As China’s economy has grown steadily in recent decades, its supporters have defended the country as an antithesis – and antidote – to liberal economics and politics. This argument seemed credible given China’s rapid growth under an autocratic and economically statist system. At the same time, the United States, a beacon of Western democracy, was suffering from economic and political sclerosis.
This contrast between the Chinese and American systems, and their disparate performances, has led to questions about the effectiveness of the Western model of free market and liberal democracy. Perhaps, as some observers have argued – notably, more recently, the economist Keyu Jin – the Chinese economic miracle could be evidence of an alternative strategy to the one that enabled the West’s success. China According to this view, the country developed through the power of statism and the wisdom of Confucianism artfully combined with the efficiency of the private sector. As China’s growth rate consistently averaged 9% per year, the basic ingredients of standard economics were called into question. Perhaps market finance, rule of law, and property rights were unnecessary devices and, from the perspective of Chinese culture, undesirable and counterproductive.
These arguments have become less credible of late, as Chinese growth slows and capital flees in search of safe havens abroad. In August alone, capital outflows amounted to $49 billion. Chinese capitalists are also leaving, fearing for their safety and that of their property. In this moment of maximum statism under the Chinese president Xi Jinping, the country’s growth is seriously losing steam, revealing the effect of an increasingly interventionist government. Contrary to widely held opinion, China’s economic miracle occurred because the government retreated from the commanding heights of central planning and gave way to the market economy. Economic statism is not the savior of the Chinese economy: it constitutes an existential threat to it.
STATE OF PLACE
Many have sought to use China as an advertisement for statism, but the country’s economic success actually has little to do with it. Although Confucianism and statism are enduring features of the Chinese system, exceptional economic growth did not begin until 1978, after Chinese leader Deng Xiaoping launched a program of economic reforms. These reforms were, in many ways, entirely conventional – slowly opening the Chinese market to the world, allowing greater entrepreneurship, reducing government price controls, and privatizing state-owned industries – and their collective effect was a reduction in state power. Rather than Chinese growth reflecting the growing power of the state relative to the market, the opposite is true.
This can be seen through a study of the first phase of significant Chinese growth in the 1980s. It was fueled by small-scale rural entrepreneurship. Tens of millions of entrepreneurs from modest backgrounds built factories that flooded China with consumer durable goods, construction materials, food and labor-intensive goods. This miracle owed nothing to the wisdom of the Chinese Communist Party, as Deng recognized in 1987. Hailing the rural economy as “our greatest success,” he said, “was one that we in no way anticipated.” . . . (These companies) were like a new force born spontaneously. . . . The Central Committee (of the Chinese Communist Party) takes no credit for this.” The Chinese state has endorsed – or slightly neglected – the spontaneous, bottom-up explosion of rural entrepreneurship, and reformist leaders deserve every credit for not stifling it. However, the virtues of omission should not be confused with those of commission. China’s economy took off because the state let go, not because it intervened.
A comparison of Chinese regions also shows that this is the case. The regions that have recorded the best economic performance since 1978, notably Guangdong and Zhejiang, have been the most market-oriented and experienced the least state interventionism. Conversely, regions where the state intervenes most, such as northeast China, are mired by high debt and struggle with lower growth rates.
SAFETY AND SECURITY
Classic economic theory holds that to create the conditions for economic growth, entrepreneurs need strong property rights. However, China has never had one. Their absence has fueled the myth that China developed through statist finance and industrial policy.
But a study of the historical record reveals the flaws in this hypothesis. In 1979, the Chinese government released capitalists imprisoned during the Cultural Revolution. These businessmen were then returned to their confiscated bank deposits, bonds, gold and private homes. This episode shows that, although China never had an American-style constitution, Beijing moved away from Maoist totalitarianism under Deng, thereby instilling a sense of security and confidence among Chinese entrepreneurs.
