreneurs have been forced to turn to shadow banks. . . .’

    Hope no one tells Simon Johnson. But then, communist China doesn’t even have Medicare;

    http://baselinescenario.com/2012/04/13/how-the-banks-stole-medicare/

    ‘…what is likely to be the most profound negative impact of the banks’ behavior on most Americans. The banks’ actions led directly to an increase in government debt, which in turn has made the reduction of that debt by “cutting runaway spending” a centerpiece of the Republican presidential campaign to date.

    ‘As a result of this pressure, Medicare now stands on the brink of being eliminated as a viable form of social insurance. Yet the executives who lead these banks – and the politicians with whom they work closely – will not be held accountable this election season.’

  7. Gravatar of happyjuggler0 happyjuggler0
    13. April 2012 at 14:27

    Hmmmm, it seems like I went into a time machine and posted before Benjamin Cole in the post that I responded to him.

    Good enough for government work I guess….

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. April 2012 at 15:18

    I’m sure this isn’t an original thought but isn’t it possible for freedom to start with economic freedom and spread to political and civil freedom?

    Didn’t the Magna Charta result from the strengthening of the fortunes of nobles and consequently lead to their ability to challenge the King? And hasn’t each progressive political and civil liberalization throughout history (Bourgoise versus Nobility, Proletarian verus Bourgoise, etc.) occured because of a fairer sharing of income and wealth?

    Communist China opened the Pandora’s Box of liberty when it decided to rely on market based reforms. It’s too late to close it now.

  9. Gravatar of Benjamin Cole Benjamin Cole
    13. April 2012 at 15:53

    Happy Juggler and Cthorm:

    Yes, Happy Juggler, you are able to anticipate my every sentiment, and so therefore I concede this argument to you!

    Seriously, I prefer that 80 percent of the USA GDP be kept in the free private-sector.

    But we have horrible resource allocation problems too—does anyone think we will get $4 trillion of value back out of Iraqistan? And conspicuous consumption and instant gratification-itis has gone wild, perhaps resulting in underinvestment in capital stock.

    Another thought: It is great to have socialized economy on a planet with a huge capitalistic economy on it. We invent, and even more importantly commercialize, everything, and China can benefit. They have the Internet, computers, cell phones, lithium batteries, and all the technical advances of our era, largely from the USA (although Europe, Japan and now Asia are increasingly adding to R&D).

    Soon, I will live in Thailand, and my wife is Thai (for 10 years now). I think the Cthorm is correct that Asian societies place harmony or non-confrontation higher on the list of social obligations, and that has many advantages. We could write books on Japan and baseball (maybe I will someday).

    My guess is that the race inside China will be between liberalization and increasing ossification of corruption and government coprolite. If you can use government to protect your market….you will.

    China may be riding the tiger while threading the needle….but with our central bank, we may be doing a Japan-lite. Not sure who “wins” this one, or if both nations continue to grow on a per capita GDP basis.

    Fascinating story to play out in next 20 years.

  10. Gravatar of Becky Hargrove Becky Hargrove
    13. April 2012 at 15:53

    happyjuggler,
    There must be a little glitch in the software, the same thing happened to me a few days ago.

  11. Gravatar of ssumner ssumner
    13. April 2012 at 17:28

    happyjuggler0, I’ve made similar arguments many times. (I also wondered how that happened (you appearing before the post you commented on.)

    Ben, Money helped, but it wasn’t the main factor.

    Cthorm, I agree.

    Patrick, About a year ago I did a post on that pointing out that Mankiw would almost certainly win. And yet Krugman keeps insisting that he’s been right about everything. . . .

    Mark, I strongly agree.

  12. Gravatar of Peter N Peter N
    13. April 2012 at 17:44

    If we had China’s demographics, we wouldn’t be talking about Medicare.

    China is reaching the point where things that can’t go on forever stop on any number of curves. Energy use, limits of central planning, possible Minsky moments, a weak financial system, infrastructure bottlenecks, rising labor costs…

    OTOH they have a lot of momentum and entrepreneurial zeal, and they still have large-scale low and medium tech industries to conquer (like shipbuilding).

