Contributing to common prosperity is compulsory

Xi Jinping’s slogan of “common prosperity” has finally gotten the attention of financial markets and foreign media, after he devoted most of the last meeting of the Central Committee for Financial and Economic Affairs to discussing the new campaign against inequality. There is little in the text of the readout from the meeting to explain this increased attention: the slogan remains mostly at the level of general rhetoric, and the discussion has not gotten much more concrete since its initial mentions.

What has changed in the context in which people are viewing Xi’s political priorities: the months-long slide in the stock prices of Chinese internet companies as they face a regulatory crackdown, and the effective outlawing of the for-profit tutoring industry, has clearly demonstrated that rhetoric can indeed have large effects. The question is what kind of real actions this new slogan produces.

The high political priority of “common prosperity” has been clear since the beginning of 2021: it was institutionalized in the five-year plan, and Xi highlighted it in a major speech in January (official English translation).

Realizing common prosperity is more than an economic goal. It is a major political issue that bears on our Party’s governance foundation. We cannot allow the gap between the rich and the poor to continue growing—for the poor to keep getting poorer while the rich continue growing richer. We cannot permit the wealth gap to become an unbridgeable gulf.

Implementing that political priority is still a work in progress: the promised “action plan” on common prosperity has not yet been released, probably because officials are still trying to figure out what will go in it. The textbook methods for addressing income and wealth inequality are through fiscal policy: greater taxation of high incomes (and/or wealth) and more transfers to households with low incomes. These methods did get a mention in the CCFEA meeting, which repeated calls for “equalizing” public services (meaning between lower- and higher-income regions), and improving systems for old-age pensions, healthcare, welfare and public housing.

There is some change at the margin visible already, as the central government de-emphasizes local infrastructure spending in favor of social transfers. And there seems to be new momentum for the most common form of wealth tax, a tax on the value of residential property: after years of delays, Chinese scholars now expect local trials of the property tax to be rolled out later this year.

But as I documented in a previous post, the conservative Ministry of Finance has signaled that it is not seeking a major expansion of tax revenue, still plans to cut taxes on some businesses, and will try to contain the costs of public welfare programs. So far, it does not sound like “common prosperity” is going to produce a radical increase in taxation or redistribution, and the CCFEA meeting explicitly stated the slogan is not about “uniform egalitarianism” (a reference to Mao-era policies).

Yet it’s clear the slogan of common prosperity has a broad reach that extends well beyond the usual areas of technical economic policy. In this context, officials have repeatedly invoked the “tertiary distribution” of income, a previously obscure technical term for private charities (the primary distribution of income is the income households earn themselves, while the secondary distribution refers to the effect of taxes and transfers). The CCFEA meeting again mentioned the tertiary distribution, and emphasized it further with a call to “encourage high-income groups and corporations to give back more to society.”

From any other government, saying “we are going to rely on private charities to solve the problem of inequality” would be an obvious abdication of responsibility and a clear signal that the government will not do much. That is not what it means in China’s case. In part this is because China’s system does not establish clear boundaries between matters of public and private involvement. Nothing is off limits to the government since the state is legitimately concerned with all aspects of society and national development.

But it is also because, as Joseph Fewsmith’s important new book reminds us, China’s government is not a Weberian system in which politically neutral bureaucrats implement rules, but a Leninist structure in which cadres are mobilized to achieve political tasks. If the political task is to increase charitable donations, then officials will ensure that charitable donations do indeed increase, using whatever means are at their disposal.

Those able to read the political signals are already trying to get ahead of the game. According to a count by Fortune, “In the past eight months, five of China’s richest and most high-profile tech billionaires have pledged at least $13 billion of their personal or corporate fortunes to charitable foundations and initiatives.” The day after the CCFEA meeting, Tencent announced it would spend 50 billion renminbi to help promote common prosperity, building on a similar pledge in April. More companies are certain to follow this example of what we might call “corporate social responsibility with Chinese characteristics.”

Given the institutional inertia and technical difficulties surrounding tax and welfare policy, the risk is that the common prosperity campaign ends up relying on political pressure and the use of arbitrary administrative interventions instead. One can easily imagine, for instance, a crackdown on tax evasion by wealthy individuals and corporations succeeding the current focus on internet regulation. It’s no wonder that, after the events of the last few months, financial markets are acting a bit nervous about this latest campaign.