Under Xi, that has changed. Chinese capitalists have once again been marginalized, harassed, sidelined and arrested. An extreme example of this treatment occurred in July 2021. Sun Dawu, an agricultural billionaire, was sentenced to 18 years in prison, ostensibly for violating land regulations but, in reality, for his outspokenness. China is moving backwards, towards the Cultural Revolution, and away from Deng’s reforms, a development that has not escaped Chinese entrepreneurs. They have become reluctant to invest and are trying to move their capital abroad. Far from reaping the benefits of its lack of rule of law, Beijing is paying the price.
THE ISLAND ENGINE
Hong Kong has always been an exception. From the end of British rule in 1997 until the enactment of the national security law in 2020, the city has preserved property rights, a free press and the rule of law. Many Chinese high-tech companies, recognizing the opportunity in this business environment, have established themselves in Hong Kong. The territory has historically been the largest investor in China, although many Hong Kong investors are Chinese companies. These companies established themselves in Hong Kong to benefit from its legal protections and benefit from the security of their assets. They then invested their capital in China. This type of institutional whitewashing was legally ambiguous, but for many years pragmatic reformist leaders chose to look the other way, allowing Chinese entrepreneurs to take advantage of Hong Kong’s rule of law and market finance while developing their businesses in China.
Hong Kong’s advanced capital market – and access to global capital in general – funded the first rounds of Chinese high-tech startups that began in the 1990s. Before the rise of China’s venture capital industry, foreign capital was needed to finance Alibaba, Baidu, Tencent and many other high-tech startups. Much of the money went through Hong Kong. This is a quintessential globalization story attributed to China’s open-door policy; to the knowledge and expertise of foreign capital; and to the hard work, ingenuity and vision of Chinese entrepreneurs.
The forces that created China’s high-tech economy are the same forces responsible for the rural miracle of the 1980s. Chinese entrepreneurship in both high- and low-tech sectors was brought about by liberalization – globalization for the sector high technology and financial reforms for the rural sector. Statist finance, eviscerating Hong Kong’s autonomy and the withdrawal of globalization can only undermine the vitality of Chinese entrepreneurship and the engine of Chinese growth.
THE MYTH OF INFRASTRUCTURE
Statism played a crucial role in building China’s impressive infrastructure. But there is an inconvenient truth: China’s economy took off well before the country’s gargantuan infrastructure expansion. China’s large-scale highway construction, for example, occurred in two waves: one in the late 1990s and the other after 2008. In other words, China built its infrastructure after more than two decades of rapid growth. Growth enabled savings and increased government revenues and land values, and financed state projects. Statism did not give rise to growth; growth gave birth to statism.
Infrastructure is beneficial to growth. But Chinese enthusiasm for this sector poses a threat to future economic prospects. The continued construction of roads, railways and ports has plunged China into precarious debt and, because of this enthusiasm, Beijing has chosen to invest in physical infrastructure at the expense of education and health in the Rural China. This prioritization has already had harmful effects. For example, the poor state of China’s primitive rural health system partly justified the draconian measures COVID-19 measures in 2022, inflicting serious, if not permanent, damage on the Chinese economy.
China has also underinvested in its human capital relative to the size of its population. Among middle-income countries, China has the lowest proportion of high school graduates in its workforce, according to a study by Stanford University. There is a growing possibility that China’s economy will stagnate as growth stalls. If this poor economic performance continues, Chinese statism will be responsible.
PRAGMATISM DISAPPEARED
Chinese success is not a story of laissez-faire capitalism but a story of progressive and pragmatic liberalization. This spirit of pragmatism has largely disappeared from China. Since 2013, the Chinese government has adopted a statist vision of economic growth. At the same time, the obsession with national security issues has weaponized the state to the detriment of the private sector. Beijing has betrayed and rejected its own formula for success, and the economy is paying the price. Ultimately, it is the Chinese people who will suffer as long as their government gets its basic economic decisions wrong.
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