China’s Leaders Want More Growth – But Innovation Requires Political Freedom Chinese reformesr would like to favor the private sector and get rid of state ownen corporations. But the state sector is also a power base for the elites

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By Paolo von Schirach

October 9, 2013

WASHINGTON – Imagine this. Imagine that not so long ago the US was an over populated emerging market with a state controlled economy. A new crop of technocratic leaders decided to use cheap labor willing to come to Detroit, Atlanta and Houston to work in factories as the main national economic advantage. United Technologies, Procter & Gamble, Hanes and other state controlled firms would make a strong push into foreign markets with the considerable  advantage of rock bottom prices for US exports made possible by ultra cheap labor provided by migrant farm laborers coming into cities from Idaho, New Mexico and Oklahoma. Imagine that this economic growth strategy had been successfully carried out for 20 or 30 years.

End of growth

But then massive growth would stop. The engine would start slowing down because the products made by the state-owned companies are no so great when it comes to quality, while the cost advantage slowly evaporated. Indeed, the supply of inexpensive migrant laborers dwindled. Fresh labor shortages now translate into higher wages.

The smart technocrats see all this; but they want to find ways to keep high levels of growth. They turn to a very senior economist for advice. He says that the only way to reignite self-sustaining growth is really to privatize state banks and major state controlled firms, this way injecting genuine competition into the system. This will inspire more investments, innovation and therefore quality improvements that will benefit consumers at home and abroad. 

Growth or political control?

The political leaders listen attentively; but then they shake their heads. “Nice ideas –they say– but this cannot be done. If we relinquish control over the economy –all the banks, the big state corporations– then, our main power base is gone. Soon enough, if we empower the private sector, we are gone too“. And so, the decision is made: no real economic reforms. This way political control is secure. America may stagnate; but the people in power will do fine, at least for many more years. 

This is about China

Alright, just put “China” in America’s place, and you have the distillation of China’s policy dilemmas. China is still doing very well, but it is losing altitude. Forget about dizzy double-digit growth. The IMF is forecasting may be 4% in just a few years. An economy built from the top, based on cheap labor to export massive amounts of manufactured products, coupled with huge infrastructure spending has worked very well; but now it has run its course. From now on, expect China to do OK, at best.

Can a smart economist solve this problem?

The WSJ just published a major front page story on this very topic. It  featured Liu He, a very senior economic policy advisor in Beijing, (A bureaucrat Tricky Task: Reignite Chinese Growth, October 7, 2013). Reportedly Liu has been tasked with producing a new blueprint for China’s growth. It would appear that Liu and his staff would favor reforms and in particular the privatization of the large state-owned banks that control the entire financial system and the flow of credit.

Most Chinese reformers know that, while China has a vibrant private sector, the gigantic system created by state banks and often inefficient state-owned corporations is a major drag on the economy. To any free market capitalist this is no surprise. Indeed, who would expect monopolistic corporations run by political appointees to be hubs of creativity and innovation? These companies may do well in a controlled, protected environment. But they are not nimble and flexible. They are slow and bureaucratic. And top-down real innovation does not really exist.

Economic control equals political control

However, state and ultimately party control over huge chunks of the economy is almost a prerequisite for the self-perpetuation of China’s leadership. 

I am not sure how this attempt to find a new formula for China’s growth will play out.

But I very much doubt that China’s technocrats, even those who would really like to see modernization, are going to take big chances when it comes to giving up control over the economy. A vibrant economy run by an eager private sector creates a middle class that will eventually demand accountability, and a voice in the political process. And this is not something that the political leadership in Beijing wants to encourage, let alone allow.

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