Charts from World Bank China Economic Update June 2021

Vogel vs. Soros on Xi vs. Deng

Two new articles out this week provide an interesting counterpoint on how Xi Jinping, China’s current top leader, compares to his predecessor Deng Xiaoping, the “paramount leader” of the 1980s and 1990s. The first is an op-ed in The Wall Street Journal by George Soros, the investor and philanthropist, and the second is a posthumous article by Ezra Vogel, the eminent scholar of Asia who passed away last year, entitled “The Leadership of Xi Jinping: A Dengist Perspective.” It is probably his last piece.

Vogel and Soros happen to have been born in the same year (1930), so they belong to the same generation of China-watchers, although of course their backgrounds are quite different. And so are their conclusions. Soros argues that Xi is reversing many of Deng’s reforms, and indeed is trying to overturn his legacy. Here’s a key passage:

Mr. Xi came to power in 2013, but he was the beneficiary of the bold reform agenda of his predecessor Deng Xiaoping, who had a very different concept of China’s place in the world. Deng realized that the West was much more developed and China had much to learn from it. Far from being diametrically opposed to the Western-dominated global system, Deng wanted China to rise within it. His approach worked wonders.

Mr. Xi failed to understand how Deng achieved his success. He took it as a given and exploited it, but he harbored an intense personal resentment against Deng. He held Deng Xiaoping responsible for not honoring his father, Xi Zhongxun, and for removing the elder Xi from the Politburo in 1962. As a result, Xi Jinping grew up in the countryside in very difficult circumstances. He didn’t receive a proper education, never went abroad, and never learned a foreign language.

Xi Jinping devoted his life to undoing Deng’s influence on the development of China. His personal animosity toward Deng has played a large part in this, but other factors are equally important. He is intensely nationalistic and he wants China to become the dominant power in the world.

There are some issues with this argument. Joseph Torigian, who is very well informed on the history of Chinese elite politics, has explained why it is not quite right to blame Deng for the elder Xi’s political purge in 1962. In the late 1970s, Xi Zhongxun played a pivotal role in the creation of the special economic zones in the late 1970s, a move for which Deng probably took more of the credit than he deserved. But both Deng and Xi Zhongxun were committed to the project of reform and opening, and the elder Xi’s greatest legacy is his contribution to that project. It makes no sense to argue that Xi Jinping is trying to undo Deng’s reforms because of resentment over his father’s treatment.

Moving away from armchair psychologizing to documented public statements, it’s clear that Xi Jinping has consistently presented himself as Deng’s heir. He wants to be the ruler who is realizing the aspirational goals that Deng set for China decades ago. This is obvious both in the focus on achieving “moderate prosperity” in Xi’s first term, and in the more recent campaign of “common prosperity.”

That term is an explicit reference to Deng, as all Chinese would understand. When Deng famously endorsed inequality in the 1980s by saying “We should let some people and some regions get rich first,” he justified that by insisting it was “for the purpose of achieving common prosperity faster.” By talking about common prosperity now, Xi is saying the time has come to deliver on what Deng had always wanted. Overall, my view has always been that Xi Jinping is a giant Deng Xiaoping fanboy: what’s remarkable is not his rejection of Deng but how often and how explicitly he has linked his own actions to Deng’s.

It’s true that on foreign policy Xi’s more aggressive approach is obviously quite different from Deng’s low-key one. But Deng was making hard-headed decisions based on his intimate knowledge of China’s very weak domestic and international position after the Cultural Revolution. It would be a mistake for Western commentators to interpret that tactic as some kind of principled acceptance of China’s subordinate role in a US-based world order.

In reality, Deng Xiaoping was an outstanding Chinese nationalist, and if he had presided over a China that was as strong as Xi’s he would probably have made quite different decisions. On this question my view is closer to Vogel’s: China is acting differently in the world today because China is different, not just because someone different is in charge. Here’s a bit from his piece:

Because of the changes introduced by Deng, Xi Jinping inherited a China that was far stronger than China during Deng’s era. Deng’s approach for dealing with foreign relations, ‘taoguang yanghui, juebu dangtou, yousuo zuowei’ (avoid the limelight, never take the lead, and try to accomplish something” was well-known. In the 1980s, Deng held back on increasing military expenditures in order first to build up an economic base. After 1995, the Chinese began to increase military expenditures even more rapidly than the economy was growing. Thus by the time that Xi Jiping came to power, since China had much greater economic and military power than during the period of Deng’s rule, he could take a much stronger stand in dealing with foreign countries.

