Interpreting China's Economy

Gregory C Chow

• Publisher: WSPC
• Year: 2010
• ISBN:
  9789814338653
• Topic: Economics
• Subtopic: Comparative Economics
• Index: Economics

This book is unique in covering all important topics of the Chinese economy in depth but written in a language understandable to the layman and yet challenging to the expert. Beginning with entrepreneurship that propels the dynamic economic changes in China today, the book is organized into four broad parts to discuss China's economic development, to analyze significant economic issues, to recommend economic policies and to comment on the timely economic issues in the American economy for comparison.

Unlike a textbook, the discussion is original and thought-provoking. It is written by a most distinguished economist who has studied the Chinese economy for thirty years, after making breathtaking contributions to the fields of econometrics, applied economics and dynamic economics and serving as a major adviser to the government of Taiwan during its period of rapid development in the 1960s and 1970s. In the last thirty years, the author has served as a major adviser to the government of China on economic reform and important economic policies and cooperated with the Ministry of Education to introduce and promote the development of modern economics in China, including training hundreds of economists in China and placing many graduate students to pursue a doctoral degrees in economics in leading universities in the US and Canada. These graduates now plays pivotal roles in China and in the US in academics, business or government institutions. The essays, a culmination of the author's expertise in China over five decades, are being widely read in China. When the author became professor emeritus at Princeton, the University named the Econometric Research Program as the Gregory C Chow Econometric Research Program in his honor.

Errata(s)
Errata

Contents:

• Economic Development
• Economic Analysis
• Economic Policy
• Thoughts About the American Economy

Readership: General readers, academics, professionals interested in China's economy.

Part 1

Economic Development

1

Entrepreneurship Propelling Economic Changes in China

The most important aspect of the Chinese economy today is its rapid changes. These changes are propelled by the Chinese entrepreneurs. This essay is an attempt to understand who the entrepreneurs are, the environment in which they work, whether the dynamic changes will continue and what policies can be proposed to improve the changes.

For years the most important topic in the study of the Chinese economy was the economic reform led by the Chinese government and the Communist Party of China. See Chow (2007) on China's economic reform. Much of China's economic reform has been completed. The government has provided an environment in which entrepreneurs can thrive and change the economy for the better. To study the economic changes is to study the behavior of this group of economic actors. I assume that they are rational economic agents motivated by the pursuit of economic gains. Their behavior can be understood in the framework of maximization subject to the constraint of the environment. Although economic thinking applies to the present study, the propositions are qualitative rather than quantitative. Economic growth can be measured by such important variables as real GDP, but economic changes in China have qualitative aspects that I cannot and do not wish to describe completely in quantitative terms. Yet economic thinking will be used for the explanation and prediction of the changes and for suggesting policies to improve them.

Where do the most important changes take place? Who are responsible for these changes? What is the environment in which the entrepreneurs thrive? Will the changes continue? What are the policies for improving the changes in the future? These are the questions to be addressed in this paper.

1 Where do the Most Important Changes Take Place?

Starting with the basic classification of the production of goods and services in terms of consumption, investment and government expenditure, people responsible for economic changes are consumers, entrepreneurs, the government and the workers who produce the goods and services. All play their part in China's dynamic changes. I consider the most important changes to be the economic innovations for which the entrepreneurs are mainly responsible. If the reader disagrees that I have selected the most important changes, the objective of this essay remains to explain and predict the role of the Chinese entrepreneurs in making important changes in the Chinese economy.

Innovations have been occurring in many parts of the Chinese economy, from private enterprises producing consumer goods and services and producer goods to educational institutions providing educational services. Economists following the development of economics education in China are familiar with the innovations being introduced in certain top schools of economics in terms of organization, ways to motivate members of the faculty and staff, and methods of teaching and research. The successful enterprises making an important impact are numerous.

2 Who are Responsible for the Important Changes?

Given that the important changes are innovations, the people responsible are the entrepreneurs. The talents and areas of interest of these entrepreneurs vary, but all are self-made and all started with very little wealth. This is a main characteristic of the Chinese entrepreneurs. Simply because in the early 1980s all Chinese were poor, potential entrepreneurs started on a level playing field where no one had inherited wealth. This environment is a major factor in selecting the entrepreneurs who succeed mainly on account of their abilities.

To illustrate, several years ago while traveling in Wenzhou, I observed the operations of Mr Tiger's factory which produces cigarette lighters that dominate the world market. Mr Tiger was a worker who had been laid off by a state-owned enterprise and started making one or two cigarette lighters a day. He later created and managed an enterprise which at the time of my visit was occupying over a quarter of the world market. Another example is Dr Shi Zhengrong, who holds a PhD in physics. He returned to China from Australia in the late 1990s to start a company producing solar panels and was able, in five years, to make his company Suntech the second largest producer of solar panels in the world, second only to First Solar in the United States, while he himself became the richest person in China. As a third example, BYD Auto, based in Shenzhen, Guangdong Province, was established by its president Wang Chuanfu in 2003. It has sold 448,400 electric cars and, in December 2008, began selling the world's first mass-produced, plug-in hybrid vehicle, the BYD F3DM. In December 2008, Warren Buffet spent $230 million buying a 10% stake in the company.

