Prospect Special

Prospect:
Does the future really belong to China?



by Will Hutton

Issue 130 , January 2007



If China does not abandon one-party rule, will it stumble under the stresses of state capitalism? Or will it show that there can be a successful authoritarian road to modernity?



Will Hutton is author of “The Writing on the Wall: China and the West in the 21st Century,” published in January by Little, Brown Meghnad Desai is a former director of the Centre for Global Governance and an emeritus professor of economics at the LSE. He is also a Labour peer

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Dear Meghnad

29th November 2006



It is a commonplace to observe that the rise of China is transforming the world. Extrapolate from current growth rates and China will be the world's largest economy by the middle of this century, if not before. If it remains communist, the impact on the world system will be enormous and very damaging. Britain and the US are, for all their faults, democracies that accept the rule of law. This is not true of China. If an unreformed China takes its place at the top table, the global order will be kinder to despotism; the fragile emergence of an international system of governance based on the rule of law will be set back and the relations between states will depend even more nakedly on their relative power.



All that, however, is predicated on two very big "ifs"—if the current Chinese growth rate continues, and if the country remains communist. I think there are substantial doubts about each proposition. What is certain is that both cannot hold. China is reaching the limits of the sustainability of its current model, and to extrapolate from the past into the future as if nothing needs to change is a first-order mistake.



Our concern in the west should be to help China face its enormous challenges without damaging us in the process. If Chinese communism can transform itself, then China could, like Japan before it, smoothly integrate into the world power system. If not, severe convulsions lie ahead.



China's economic growth is based on the state channelling vast under-priced savings into huge investment projects driven by cheap labour. Some 200m of China's 760m workforce are migrant peasants employed in factories, construction sites and offices in its new towns and cities—the biggest migration in history. The Communist party has permitted free movement of prices, encourages profit-seeking and has sharply lowered tariffs on imports and obstacles to inward investment. Its success in creating annual growth of some 9.5 per cent for a generation, lifting 400m people out of poverty, is widely acknowledged. But the party keeps firm control of ownership, wages and company strategies—and of the state. In other words, China occupies an uneasy halfway house between socialism and capitalism; its private sector, although growing, is still puny. It is a system of Leninist corporatism—and it is this that is breaking down.



The breaches in the model are all around. How much longer can China's state-owned banks carry on directing billions of dollars of savings into investments that produce tiny or even negative returns and on which interest is irregularly paid? Poor peasants' ability to create the savings needed to fuel growth is reaching its limits. And in any case, for how long can a $2 trillion economy save at more than 40 per cent of GDP? It is reaching the limit of its capacity to increase exports (which in 2007 will surpass $1 trillion) by 25 per cent a year; at this rate of growth they will reach $5 trillion by 2020 or sooner, representing more than half of today's world trade. Is that likely? Are there sufficient ships and ports to move such volumes—and will western markets stay open without real reciprocity on trade? Every year China acquires $200bn of foreign exchange reserves, mainly dollars, as it rigs its currency to keep its exports competitive. It is absurd for a poor country like China to be lending to a rich one like the US; in fact, it is unsustainable, and the financial markets seem to agree.



China would like to lower the current feverish growth rates, but the tools available in the west—raising taxes, cutting spending and lifting interest rates—are not available to China. The party dare not trigger protests by raising taxes; officials in state enterprises and provincial governments ignore orders to lower spending because their careers depend on generating growth and jobs. And raising interest rates could create a credit crunch as loans go sour.



Nor are the limits solely economic. The 200m migrants resent seeing others grow rich as they languish in poverty. Inequality is soaring and corruption is endemic, infecting chief executives of banks, provincial governors and judges. About 400,000 people a year die of respiratory diseases caused by polluted air. China's GDP is a fifth of America's, but it releases nearly as much carbon dioxide into the air. To cap it all, the Communist party is in ideological crisis: it says the class war is over even while claiming monopoly power as the trustee of the 1949 revolution. Without continued economic growth, the party's legitimacy would be in question.