Vogel’s piece also has some interesting comments on the differences in the management styles of Xi and Deng. While Xi is a famous micro-manager, taking personal charge of policymaking on every important issue, Deng was happy to let his subordinates make decisions most of the time. Vogel attributes this to Xi’s insecurity and lack of experience in central government before he took over, a big contrast to Deng’s decades of service.

Xi is also more focused than Deng was on exerting control over localities and their officials, but again Vogel sees this as a difference of circumstances more than personalities:

In the early years of Deng’s rule, when the economy was much smaller, local Chinese governments depended on allocations from the central government and the size of the resources they were forced to forward to the central government. There were no sizeable pockets of local wealth that allowed local areas and local enterprises to carry on activities apart from the national budget.

During the decades under the leadership of Jiang Zemin and Hu Jintao, businesses and local governments acquired resources that enabled them to initiate activities on their own. When Xi Jinping became the pre-eminent leader in 2013 Party officials gave him the power to clamp down on corruption. Popular support for clamping down on corruption was also very strong. But from the perspective of Beijing, the problem was broader than corruption. It was the problem of keeping control over local areas and successful enterprises.

China in the 2020s is not France in the 1960s

That sentence seems obvious enough that I would not need to write it. But there does seem to be a strain of thought out there that sees China’s economic system, with its high levels of state ownership and extensive planning, as basically the same thing as the mixed economies that Western Europe had in the immediate postwar decades, which featured more state ownership and planning than after the 1980s. In this view, China today confronts the Western economies not with a completely foreign economic system, but with an image from their own past, a reminder that they have drifted too far in a market fundamentalist direction. The most prominent proponent of this line is probably Thomas Piketty; his recent commentary on China includes this passage:

On the economic and financial level, the Chinese state has considerable assets, much greater than its debts, which gives it the means for an ambitious policy, both domestically and internationally, especially regarding investments in infrastructure and in the energy transition. The public authorities currently hold 30% of everything there is to own in China (10% of real estate, 50% of companies), which corresponds to a mixed economy structure that is in many ways comparable to that found in the West during the period of prosperity 1950-1980 (known in France as the ‘trente glorieuses’). Conversely, it is striking to note the extent to which the main Western states all find themselves in the early 2020s with almost zero or negative patrimonial positions. 

Piketty’s comparison is based on empirical data: the estimates he made, in a joint paper with Li Yang and Gabriel Zucman, of the extent of government ownership of assets in China. He finds that China’s recent level of 30% is similar to the 15-25% that prevailed in Western countries in the 1970s. So if you squint at his chart, the line for China today does get close to the lines for Britain and Germany in 1978.

The good thing about data is that they can challenge your intuitions. Still, the claim that an authoritarian state that spent decades under socialism has basically the same political-economic structure as that of the postwar European democracies is not the world’s most obviously plausible argument. And looking at different data indeed tells a different story.

When I’ve tried to grapple quantitatively with the question of the role of the state in China’s economy, I’ve focused on state-owned enterprises, whose large role is one of the most obviously distinctive features of China’s system. China’s own official data on state-owned enterprises imply that they have generated value-added equivalent to around 25-30% of GDP in recent years. (If you don’t believe my numbers, there is a World Bank paper that comes to basically the same conclusion using different methods). Conceptually, these figures represent the flows of income generated by the stock of assets counted by Piketty.

We can compare these numbers to historical figures for European and other economies thanks to an IMF research project from 1984 published as the the book Public Enterprises In Mixed Economies. According to these estimates, state-owned enterprises accounted for 12-13% of GDP in France in the 1960s, 10% of GDP in Germany in the 1970s, 7% of GDP of Italy in the 1970s, and 10% of GDP in the UK in the 1960s and 1970s. After the privatization wave of the 1980s, state-owned enterprises in the UK accounted for about 2-3% of GDP, according to the 1995 World Bank study Bureaucrats in Business (it did not have more recent estimates for continental Europe). In the US and Japan, state-owned enterprises have historically been about 1% of GDP.

The state-owned enterprise sector in China today, therefore, is actually two to three times larger relative to the economy than it ever was in continental European economies. And China’s state enterprise sector is 10-15 times larger than the now quite minimal state sectors in the English-speaking economies. Those are big differences! It seems clear that China’s socialist market economy is quantitatively and qualitatively different than the mixed economies of the postwar European social democracies, as indeed we should expect given their quite different political foundations. When these economies engage with China, they are not engaging with a version of their past selves but with a quite different kind of entity. I think these differences make China more interesting and worth understanding than if it were just retreading the past trajectory of Western Europe.