These examples illustrate the variety of innovations occurring in China. In 2010, Forbes reported that China has 64 billionaires (excluding Hong Kong which has 25), including 27 new ones (implying an extremely rapid rate of increase), second only to the United States which has 403, or 40 percent of the world total. Based on the list from http://www.forbes.com/lists/2010/10/billionaires-2010_The-Worlds-Billionaires_CountryOfCitizen_3.html, I have recorded the top six in Appendix A.

The businesses in which these six entrepreneurs are engaged include beverages, animal feed, retail, batteries and electric cars, and real estate, suggesting that one can succeed in a variety of businesses that provide consumer and producer goods. Three of the six had a college education while the remaining three did not. I was impressed by the two leading entrepreneurs in Taiwan and Hong Kong: Wang Yung-ching of Taiwan (who passed away two years ago) and Li Ka-shing of Hong Kong. Both did not have much education and started as low-paid workers but had excellent business skills and judgment. Many leading entrepreneurs in mainland China are of the same type.

3 What is the Environment in Which the Entrepreneurs Strive?

The environment will be discussed in terms of the following components.

3.1 The government

The government is contributing directly to economic changes but the present discussion is concerned with its role in providing an environment in which innovations by the entrepreneurs occur.

3.1.1

The Chinese government has provided a set of market institutions to enable the entrepreneurs to thrive. These institutions have well-known shortcomings but are good enough to allow the entrepreneurs to innovate. One institution is the enhanced legal status of entrepreneurs, from allowing entrepreneurs to join the Communist Party since the late 1990s to the March 14, 2004, constitutional amendment on private property stating that “legally obtained private property of the citizens shall not be violated.”

3.1.2

Like other governments, the Chinese government has been building economic and social infrastructures to facilitate the entrepreneurs' work.

3.1.3

The Chinese government plays an important role in regulating the economic behavior of the entrepreneurs.

In establishing a new business and in operating an established business Chinese entrepreneurs need the approval of a set of bureaucrats, of the central government if the enterprise operates nationally or internationally and of the local government where the enterprise is located. Any bureaucrat along the way has an incentive to collect economic rent from the entrepreneur. Thus the entrepreneurs need to be skilled in dealing with government officials.

In the process of rent seeking, a Chinese government bureaucrat performs a useful function by selecting the able entrepreneurs whose undertakings require his approval. To maximize the present value of rents to be collected in the future, a bureaucrat will try to select the entrepreneurs who are most promising in running a profitable enterprise. Most bureaucrats themselves are intelligent. They are members of the Communist Party which has an indirect election process for selecting more talented people to serve at higher places although some are selected through personal favors and connections. Intelligent bureaucrats have an incentive to support the able entrepreneurs in order to increase future rents to be collected.

3.1.4

The Chinese government conducts macroeconomic policies to provide a stable economic environment for the entrepreneurs to strive in. In so doing, it is less subject to the influence of an independent legislature as in the US. This may affect the functioning of the Chinese macroeconomy and thus affect indirectly the environment of the entrepreneurs.

China has not experienced severe economic crises during the recent world economic downturn because its institutions are not allowed to take the large risks that American financial institutions could take. The issuers of derivative securities in the US are able to create financial assets whose values fluctuate greatly while the issuers are not required to have sufficient capital to bear the risk. The financial crisis in the US demonstrates that free exchange can lead to extreme risk taking and economic chaos. The Chinese government is slow in allowing financial derivatives to be introduced. Either by the act of the Chinese government or as a part of the nature of the Chinese people, Chinese consumers do not and cannot take as much risk as American consumers. They do not use credit excessively and spend money that they have not earned. The Chinese banking system is stable because it is mainly owned by the government; depositors do not worry about the safety of their deposits. Thus the economic environment in which the entrepreneurs strive is more stable than in the US in many respects.

3.2 China's market institutions

I treat the market institutions as a separate component of the environment because government policy is only one factor in the formation of China's market institutions. I single out free entry as an important aspect despite all the imperfections of China's market institutions. Free entry is demonstrated by the different kinds of entrepreneurs and the different types of innovations that have taken place. This aspect of economic freedom enables the Chinese entrepreneurs to thrive.

3.3 Chinese legal institutions

It is well recognized that a Western-style legal system is not being practiced in China although the Chinese legislature has introduced many laws similar to Western ones to facilitate the conduct of economic activities, especially by foreign investors. These laws are not strictly enforced. To be successful, Chinese entrepreneurs have to conduct business in the Chinese way, using guanxi, for example. They have the ability and are accustomed to doing this.

3.4 The Chinese culture in defining the rules of the game

Here, I use the term “culture” in a narrow sense. In a broad sense Chinese culture has affected both the behavior of the Chinese government and the Chinese legal institutions discussed above. In the narrow sense I refer to the cultural setting in which the Chinese entrepreneurs function. There are certain culturally acceptable ways of conducting business with partners and competitors and of treating employees. Social status is important for getting things done. Thus an able entrepreneur must invest in establishing a high social status. It is often observed that the US is ruled by law and China is ruled by people. One aspect of the rule by people is that those with high social status who are highly respected can get things done even without occupying a high position. Deng Xiaoping was the paramount leader of China for years without holding a very high position in the Chinese government.