Behind all these problems lies China's only partial conversion to capitalism. Everything in China is subject to the party. Yet capitalism is much more than the profit motive and the freedom to set prices that China's reforms have permitted. The effective use of resources also depends upon a network of independent processes of scrutiny and accountability, undertaken by people in multiple centres of power and backed by rights and private property. A democratic election system is but the coping stone of this structure.



Judges who rule on evidence to deliver justice, newspapers reporting events and even corporate whistleblowers are crucial to the operation of western capitalism. It is the interaction of these hard and soft processes—what I call an "Enlightenment infrastructure"—that allows technological progress to be exploited efficiently and relatively honestly. China had markets, property and technology in the 18th century; it fell behind because it didn't have Enlightenment structures. It lacked the "trinity" of pluralism (multiple centres of political and economic power), capabilities (rights, education, private ownership) and justification (accountability, scrutiny, free expression).



The Chinese Communist party, despite local piecemeal experimentation, is repeating the mistake of the Confucian imperial system. It is the lack of independent scrutiny and accountability that lies behind the massive waste of investment and China's destruction of its environment. The reason so few people can name a great Chinese brand or company, despite the country's export success, is that there are none. China needs to build them, but doing that in an authoritarian state is impossible. In any case, more than 55 per cent of China's exports, especially high-tech ones, are made by foreign firms—another sign of China's weakness.



China needs to become a more normal economy. Chinese consumers need to save less and spend more, but people without property rights or state welfare are understandably cautious. Giving them more confidence would require secure property rights and taxation to fund a welfare system. That would mean creating an empowered middle class that would want to know how its taxes are spent. This is a political impossibility.



If this argument is right, the terms of debate about China must change. Instead of frightening ourselves about China's rise, we need to recognise our own strengths and its weaknesses. We need to be confident about so-called western values and processes—and strengthen them at home and abroad. The best way to meet the China challenge is not to close our markets and build our armies—a strong impulse in the US. It is to stay open, confident that China will only be able to truly compete with the west if it becomes more like us.



Yours

Will

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Dear Will

1st December 2006



For a liberal pluralist, you sound oddly like a monist, if not a monotheist. For you, there is only one road to capitalism—the western one—and only one political system—ours.



China has achieved rapid growth with a policy of under-consumption and over-saving, and exports rather than domestic consumption. But this is not an unusual path, nor one that China is stuck on. Japan and South Korea used the same model and are now part of the OECD club of rich countries. Moving millions of peasants to urban manufacturing centres is neither totalitarian nor sinister. It was proposed as the standard development model by Arthur Lewis, a Nobel laureate, in 1954, and is indeed the classical model. (If it was less dramatic in parts of Europe, this is partly because a third of Europeans moved to North America in the second half of the 19th century.) There are no other ways of shaking off poverty. The services sector alone will not do it, and nor will a green revolution, as India is finding out.



China's very large numbers do not in themselves make its development unsustainable. If India can achieve 8 per cent growth on a 25 per cent savings rate, China (which now has 10.4 per cent growth on a 44 per cent savings rate) will surely manage the same. Moreover, China has been reforming its banking sector and the world has shown its approval by buying up the shares of Chinese banks.



China has a lot to learn about macroeconomic management, but its failings have nothing to do with totalitarianism. India is also shy about liberalising its capital account. The Asian financial crisis of 1997 taught China and India to keep a pool of liquidity handy, even at the cost of forgoing a better use for the money.



Yes, there is a Leninist party in power within a state capitalist system. But capitalism has no unique path, nor does it require a liberal democratic infrastructure to flourish. Japan's economic rise took place without a fully liberal infrastructure, and most European states, including Britain and Germany, were capitalist before they were democratic. What the most recent phase of globalisation has shown is that capitalism requires neither the Weberian Protestant ethic nor liberal democracy; any country with a decent savings rate, mass education and access to western markets can "do" capitalism. It is not a western Christian monopoly. Indeed, some Asians are proving better at it than the Europeans.