It is true that the European economies had sustained fast growth in the postwar decades, which invites comparison to the sustained fast growth of China in more recent decades. But in both cases I would point to the magic of catch-up growth and trade liberalization as the most obvious drivers (on this, see Brank Milanovic’s interesting comments on the misplaced nostalgia for Europe’s postwar years). Europe in 1945 and China in 1978 both had quite backward capital stocks that could be rapidly expanded and modernized, as well as relatively high levels of human capital that could be productively deployed once war and political turmoil were over. And in both cases increased participation in global trade, through the European Community/European Union or GATT/WTO, could further accelerate specialization and technological progress.

Food security and structural transformation

There is a new working paper out from the Bank of Japan, written by four authors from its international department, considering the prospects for China’s productivity growth over the long term. It’s pretty interesting and not just the usual stuff. One of the novel aspects is its analysis of food security. While that’s not a traditional topic for a productivity analysis, the logic is pretty straightforward.

Part of the growth in China’s labor productivity is coming not just from improving the productivity of specific industries, but from the shift of workers across industries (since China’s workforce stopped growing about a decade ago, labor productivity growth accounts for virtually all of its GDP growth: GDP growth = growth in output per worker + growth in number of workers). The structural transformation of the economy–moving workers from sectors where they produce less value-added, like agriculture, to those where they produce more value-added, like manufacturing–is one of the fundamental motors of economic development.

The authors estimate that out of China’s 10.7% average annual productivity growth from 2006-10, moving workers across sectors accounted for about 2 percentage points, and about 1.5 percentage points of the 7.6% growth from 2011-15 (these numbers are not given in the text, so I estimated them from a chart; apologies for any inaccuracy). But the reallocation of labor across sectors contributed less than 0.5 percentage points of the 6.9% growth over 2016-19, so a slowdown in structural change does seem to a factor in China’s overall growth slowdown.

The authors suggest that if the government’s concerns for food security lead it to try to keep workers in agriculture, that could impede structural transformation and therefore slow growth. They model a future growth trajectory for China that suggests that if its industries continue on the same path of productivity convergence and structural change as Japan, South Korea, Taiwan and Singapore, it can grow by an average of about 4.8% until 2035. But that trajectory of structural transformation would mean a continued sharp decline in the agricultural share of employment, and thus (since labor productivity growth in agriculture is slow) in agricultural output. So a continued rapid pace of structural transformation may not be compatible with food security. Here’s the relevant passage from the paper and the supporting charts:

The first issue concerns the balance between food security on the one hand and the shift of labor from agriculture to other industries on the other. In China, agriculture at present accounts for a larger share of GDP than in the East Asian 4 when they were at a similar per capita GDP level, reflecting the Chinese government’s policy of achieving a rate of food self-sufficiency of 95% or higher. However, in the baseline estimate, the employment share of agriculture and the share of agriculture in GDP will decrease significantly in the future due to a combination of the movement of labor across sectors and the effects of the aging of the population. As a result, real output in agriculture would drop to less than 40% of the current level, which means that China would have to effectively abandon food self-sufficiency.

However, in practice, it is unlikely that the Chinese government will tolerate such a change in industrial structure from the perspective of food security. Therefore, to consider a more realistic path, we assume that the shift of labor from agriculture will be limited to an extent that maintains the current level of real output in agriculture. In this case, GDP in 2035 would be about 10% lower than in the baseline estimate and only 1.87 times the current level.

It is possible to quibble with some of the details in this analysis. The Chinese government does not actually have a target of 95% self-sufficiency in all food supply. In the past, there had been an official target of 95% self-sufficiency of staple crops (liangshi 粮食, which is usually translated as grain but also includes beans and tubers). But this was difficult to enforce, and in practice large imports of soybeans have been tolerated. Xi Jinping proposed adjusting this policy early in his tenure to have a more realistic target (see my previous post from 2015 on the food security policy debate).

The white paper on food security published in 2019 mentions 95% self-sufficiency in cereals (rice, wheat, corn), but as an achievement rather than a strict target. The white paper does articulate an overall goal of self-sufficiency–“China makes sure it relies on itself for food supply”–but this is not given a strict quantitative definition, which allows the government flexibility (see this analysis from the excellent Dim Sums blog on Chinese agriculture). The government’s actual goal is probably to maintain certain levels of output of staple grains rather than to limit all food imports. It’s likely that could be accomplished even as the shares of agricultural employment and value-added continue to decline.