    Sooner or later, they’ll stumble, but they could hold it together for another 3 to 5 years. By then maybe some technological horse will sing for them. They’re investing at a frightening rate (photovoltaic power, clean coal…).

  13. Gravatar of Robert Robert
    14. April 2012 at 03:56

    I buy that Chinese are pragmatic about economic development, but I’m not sure about them being more culturally pragmatic then Americans as, I think, you mentioned previously. You may be right that Americans can be overly politically correct when talking about culture, but, in China, if you hear some of the things many Han Chinese say about Uyghurs or even Tibetans — it doesn’t sound very enlightened. In fact, I would argue that many Americans have a more nuanced view of things like race and culture considering the level of diversity that exists in the states. I tend to think that their history is presented to them in a way that emphasizes supremacy of Han people historically, while painting them as victims more recently. Keep in mind the way the education system works in mainland China. School textbooks all have to be approved by a ministry of education that ultimately serves the party. You’re also absolutely right that things are getting better in China from a values perspective, but the K-12 education in China doesn’t seem to be improving in a way that inspires better cultural understanding.

  14. Gravatar of ssumner ssumner
    14. April 2012 at 12:29

    PeterN, Yes, they’ll stumble, and then recover.

    Robert, I agree. My previous post was too simplistic about pragmatism.

  15. Gravatar of Jim Glass Jim Glass
    14. April 2012 at 20:59

    The New York Times just had two major stories (one on Page One) about the Bo Xilai, his wife, murder and money tale. Non-gated (syndicated) versions, one, and two.

  16. Gravatar of Jim Glass Jim Glass
    14. April 2012 at 21:09

    I’m sure this isn’t an original thought but isn’t it possible for freedom to start with economic freedom and spread to political and civil freedom?

    Didn’t the Magna Charta result from the strengthening of the fortunes of nobles and consequently lead to their ability to challenge the King? And hasn’t each progressive political and civil liberalization throughout history (Bourgoise versus Nobility, Proletarian verus Bourgoise, etc.) occured because of a fairer sharing of income and wealth?

    Well, in retrospect, growth of political liberty seems always driven by increasing economic liberty and success. But that view is extremely contaminated by the equivalent of survivor bias. In the great majority of cases, growing economic liberty and success gets squelched by the warlords, literal and political. For political and economic liberty to grow, the warlords themselves must profit from it — be bought out — or they kill it.

    My favorite example is from North. The famed British Navy circa 1700 was only 10% “Royal”. The rest of the ships were provided, provisioned, controlled by the lords and magnates of coastal towns, who would come together to fight when called, maybe. Pretty much literally Warlords at Sea. Not only did this create serious command problems, but the WaS extracted huge rents just as one can imagine, enriching their selves and allies via monopoly provisioning profits. So provisions were both semi-poisonous for crews and extortionately expensive — with all innovation in naval logistics suppressed by the WaS monopolists. But there was no other way, he who owned the ships and financed their initial provisioning called the tune.

    Then when the Seven Years War with France was not going well, the naval “Board of Victualling” got a brainstorm: go into the new “bond market” and sell navy bills to be paid “in due course” on the govt’s credit. With the new source of up-front funds, the Board could open provisioning to competitive bidding, slash costs and spur innovation. The problem was the WaS faced a huge loss of rents as a result and still controlled the ships so they could kill the deal to protect their personal power, income, and patronage. This is where growth and modernization die, 19 times out of 20.

    But the productivity gains from the navy bills proved *huge* — maximum ship time at sea quickly rose from four weeks to six months(!) at slashed cost. This meant a “bigger pie”, more victories, conquest, loot. That let the govt buy out the WaS with a bigger piece of the action — in exchange for giving up their rents in port they got a lot more in profits from conquest at sea. When the French holdings in North America were won after the greatly improved British navy defeated the French navy, “the pie” got really a whole lot bigger.