The set of rules implicit from Chinese culture affect the way in which Chinese entrepreneurs establish their position in society, partly to make their economic activities more successful. In Hong Kong, for example, by contributing large sums to charity, entrepreneurs gain social status which is an important asset for getting things done.

3.5 Chinese workers

I do not refer to the abundance of Chinese workers that has led to low wages, an important factor in attracting foreign investment to China. (The relative wage in coastal provinces in China has increased so that some foreign investors have been moving to neighboring countries including India and Vietnam where wages are even lower.) I refer to the work ethic and skills that the Chinese have inherited from thousands of years of market economic activities.

3.6 The Chinese entrepreneurs themselves

The Chinese entrepreneurs have their own characteristics, different from the characteristics of entrepreneurs elsewhere, because they are the result of thousands of years of Chinese history and culture as well as the recent history of turmoil and economic progress. I am not knowledgeable enough to give a complete account but can only mention a few relevant points.

Entrepreneurship has been developing for thousands of years since the market economy has existed for thousands of years. The quality and skill of Chinese entrepreneurs have been inherited from such a long historical tradition. Recent economic turmoil during the Great Leap Forward movement of 1958-61 and the Cultural Revolution of 1966-76, as well as the low standard of living during the period of economic planning up to 1978, has given the recent generation of Chinese the skill to survive and the strong desire to get rich. The recent economic growth shows the younger generation that opportunities are there for them to take. The intelligent entrepreneurs understand the environment and have the instinct and skill to take advantage of it. For example, many able Chinese entrepreneurs have taken advantage of the skill and diligence of workers by motivating them and giving them a sufficiently good set of working conditions.

4 Will the Changes Continue?

My answer is yes. Given the entrepreneurs' motivation to succeed and the favorable environmental conditions, we can predict a continuation of their behavior and of similar successful changes in the future. This prediction will be proven wrong only if the motivation or ability of the entrepreneurs change (which is extremely unlikely) or if the environment becomes less favorable.

Topping the list of possible changes in the environment for the worse is the possibility that the opportunity for innovation will vanish. Schumpeter (1947, p. 124) predicted that the “perfectly bureaucratized giant industrial unit…ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose…its function.” This has not happened to the Chinese entrepreneurs who keep on innovating and creating new firms as described in this paper. In the foreseeable future, opportunities for innovation in China and in the rest of the world will still be there for one reason alone. Future increase in output will require the use of energy and environmental resources that will damage the environment unless new methods of production are found to increase the output/energy ratio or to provide new methods of utilizing alternative sources of energy to fossil fuel. The opportunity and the need for innovation for this purpose is unlimited. Economic progress damages the natural environment unless new ways of producing and consuming are found that are friendly to the environment.

Now let me turn to other obstacles. These obstacles can be logically classified as obstacles occurring in the different components of the environment in which the entrepreneurs operate, as listed in Section 3.

The most often discussed is the instability of the Chinese government. Different observers have different opinions concerning its possible instability. Pessimists may point to serious problems facing the Chinese government, including problems of rural poverty and income inequality, the shortcomings of a one-party political system, the deterioration of healthcare provision for a large number of people in the rural area, the corruption of government officials, etc. Space constraints do not allow me to discuss each of these possibly destabilizing factors. A reader having a strong opinion on the possible instability of the Chinese government will answer the question in this section differently. On the issue of rural poverty and income inequality, the reader may refer to Chow (2009a).

One can go through the list of components of the environment facing the Chinese entrepreneurs. If a reader can find an important reason for that component to become unfavorable to entrepreneurship, his projection will be different from what I have stated.

Such differences are similar to projections based on econometric models. Different economists may select different sets of variables to be included in a model and specify different ways in which the selected variables interact to give forecast. I have described the economic actors and their environment and use this description (or model, if it were quantitative) to predict the behavior of the actors in the future. Unless there are some basic changes in the way the actors function or in their environment, my prediction should be valid.

5 What Policies Could Improve the Changes in the Future?

I could go through each component of the environment listed above to suggest how they can be improved. Since the list covers many aspects of the Chinese economy, only selected policy recommendations will be included.

5.1 Government

Many observers agree that the Chinese government has done a good job in carrying out economic reform to provide a set of market institutions and in providing social and economic infrastructures for the entrepreneurs to thrive. One can always point to specific reform measures or infrastructure building that can be improved. Certain large government projects such as the Western Development involve waste and corruption and can be improved.

I have pointed out the positive side of having government bureaucrats selectable entrepreneurs to support in the process of collecting economic rents. The negative side is the inefficiency of having so many layers of bureaucrats who have the authority to interfere with the working of the entrepreneurs. This is well-known by the leadership of the Chinese government but it is not easy to improve this. An able leader like Zhu Rongji was once able to streamline the Chinese g...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Preface
• Contents
• Part 1 - Economic Development
• Part 2 - Economic Analysis
• Part 3 - Economic Policy
• Part 4 - Thoughts About the American Economy
• About the Author