Nonetheless, I think the paper’s point that official food security concerns can act as a brake on structural change is correct. China’s actual agricultural policy has been fairly conservative, in the literal sense of trying to conserve an existing order. The trade war with the US reinforced the risks of relying on imported food, and Xi urged more focus on domestic production. While there may not be hard target on the acceptable level of food imports, there is a general push to maintain a large population of agricultural workers and slow rather than accelerate their shift into other sectors. Xi’s government for instance is encouraging rural residents who migrated to the cities for nonagricultural work to return to rural villages. The government has been clear that it wants to preserve the collective system of rural land ownership, which prevents farmers from being dispossessed of their land but also limits their freedom to leave it (for more on this point, see this Dim Sums post from March).

The paper is entitled “China’s Long-Term Growth Potential: Can Productivity Convergence Be Sustained?” and is worth a read.

Xi Jinping on a September 2018 tour of Heilongjiang province

The deep roots of China’s financial conservatism

A growing theme in China’s recent policy rhetoric is the forceful contrast between economic policymaking in China and “the West,” particularly the US. Not just in the old-school “our socialism is better than your capitalism” way, though there is some of that, but more in the vein of: “we do orthodox fiscal and monetary policymaking better than you do.” Central bank governor Yi Gang wrote an impressive article in 2019 in which he laid out China’s determination to avoid zero interest rates, quantitative easing, and all the rest of it. A more recent example of the genre was a speech this month by Guo Shuqing, China’s top financial regulator; here’s a couple of samples from the official English translation:

When fiscal spending has been largely supported by money printing, it is like an airplane getting stuck in a spinning vortex: it would be very hard for the airplane to get out easily on its own. Before 2008, the Fed balance sheet was less than about US$800 billion, but it has now expanded to almost $8 trillion. Meanwhile, the ratio of the US federal debt to its GDP has surged to a record high since the World War II. …

China didn’t flood the market with liquidity while strengthening its macro policy responses. Some countries criticize that China failed to implement adequate policy responses and make sufficient contribution to global economic recovery, which is evidently a bias or misconception. In fact, China has made quite strong policy efforts.

What I’ve only recently started to appreciate is just how deep the historical roots of this kind of thinking are in China. During the civil war between the Communists and the Nationalists, each side issued its own currency in areas they controlled, so there was competition between the different monetary and fiscal regimes. The Nationalists lost that battle: their money printing to finance fiscal obligations led to dramatic hyperinflation in the mid-1940s, with triple-digit increases in the money supply and price indexes (see for instance the 1954 article “Hyperinflation in China“). After the Communist victory in the war, one of the new government’s first great accomplishments was to stabilize the currency and end hyperinflation.

That seems to have been a formative experience for many of China’s economic thinkers. Even a couple of decades later, they were still touting the benefits of a stable currency and low government debt to Western visitors. There’s an interesting anecdote to this effect in John Kenneth Galbraith’s A China Passage, his diary of a 1972 visit to China in the company of Wassily Leontief and James Tobin (I did not know about this book before but recently stumbled across a copy at my favorite bookstore in Philadelphia). Here’s the relevant passage:

The government has no external or internal debt–a loan from the Soviets negotiated at the time of the Korean war was paid off ahead of schedule in 1968. The budget operates with a slight surplus. In our discussions in Peking information on Chinese finances was provided with great precision and competence by a member of the Institute of Economics of the Academy of Sciences. She notes that “The Chinese currency is one of the most stable in the world. In contrast with some capitalist countries, no borrowing, no inflation, no devaluation.” Being, like all our hosts, impeccably polite, she did not specify the capitalist country.

One of the more engaging moments of the visit was when James Tobin, who with Walter Heller was one of the men who made the New Economics legitimate under President Kennedy, undertook to explain in response to a question why it was often good for the United States to have a budget deficit and increase its debt. He might have had it easier with Andrew Mellon.