Many people simply find it hard to believe that countries like China and India, which were famine-stricken and miserable only 40 years ago, are now wiping out western industry. But this was the American complaint in the 1960s when facing European competition in the car market. How could these upstarts compete with Detroit? But compete they did, and they were soon followed by Japan and South Korea. Today the upstarts are China and India, and tomorrow they will be Ghana or Kenya.



Capitalism is not, as you say, about "much more than profit." It is first and foremost about profit and capital accumulation. It has accommodated a variety of institutional arrangements and only in the most recent phase of globalisation have we thought that an Anglo-Saxon-style liberal democracy is its sine qua non.



Let me now come to the political issue. The Chinese Communist party is at one level Leninist, but it is unlike the Russian Bolshevik party. The Chinese communists had to struggle to win the support of the peasantry for a decade and a half before they won power in 1949. They developed a philosophy of responding to popular needs within the confines of a single party. This is what they call people's democracy, and it is much more real than it was in eastern Europe. My colleague at LSE, Chun Lin, argues in The Transformation of Chinese Socialism that the Chinese concept of people's democracy is viable. In her view, the tradition has some strength left in it, although the party will have to become even more responsive. Deng Xiaoping encouraged inegalitarian capitalist growth for a period, but there may now be a reaction against it. At the recent People's Congress, Hu Jintao made some noises about the distress in the rural areas; the system can respond.



You fear that China's arrival at the top table will be harmful for the international liberal order. Yet the UN security council had the Soviet Union as well as China at the top table for decades. And I scarcely need to remind you of the many times since 1945 that the US and Britain have deviated from liberalism and multilateralism. We do need a liberal multilateral order, but not one based on western hegemony. The arrival of China and India will compel the west to learn to be truly plural and multilateral rather than a liberal bully.



Your rendering of history is the old Whig account. Everything we do is progressive and liberal and has always been so; all our cruelties as colonial powers are forgotten. Yet your trinity of pluralism, capabilities and justification is both very recent and very Anglo-Saxon. Rights have been established only recently; ask any black or Native American or a Catholic living in Ulster. (And a large minority in the US, including its president, believe in the literal truth of the Book of Revelation about Jewish rights to Palestine.)



It would be nice if individualism, liberty and pluralism were necessary for capitalism. But he fact is that it can manage without those things. Capitalism does release forces that undermine authoritarian regimes, but unevenly and never inevitably. China may yet move towards liberal individualism. But it does not have to, and it would be unwise to bet on any imminent move in that direction.



Sincerely

Meghnad

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Dear Meghnad

3rd December 2006



You have failed to address most of my points about Chinese weakness. Instead you suspend your critical faculties when it comes to China—dazzled by its growth and keen to show how China's strength is proof of the frailties of western capitalism and liberal democracy. But it isn't.



China requires ever more investment to secure the same growth rate. Qu Hongbin and Ma Xiaoping of HSBC calculate that the additional output produced by every extra dollar of investment is now below what it was in the late Mao years. Outside the foreign-owned private sector, China's productivity is lamentable. In agriculture, the latest figures show that Chinese value-added is $490 per year per head compared with $1,040 in the Philippines and $4,851 in Malaysia. The labour productivity of China's state-owned enterprises, still constituting a third of GDP, is 4 per cent of US levels; one third of their workforce is only semi-employed.



You liken China's experience to the rest of Asia. But China is far more reliant on foreign direct investment (FDI) to deliver its export growth. Only 20 per cent of Taiwanese manufacturing exports and 29 per cent of Indonesia's were made by foreign companies at parallel stages in their development; in 2005, 55 per cent of China's exports were made by foreigners—and over 80 per cent of its telecommunication and electronic exports. China needs FDI to make good the deficiencies of its indigenous institutional infrastructure. China set itself a target of 50 companies in the world's top 500 by 2010. It will do well to have one.