    As consequences, the British Navy took a huge jump towards being a “professional” navy and the British financial markets took a huge leap forward — both to be great advantages over the competition in later wars, building the Empire.

    But it didn’t happen because the new financing was a smart idea, fair, progressive, innovative, or anything like that. It happened because the WaS were *bought out*, they made *more profit* from the bigger pie than they would have from their rents, in a deal that benefited both sides, them and those prosecuting the war. If they hadn’t gained from the deal they would have squelched everything, just like warlords keep people poor everywhere for their own gain.

    North, Acemoglu, and such development economists are pretty dismissive of the idea that economic success comes from having smart people, getting top expert advice, culture, or anything like that. They say it comes from the warlords and top power elites making deals among themselves to benefit themselves, which happen to have spillover effects for the general good, which then maybe can be harvested. Just like Smith’s baker provides his bread to the public out of self-interest.

    At Econtalk Acemoglu has a podcast about his new book. But Bruce Bueno de Mesquita has four that IMHO are better at verbally explaining this thinking with a lot of historical examples, showing why its so hard and rare to reach the tipping point where the power elites gain more from providing public goods than from providing private goods to themselves.

  17. Gravatar of John John
    14. April 2012 at 21:32

    Ben Cole,

    You said “It raises an interesting question: Can a centrally planned economy work, if done intelligently and supported by an accommodative central bank?”

    That reminds me of Paul Samuelson saying in 1988 that the Soviet Union was proof that a command and control economy could survive and even thrive. Get ready to be on the wrong side of history. China will not blow us out of the water economically if that saying has any possible meaning. US per capita GDP will be higher until 2100 or the world ends; whichever comes first.

  18. Gravatar of Jim Glass Jim Glass
    14. April 2012 at 22:11

    “It raises an interesting question: Can a centrally planned economy work, if done intelligently and supported by an accommodative central bank?”

    The “socialist calculation problem” was seriously and enthusiastically debated in its day, but that was long ago and the answer was determined decades back.

    China’s govt may reform politically or not. If it doesn’t, and tries to remain a one-party political monopoly planning and directing the economy, it will fail to produce a developed nation. Period. It won’t matter how many very smart people it has in it and working for it. End stop.

  19. Gravatar of Rien Huizer Rien Huizer
    14. April 2012 at 22:40

    Scott,

    The underlying article does not tell you a whole lot, except that what is now illegal loansharking in Wenzhou may apply for a government registration. What that registration entails no one knows. Certainly there is no indication that these “financial institutions” will offer depositors more protection or that lending (and collection) will be more in line with normal banking practices. Registration does not equate to regulation, supervision and depositor protection. It looks more like the Japanese move, a few decades ago to legalize the Sarakin (informal consumer lenders. operating in the no man’s land between consumer banking and loans sharking by organized crime).

    Bank reform in China is a very hard topic and probably this is a “caring government” response to local agony, not limited to provinces like Zhejiang or the symbolic city of Wenzhou. To what extent this is the way to introduce non-state banking into China is hard to say. Probably more symbolic than real.

    The problem that needs to be solved in China is the governance of the State Sector as a whole. The most difficult component of which is to “monetize” influence and distribute the result of that over the party elite.Not much different from the challenges in Russia under Yeltsin.

    As most readers here probably do not know, the big four SOE banks are still controlled by the state (via a Central Huijin, see also
    ttp://www.bloomberg.com/news/2012-02-04/central-huijin-plans-for-china-banks-to-reduce-dividend-ratios.html) although all of them are listed as well. The primary task of the SOE banks is to control the finances of the private sector activities of the State organized into SOEs (the more development/public sector activities are under the China development bank, 100% owned by the State). There is no role for the State banks in p[rivate business finance except when related to SOE finance (JVs). The State banks are of course active in retail and consumer banking, but a lot of that is an outgrowth of their busioness banking ( salary accounts replacing pay packets, housing loans replaging corporate rental housing)

