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China’s Miracle Demystified

Justin Yifu Lin's picture

Since beginning its transition 30 years ago, China’s economic development has been miraculous.

The average annual growth rate of GDP reached 9.8 percent, far exceeding the expectations of most people in the 1980s or even early 1990s, including Deng Xiaoping who initiated the reforms. Deng’s goal was to quadruple China’s economy in twenty years, implying an average annual growth rate of 7.2 percent per year.

In 1979, China was inward-looking and its trade as a percentage GDP was only 9.5 percent. Now China is the world’s largest exporter and the third largest importer, with trade contributing around 70 percent of GDP. Over 30 years, more than 600 million people got out of poverty.

China’s miracle raises the following five questions.

  1. What was behind China’s extraordinary performance?
  2. Why Did China Fail before the Transition in 1979?
  3. Why Didn’t Other Transition Economies Perform Equally Well?
  4. What Costs Did China Pay for Its Success?
  5. Can Other Developing Countries Replicate the Miracle?


Here are my answers to these questions: 

1. What was behind China’s extraordinary performance?
After the industrial revolution, sustained growth in any economy depended on continuous technological innovation as well as industrial diversification and upgrading.

As Angus Maddison shows, before the 18th century, the average annual growth rate of per capita income in the West was only 0.05 percent for years. That means it took 1,400 years for Europe’s per capita income to double prior to the 18th century. In the 19th century, it took about 70 years; and in the 20th century, 35 years.

The industrial revolution sped the move away from an agrarian society where 85 to 90 percent of the labor force worked in traditional agriculture. The move from agriculture to nonagricultural and manufacturing sectors was gradual but inexorable. In the manufacturing sector, it was at first very labor-intensive, and then became more capital-intensive as technology advanced. Ultimately, the service sector dominated. Overall, the process was one of continuous structural change.

As a late-comer to this modernization process in 1949, China had the advantage of backwardness. To innovate, China did not have to invent the technology or industry by doing R&D. It could borrow technology, industries and institutions from the advanced countries with low risk and costs. East Asian economies, including Japan and the four small dragons as well as China after the transition in 1979, all tapped into this advantage. 
 
2. Why Did China Fail before the Transition in 1979?
China didn’t tap into that potential until 1979 because it adopted a misguided modernization strategy. 

Revolutionary leaders such as Mao Zedong and Zhou Enlai hoped to make China an advanced country immediately after the founding of the People’s Republic of China in 1949. They adopted a strategy to build up advanced capital- and technology-intensive industries even though China was an agrarian economy.

The government’s priority industries went against China’s comparative advantage. The government needed to protect them by giving them monopoly positions and subsidizing them through various price distortions, including suppressed interest rates, over-valued exchange rates and so on. The price distortions created shortages and the government was obliged to use administrative measures to mobilize and allocate resources directly to the non-viable firms in the priority industries.

Through those interventions the government was able to set up modern advanced industries, but the resources were misallocated and the incentives repressed. Economic performance was very poor. Haste made waste.

3. Why Didn’t Other Transition Economies Perform Equally Well?
Not only China but also all the socialist countries and most developing countries after WWII adopted a similar development strategy. In the 1980s and 1990s, they all engaged in reforms to transit to a market economy. However, their governments did not realize that the existing distortions were endogenous in a sense that they were instituted to protect the non-viable firms in the priority sectors.

Some of them eliminated the distortions immediately. The priority sectors collapsed, causing a contraction of GDP, surge of unemployment, and acute social disorder.  Others, to avoid this, continued to subsidize those non-viable firms through disguised subsidies and protection, and efficiency suffered.
China adopted a pragmatic, gradual, dual-track approach. On the one hand, the government continued to provide transitory protection to the non-viable firms in the priority sectors, and on the other hand, it liberalized private enterprises and allowed joint-ventures’ entry to labor-intensive sectors--areas in which China had comparative advantage, but were repressed before. In this way, China achieved stability and dynamic growth simultaneously. 