There seems to be a pretty direct line from Galbraith’s unnamed Chinese interlocutor in 1972 and the defiantly conservative posturing of today’s top economic policymakers. With the commemorations of the 100th anniversary of the Party’s founding in full swing, there’s even more attention than usual to this history. The Economic Daily newspaper has been running a series of articles on the Party’s pre-1949 economic policies: one focuses on Chen Yun’s success in containing inflation in 1943-44, while another highlights Xue Muqiao’s achievements in stabilizing currency in 1940-41. The message from such historical arcana is pretty straightforward: the Party’s track record of steady economic management goes back a very long way.

Skeptics will be quick to point out that this kind of rhetoric is a bit incongruous coming from the country that, in the decade after the 2008 global financial crisis, engaged in one of the largest and most expansions of debt in economic history. Yet the effects of the old conservative line of thinking were visible even then. Because the Ministry of Finance was obsessed with keeping its own debt and deficit metrics under control, it ended up tolerating excessive borrowing by local governments and SOEs.

A couple of further comments on the Galbraith book: I wish it had had more of the kind of anecdotes I quoted above. On the whole it is not very insightful: he is too obviously and easily swayed by the fact that his Chinese hosts fed him well and put him in nice accommodations. He modestly announces his lack of China expertise at the opening, but does nothing to compensate for how those gaps in his knowledge kept him from understanding the context of what he was seeing (a problem that is blindingly obvious now but was clear even to other contemporary non-specialists; see for instance Martin Bernal’s 1973 review). As a result, me makes some fairly cringeworthy comments.

China census reveals the true scale of the Northeast’s decline

China’s northeastern rust belt, dominated by state industry and comparatively isolated from global trade, has been in relative economic decline for decades. Hardly any younger friends who had grown up in the Northeast still lived there. But a few years ago, after the industrial recession of 2014-15, a lot of anecdotal information suggested that decline had entered a new and more aggressive phase.

Stories about empty neighborhoods and abandoned schools were more widespread. Local journalists documented shrinking cities throughout the Northeast. Some cities indeed reported declining population numbers, but others just stopped publishing population figures altogether. I wrote a blog post entitled “China’s Northeastern Rust Belt is headed for demographic crisis” in 2016. Yet the official population figures from those years did not really show a crisis: the population of the three Northeastern provinces–Liaoning, Jilin, Heilongjiang–declined by only 1.1 million people from 2010 to 2019. That’s still a pretty poor showing for a period when the population of the nation as a whole was still growing, but not a massive change in the trend.

The 2020 population census has revealed, however, that those numbers were completely wrong. According to the results, the three northeastern provinces have actually seen their combined population decline by 11 million people, or roughly 10%, since the 2010 census. The chart below shows the difference between the population numbers that have been published annually for the previous decade, and the trend implied by the 2020 census. The dotted lines are a simple linear extrapolations between the 2010 and 2020 census data points, so they assume the population decline began in 2010. If instead more of the population decline happened after 2014-15, which seems plausible, then the downward slope of the lines would be even steeper. In either case, population trends have clearly changed dramatically over the past decade.

Asked about the Northeast’s population loss at the press conference on the census results, Ning Jizhe, the head of the National Bureau of Statistics, gave the following response:

The population decline in the Northeast is influenced by a variety of factors including the natural environment, geography, population fertility levels, and economic and social development. The Northeast is located at a high latitude with relatively long and cold winters, and some Northeastern people are migrating to the warmer south. This is a trend of population movements in many countries around the world: both Europe and the US have seen this kind of phenomenon. In addition, the natural population growth rate in the Northeast has been lower than the national average for a long time, because of fertility-related values and behavior. It is also important to see that the economy of the Northeast is in a period of structural adjustment. The economically developed coastal provinces and cities offer diverse opportunities and employment prospects, which are very attractive to people in other regions including the Northeast.

Although his carefully neutral language does not quite do justice to the scale of the outmigration, this is a fair summary of the drivers of the population decline. While fertility has declined across China, the decline has been much sharper in the Northeast. Government family planning policies were more effective at changing behavior, as more of the population worked for state-owned enterprises that aggressively enforced restrictions. Fewer births translated into shrinking numbers of young people, and there were many more reasons for young people to leave than to stay. The state enterprises that had been located in the Northeast for strategic or geographic reasons were cutting rather than adding jobs. Corrupt and inefficient local governments did little to promote new industries or the private sector, and few entrepreneurs sought out the Northeast. As a result, more and better jobs were on offer elsewhere. And it is not surprising that, given a choice, fewer people are willing to endure winters where temperatures regularly reach -30° C.