Capitalism is far more subtle than either free market fundamentalists or Marxists accept. Of course, China has to move its peasants to its cities in order to develop. But capital still has to be allocated efficiently. And if an economy is to produce self-sustaining productivity growth, its companies must do more than exploit cheap labour. They must develop the "soft" processes that spur productivity and innovation. China's have not.



The political inequities in the way China handles migration—every worker has to have a licence to migrate and most migrants do not, thus rendering them illegal—and the frequent confiscation of peasant land have the same roots as the weaknesses in the enterprise system. China lacks the Enlightenment trinity.



The growing peasant and worker protests (4m protesters and 800,000 strikers in 2005) suggest that many Chinese want enforceable property rights and the legal right to strike—these are not western idiosyncrasies. You are right to say that Hu is raising the issue of social justice—but efforts in this direction are tiny. The tax burden on peasants was reduced by 0.1 per cent of GDP in 2005. Hu dare not increase the tax burden in cities. Why? Because there would be a demand for accountability.



Amartya Sen argues that many third world intellectuals are unable to get past the experience of colonialism to see the value of western institutions and values—and the parallels they have with the best of their own traditions. You conform to Sen's model. Why don't you include China's 18th-century imperial land grab of central Eurasia—nearly doubling China's land area—and the subsequent ethnic cleansing as part of your list of past robbery and state crime? Because it wasn't western?



The paradox is that the best way to challenge the west is to beat it at its own game. Japan's response to its economic crisis, the growth of democratic institutions in Taiwan and South Korea and the increasing success of an open India (sadly held back by caste and sexism, especially in the countryside) support my thesis. But I am not complacent about the west: the last third of my new book is about how the US, Britain and others fail to practise what we preach.



Best

Will

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Dear Will

4th December 2006



Whatever else I may be, I am not a third world intellectual, having spent two thirds of my life in Britain! Nor am I a postcolonial postmodernist. I have a simple position: no nation, no region, no empire has any monopoly on virtue. East and west have both indulged in ethnic cleansing. China's imperial past is like any other country's, except the Chinese do not suffer from western amnesia.



Back to economics. Chinese agriculture is not as bad as your figures imply. It has been concentrating on grains (it had a terrible famine 40 years ago) while Malaysia and the Philippines have been commercial crop growers for a long time. The latter are higher value-added items.



China doubled its manufacturing labour force between 1983 and 2003, to number slightly over 100m. But China's rural economy, like India's, still suffers from scarce land and surplus labour, and this is why many more millions need to be taken off the land—something only achievable by rapid manufacturing growth. Public enterprise in China, as in India, is capital-intensive and inefficient. But the private sector is not as puny as you imply. If productivity is low in public sector manufacturing and agriculture, town and village enterprises and the genuine private sector, plus the foreign-owned sector, must conversely be productive. China exports low-tech products where there are few brand names, but that is where its expanding market is.



China has chosen to invest in infrastructure, unlike India (or the USSR when it was growing fast). This is a slow process. When you go to China you see new airports and empty highways and the Shanghai maglev. In India, the airports are slums.



China is also less centralised than it seems. It has large regional centres which run their own economic policies, with regional party bosses often disobeying the centre. Beneath the Leninist façade, China is making a transition to an economy where the centre is nominally in charge of certain things—foreign exchange policy or defence—while the people do whatever they think will make them better off. And, yes, protests arise out of inequities, as they do in India. But the fact that they occur and that China has an active "new left" (see Chaohua Wang's One China, Many Paths) tells me that China is not monolithic. It is just not a liberal democracy along Anglo-Saxon lines.



I do not defend the inequities or brutalities thrown up by China's growth. But I don't think they are a sign of weakness. Despite similar problems in most other economies in the past, none collapsed because of excessive growth. The USSR died because of stagnation.