4. What Costs Did China Pay for Its Success?
One of the main drawbacks of China’s gradual, dual-track approach to transition is the widening of income disparities. From a relatively egalitarian society in 1979, the Gini coefficient reached .47 in 2007.

The reason was the continuation of distortions in various sectors, including the overconcentration of financial services by the four large state-owned banks, the almost zero royalty on mining, and the monopoly of major service industries, including telecommunication, power, and finance.

Those distortions are used to subsidize or protect the non-viable firms in the old priority sectors. They also favor big corporations and rich people. For example, the interest rates that big banks charged are kept artificially low, allowing big companies and rich people to benefit at the expense of middle class depositors who have limited access to credit services.

The result is a widening of income disparities.
The large corporations and rich people have a higher saving propensity than low-income households. The widening of income disparities also contributes to the saving-consumption imbalance and China’s large trade surplus, which reflects the disparity in saving and consumption in recent years. Therefore, it is imperative for China to remove the remaining distortions and complete the transition to a market economy.

5. Can Other Developing Countries Replicate the Miracle?
Other developing countries can replicate China’s performance. Every developing country has a similar opportunity if they know how to tap into the advantage of backwardness, learn to borrow technology from advanced countries and upgrade their industries step by step.  

Most developing countries also have all kinds of distortions and non-viable firms due to their governments’ past development strategies and inappropriate interventions. In this respect, China’s experience in the past 30 years provides useful lessons.

In the transition process, it may be desirable to adopt a dual-track approach, providing some transitory protection to those non-viable firms to maintain stability, but liberalizing entry to sectors in which the country has comparative advantage.

Ultimately, however, sustained and inclusive growth requires eliminating all distortions and completing the transition to a well- functioning market economy.

Comments

Submitted by Joe on
"In the transition process, it may be desirable to adopt a dual-track approach, providing some transitory protection to those non-viable firms to maintain stability, but liberalizing entry to sectors in which the country has comparative advantage." Yes, but what about non-viable firms that may become viable in the future - the idea of dynamic comparative advantage and the work of Ha Joon Chang suggesting that early protection of firms such as Toyota and Samsung allowed them to become industrial powerhouses further on in their development?

I would suggest not to leave out the important role experimentation and learning from experiences/practice, both at the 'grass-root' level in China and abroad, have played in China's success story. The Chinese government had no blueprint for reforms but rather relied a lot on experimentation, be it in bottom-up processes or top-down processes. Thus, one may argue whether transition was gradual in the sense of ex ante defined steps to a certain target. With hindsight it appears gradual, but this notion neglects the importance of testing, of provisionary regulations etc. that have been such an important ingredient of Chinese policies. Consequently, a central lesson to be learned from the Chinese model is to actively and strategically organise policy learning. This may prove to be more important than copying specific policies applied in China or anywhere else.

Submitted by Anonymous on
Of course, the "other socialist" countries had and have much higher standards of living than China. GDP per capita in the Czech Republic, for example, is 5 times that in China. At the other extreme, GDP per capita in Albania is the same as that in China. The auhtrorities in Central Europe made many mistakes; but they did put societies on a firm footing. But China can still achieve the living standards of the countries in central Europe, within 10-15 years.

Submitted by simone on
still don't think it's a miracle if it doesn't engage the poor people too.