Economic decline and population loss in older industrial regions is a widespread phenomenon in developed countries, and has been particularly challenging for Europe. So what’s unfolding in China’s Northeast is not unique. But it also has some Chinese characteristics. The Northeast has always been the most socialist part of the country–officials still call it “the eldest son of the revolution”–and some of its problems are a payback for the distortions of socialism. The disastrously low birth rate as a result of the authoritarian intervention in families’ childbearing plans is one example.

So is the scale of the out-migration, which is large partly because too much of China’s population was located in the Northeast to begin with. Socialist China located a lot of industry in remote places for strategic and ideological reasons, much as the Soviet Union did with developing Siberia. In the 1950s, the northeast benefited from proximity to the Soviet Union and its assistance in building China’s new industrial base: it was the site of half of the civilian industrial projects supported by the Soviets. In the 1960s, the Daqing oil field in Heilongjiang became the national model for a new style of Maoist industrialization.

The economy of China today, which is much less focused on natural resource extraction, much more focused on global trade, and more open to consumer preferences, is not going to keep as much of its productive capacity in an isolated and inhospitable region. Some adjustment is probably unavoidable, but that doesn’t mean the Northeast can’t be a better place to live than it is now. Slowing or stopping the population decline, as various Chinese scholars have suggested, probably requires making the Northeast more like the rest of China: more hospitable to private investment, with local authorities more engaged in developing new industries than protecting old ones. The population exodus does make that harder, as the younger generation who could lead a transformation increasingly go elsewhere.

Demographics might change everything for China–except the growth model

The working paper on demographics recently published by the People’s Bank of China is a pretty interesting document, and has gotten more than the usual amount of attention. It doesn’t read much like the cautious, dry and technical papers previously released by this august institution. There’s not much quantitative analysis or rigorous logical argument; it’s more like an extended op-ed, arguing vigorously that major demographic changes for China are coming and that the country needs to wake up to that fact and adapt quickly.

This call to arms is well-timed. It seems likely that the much-delayed figures for China’s 2020 population census will confirm what many demographers have been saying for a while: that China’s fertility rate has been overstated, and therefore that its demographic transition and the aging of its population are going to happen even faster than standard forecasts project. The authors (listed as Chen Hao, Xu Ruihui, Tang Tao, and Gao Hong) say that China’s government should lift all remaining policies that restrict births, and switch to strongly encouraging childbirth and reducing the financial burdens (like education) that discourage families from having more children. They even suggest that China could experiment with immigration–previously an almost taboo topic–to help replenish its shrinking and aging population.

But what is perhaps more interesting than all the things the authors think should change is what they think China should not change: an investment-focused growth model. They don’t actually hold out a lot of hope that pro-natalist policies will be able to turn the demographic tide; they acknowledge that the measures tried in the past by developed countries generally have not had dramatic effects (their point is more that China’s government government should at least stop actively discouraging childbirth). They argue that the only really successful adaptation to a shrinking and aging workforce has been to boost investment: substituting capital for increasingly scarce labor. The analysis of Japan is particularly interesting:

In response to declining labor and rising wages, developed countries have gradually replaced labor with capital, and in order to overcome diminishing marginal returns to capital, have conceived of using the abundant labor resources of developing countries to complement their excess capital. To this end, developed countries have used multinational corporations’ overseas expansion, deploying their output and capital exports to capture a higher return on capital. In fact, this strategy of developed countries has been extremely successful. Japan, for example, whose aging is severe, has created another Japan overseas during its supposedly lost two decades; the annual capital gains from overseas repatriation are about 3-4% of its GDP, and this money has become an important source of funding for its retirement.

An aging population poses a challenge to an investment-driven growth model, because it implies that the supply of household savings that can be mobilized for investment will shrink. This is pretty intuitive: as the population ages, a larger share of people become net consumers (retired people living off their savings) while a smaller share of people are net savers (working people at the peak of their earnings power). Therefore the average savings rate across households is lower. China’s data seem to support a strong role for demographics in both the rise of its household savings rate, and its decline since 2010 (see chart). As the population ages further, we should expect the savings rate to decline more.