    Under Central Planning, the banking sector (consisting then only of the People’s Bank of China, now the Central Bank) was basically the cash management agent /bookkeeper of the central planning system. Since then the “monobank” has undergone successive waves of modernization: (1) split into several functional units (PoBC and the Big Four) (2) corporatization plus recapitalization after the problems in the 1990s, which led to parallel reforms in the SOE sector and the banking system (3) listing of non-controlling stakes and strategic alliances with foreign banks.Paralel to that a complete internal modernization with China-wide computer systems and declining influence of provincial gvts over lending decisions This process led to a completely different governance structure in the SOE sector (still by far the largest part of China’s formal economy), with declining power for provincial gvts and central industry ministries and more direct control by the State Council (the body that mr Wen chairs) through the quasi holdings SASAC (industries) and Central Huijin (banks) (Huijin itself formally a subsidiary of the so-called sovereign wealth fund CIC which in turn is jointly controlled by the MoF (Treasury) and the PoBC (Fed). Finally there is an oversight body in order to comply with Basle I, II and III).

    The problem of this structure is of course twofold: it lacks truly independent checks and balances (everything ends up in the State Council and the parallel organization of CCP entreprise representation, which makes it hard to separate fiscal and monetary policy (what is the difference between a loan that is not intended to be serviced and a fiscal transfer?). A second problem is that the much higher levels of centralization of SOE sector governance are taking away the benefits of the decentralized approach that made China’s transition so different from the USSR, and the different types of informal activity that are likely to flourish under either model, with their differentiated consequences for private wealt accumulation of state and party functionaries. The three eye catching experiments in China (the two mentioned in the Economist are really functionally unrelated except that they happen in Wenzhou): Wenzhou, Wukan and the treatment of Bo Xilai must have something to do with attempts to resume reform under very different circumstances than in the 1990s. The pattern seems to be (1) centralization (more or less complete)(2) privatization (unfinished) (3) turning the gvt and financial sectors into things with more normal fiscal and monetary functions (highly contentious).

    Unfortunately, the status quo bias is now much higher than in the 1990s and there is real money at stake. So we may see lots of symbols but only piecemeal further reform.

  20. Gravatar of Evan Soltas Evan Soltas
    15. April 2012 at 11:00

    Hi Scott,

    Without reading this post of yours, I think I came to broadly the same conclusion as yours in a post on my blog I wrote yesterday — that China is now on a path where increasing liberalization is effectively inevitable.

    In particular, I think there’s really strong evidence that in this time of leadership transition, the gov’t has decided to emulate South Korea in 1990. I’m getting this from a re-reading of the Bo Xilai dismissal, the winding-down of capital controls in recent months, the background of China’s presumptive next leaders, and the announcement of a new export strategy which is highly reminiscent of S. Korea’s at that time.

    http://esoltas.blogspot.com/2012/04/china-next-south-korea.html

    - Evan Soltas

  21. Gravatar of ssumner ssumner
    15. April 2012 at 11:27

    Jim Glass, Thanks, I didn’t realize that about the Royal Navy. Fascinating stuff.

    And yes, I saw they were going after Bo’s wife—reminds me of Madame Mao.

    Rien, I certainly agree with your critique of the Chinese system, but I am more optimistic about reforms than you are.

  22. Gravatar of ssumner ssumner
    15. April 2012 at 12:07

    Thanks Evan, I did a post on that.

  23. Gravatar of J.V. Dubois J.V. Dubois
    16. April 2012 at 07:34

    Scott: I think what Jim writes about is in less detail described in “Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History”a fantastic book by Douglas C. North. He has several very interesting historical chapters, begining in medieval England land law through Royal Navy story, french revolution or English/Wales Reform Act of 1832.

    North’s arguments are very captivating and it is all incredibly interesting reading despite of a little too academic vocabulary (at least it was for me as history is my hobby). At least North tries to answer why it was in modern era an not in ancient Greece or medieval Italian Merchant Cities that liberal democracy and capitalism emerged.

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