Submitted by Hudson Lucky Masheti on
Across Asia, the emergence of China as an economic power – face spells opportunity for world economies. China's global economic indicator of GDP supersedes other international economies by 8% per annum on domestic economic development especially; labour, industry, human resource and environmental refugee policy. Alone among developing Nations, China commands attention and awe. China’s size and rapid growth have deepened in the sense that, the People’s Republic will inevitably draw market share and Foreign Direct Investment (FDI) away from its neighbors (Africa). The year 2001, China garnered almost US$ 47 Billion in (FDI) up tenfold since 1990 – in anticipation of greater market access once it joined (W.T.O.) in December. Asia’s experience shows that Africa’s challenges in accelerating economic development can be overcome. On the other hand, Africa’s share of World Trade needs to be improved because it has plamented since 1960’s. The erosion of Africa’s World Trade share between 1970 and 1993 presents a staggering annual income loss of US$ 68 Billion. Africa’s diverse economies reveal opportunities and challenges, where growth is not sufficient for poverty reduction but it is essential. Savings must increase while also allowing consumption to rise fast enough to reduce poverty. Where degraded infrastructure has emerged as a critical barrier to growth. I applaud the Chinese theme “ AN OPENING CHINA NEEDS THE WORLD, AN ADVANCING WORLD NEEDS CHINA”. And I am extremely impressed by the caliber of the Chinese leaders whom I have read about in the subjects of: - Beijing, an Ancient Capital embracing the New Millennium with the Honorable Liu Qi, Mayor – Beijing. Realizing Jiangsu’s Cross Century Target by the Honorable Ji Yunshi, Governor – Jiangshu Province. Hainan Province “A Shining Pearl” embedded in the South China Sea by the Honorable Wang Xiaofeng, Governor – Hainan Province. Opening up Sichuan, a Hot Land for Investment by Honorable Li Dachang, Vice Governor – Sichuan Province. Shenyang – Development for the People by Honorable Mu Suixin, Mayor, Shenyang. China’s Future from its Special Economic Zone by Honorable Li Zibin, mayor – Shenzhen. Beijings Business Connection by Honorable Yao Wang, President Beijing sub council for the Promotion of International Trade. Shanghai, in the words of Honorable Xu Kuaongdi, Mayor Shangai; entitled “The Future of China's Economic Center” people are the bedrock of development. China Council for the Promotion of International Trade in the words of Honorable Yu Xiaosong as the President of the Expanding International Trade Council, cannot be underestimated, In this respect, the developing countries needs to adopt the China’s Miracle by depending on continuous technological innovation, industrial diversification and upgrading, move from agriculture to non Agricultural and manufacturing sectors and impress the market economy. Hudson Lucky Masheti Kenya (East Africa)

Submitted by Mitch on
What you are witnessing, the growth of the Chinese economy despite the economic collapse, is the same thing that is happening in the U.S. economy - massive stimulus spending. The economic growth in China, like the U.S., is temporary. Much of the Chinese lending is finding it's way into the Chinese stock and housing market. China is facing the same stock market and housing bubble collapse the U.S. faced two years ago.

Submitted by Anonymous on
The reasons for China's success are the two things the author does not mention: its driven, largely homogenous, nationalistic culture and its authoritarian political system. All the East Asian nations benefit from the cultural advantage, the result of their uniquely long histories as nation states, and all of them rose fastest under competent, forward-looking authoritarian governments. That's all there is to it. There is no mystery, no magical economic or governance code to crack. No research is needed. They succeeded because they know what they want, they are united, they don't complain, they do what they are told and they work harder. Most of all, that last one. They work harder. (expat, 20 yrs in East Asia)

Submitted by Anonymous on
I agree with you that "working harder" is one of the most important factor for the success of East Asian nations. But witnessing the impressive success of mainland China from Hong Kong, I have to add one attribute to the success formula. No doubt, Chinese are born hard-working but generally speaking loosely organised by nature. But when the hard-working Chinese team up with the superb organising ability of CCP then it makes them a winning team.

Submitted by Subhashini on
Agree that the author has missed the authoritarian political system and the homogeneous culture....this is what is missing with India and the main obstacle India face in replicating Chinese model....democracy, multi party system, diversity all makes implementation of policies, reforms in India is much more politically challenging...

Submitted by Benilyn U. on
China's central financial institution once again bumped up the level of cash reserves the nation's banks must hold. The move is a try to control Chinese inflation that is emerging as a severe threat to a global economy reliant on cheap Chinese exports. A 25 percent tariff on Chinese imports is the solution floated by Donald Trump, whose attempt to score points with such a canard has inspired laughter among the cognoscenti. Here is the proof: China struggles to curb inflation that threatens global growth

Submitted by Gianni on
The miracle of China is going on. The only one problem is: when USA and Europe will be poor, how long the miracle will continue?

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