You do not think China can repeat Asian success. But I recall when Americans didn't believe Japan could compete with them. They said that the Japanese could only copy and not innovate, because Japanese culture was too conformist. Yet China filed 130,000 patents in 2004, the fourth highest in the world (after Japan, the US, and South Korea), three times more than Britain. This represents a growth of 517 per cent since 1995, and equal proportions of residents and non-residents were responsible.



You see the inequities and brutalities of China's growth as unique to China's communist system, and it offends your liberal sensibilities. You want these inequities and brutalities to be swept away. I see them as part of the historic path of rapid accumulation that many economies pass through. This is how income growth occurs in capitalism. What's new?



Good wishes

Meghnad

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Dear Meghnad

4th December 2006



China's model may have served it well in mobilising the saving for industrialisation, but it is now reaching the limits of its possibilities. Your own figures show that half China's patent applications come from foreign-owned companies. China's own resident patents place it 17th in the world league table, and only 30 per cent are for new inventions. Most of China's new jobs since 1980 have come from services, not manufacturing as you imply, and productivity in services is nearly as poor as in agriculture and state enterprises.



I am not predicting China's collapse. What I am saying is that it faces a profoundly difficult transition to a more normal economy with normal levels of savings, investment and consumption and less dependence on exports. My argument is that the direction of change has to be the same as that emerging in the rest of Asia. This means China needs to incorporate my three-cornered cluster of Enlightenment processes—pluralism, capabilities, justification—into its internal workings. They will look very Chinese and not western, but their function will be the same.



It is in our interests for this change to happen—both to allow China to carry on growing and for it to have a greater vested interest in maintaining a rules-based international system. China's indifference to Africa's authoritarian despots, as it courts the continent for energy and raw materials, is a foretaste of what an unchanged China will be like.



You contrast the west's amnesia about its past with China. But nobody in China knows about the doubling of China's land area under the Qing, any more than they know about China's war against Vietnam in 1979, or even Tiananmen. They are written out of the history books; the websites are blocked. It is shocking that a leading British intellectual like yourself can excuse such manipulation of the truth while being so ready to criticise the open society of which you have been part for most of your life. This debate would have been impossible in China. Until it changes, it will be condemned to a colossally inefficient and socially cruel form of development, because it is disdainful of human dignities and the imperative of accountability.



Yours

Will

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Dear Will

4th December 2006



So anything China does which is good is foreign and everything else is sinister. So China is exploiting Africa's resources, and this is an indicator of China's authoritarianism. How unlike the Belgians and the French and the British, with their Enlightenment trinity and liberal freedoms, who nurtured Africa lovingly, never coveted its resources and cured its poverty!



You say services are generating more jobs in China than manufacturing. Perhaps, but the same is true of India and Britain. So what?



Non-residents filed 50 per cent of China's patents, 47 per cent of EU patents and 81 per cent of US patents. So what? China has just surpassed Japan in spending on R&D but you will no doubt say that is all foreign. If China is weak in every sector—agriculture, manufacturing, services, innovation—why do you fear it will rise inexorably and pollute the global top table where only virtuous western powers should rule?



You say China must join a rules-based international system. Yet when it joins the WTO and exports bras and shoes to the EU, they are locked up in warehouses while Peter Mandelson soothes the Italian and French producers, telling them why they don't have to obey the rules.



China is going through a fascinating experiment of growth at rates never achieved by any other country for such a sustained period. It needs to go on doing so. It has the second or third largest GDP, yet it is desperately poor in per capita terms. It solved the problems of mass illiteracy and extreme poverty with a dictatorship. I am curious to see if it can achieve this impossible combination of capitalism with a Leninist party. No one else has tried. It may fail, but why not let it go through the experiment and leave it to the Chinese people to revolt if they want a different regime?



In the 18th century, Voltaire thought China was enlightened compared to France. Now you say China is benighted because it is not like us. It is easy to forget how we got from there to here. It is a bit like the environmental damage caused by development. We rich countries tell the latecomers that they cannot do what we did when we were poor: you must behave like us now, even if it condemns you to remain poor. We shall see.



Merry Xmas

Meghnad



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