For many economic observers outside China, the typical reaction to this prospect is something like relief: finally, China’s economy will normalize from its unbalanced, high-investment phase onto a trajectory more typical of other economies. This is decidedly not the reaction of the authors of this paper. They view the prospect of naturally lower savings rate with something like alarm. They do not see the transition to a lower share of investment and higher share of consumption as a normal process that unfolds as China becomes more developed, but something to be vigorously resisted. This section is worth quoting in full:

First of all, we should be highly vigilant and prevent the savings rate from declining too rapidly. We must be clear that our country not only bears the burden of development, but the burden of caring for the elderly. Understand this: without [capital] accumulation, there is no growth. Secondly, we must recognize that consumption is never a source of growth. We must understand that it is easy go from frugality from extravagance, but difficult to go from extravagance to frugality. The high consumption rate of developed economies has historical reasons; once you switch, there’s no going back, so we should not take them as an example to learn from. Thirdly, we should pay attention to investment. We must expand domestic investment in the central and western regions; although China’s marginal return on capital continues to decline, the potential for replacing workers with robots in the these regions is still promising. We must expand outward, and especially invest in Asia, Africa and Latin America, because these regions provide the only remaining large demographic dividend.

It’s remarkable how justifications for regional investment policies and the Belt and Road Initiative have worked their way into a paper on demographics. I don’t know if these prescriptions are wrong or right; certainly I cannot claim to have solved the problem of how to respond economically to an aging society. But I do find this paper a fascinating example of contemporary economic thinking in China, for the way in which it starts from different premises than we might expect, and comes to different conclusions. Many countries are already dealing with reality of an aging population, and as China starts to face up to the same problem, we should not assume that the solutions it reaches for will also be the same.

China’s fiscal policy and the new rhetoric of inequality

The Chinese Communist Party is now ideologically committed to reducing income inequality. That the previous sentence is not in fact a meaningless circular statement says a lot about the peculiar evolution of socialism in China since 1978. But after dodging around that part of its socialist ideological heritage for the last few decades, China’s leadership is now grappling with the issue of inequality more directly, at least in its rhetoric. The 14th Five-Year Plan adopted in March includes a section that calls for “proactively narrowing regional, urban-rural and income gaps.” And Xi Jinping himself has recently been highlighting the goal of “common prosperity,” a term that has deep political resonance in China because of its use by Deng Xiaoping.

This has not been a sudden shift of direction. Various elements of the bureaucracy have been working over the last couple of years to lay the ground for this new policy focus, a process that I described in a previous post. Attention to inequality is a natural sequel to, and development of, Xi’s now-concluded campaign to eliminate absolute poverty. But how this new rhetoric will translate into reality is far from clear. Officials have not yet put forward big ideas on how to actually narrow inequality, and it seems they could not reach agreement on the details in time for them to be included in the plan. The Five-Year Plan document itself includes only a general discussion of goals, and a pledge to draft a separate “action plan” on common prosperity.

In the US, those who want the government to do more to reduce inequality usually focus on major shifts in fiscal policy, like raising taxes on higher-income households and expanding benefits for lower-income ones. But China’s fiscal policy is peculiarly conservative in its spending priorities and its tax structure is actually regressive. It’s notable that, for instance, the government declined to offer any direct income support to households during the Covid-19 pandemic, which it could have done for a very modest fiscal cost. Rightly or wrongly, a bias toward supply-side policy is strongly entrenched among Chinese officials. Xi’s new political rhetoric about reducing inequality and achieving common prosperity thus sits rather awkwardly on top of a set of entrenched government policies that have long tolerated, or even encouraged, greater income inequality.

The signals so far do not suggest that a radical reordering of the government’s taxing and spending priorities is on the way. At a press conference last week, assistant minister of finance Ou Wenhan was asked about how fiscal policy would help advance “common prosperity,” and his response offered a few clues to official thinking. Importantly, he said that “it is necessary to maintain the overall stability of the macro tax burden” over the coming five years. That means there will not be a major increase, or decrease, in tax revenue’s ratio to GDP. In other words, the government is not preparing to raise revenue to finance a major expansion of the welfare state. Indeed, Ou indicated that it still wants to cut taxes at the margin for manufacturers and small businesses.

Any additional spending on redistributive programs will therefore have to come from moving around existing funding sources. While Ou did pledge to improve the social safety net, there were no promises of a generous New Deal for China’s citizens. Indeed he warned that protections must not go too far, or be too expensive. “We must strengthen our ability to evaluate the fiscal affordability of livelihood policies, and avoid the risk of over-promising and over-protecting,” he said.

Another indication of the government’s interest in keeping down the fiscal cost of addressing income inequality is its focus on the so-called “tertiary distribution.” In the jargon, the primary distribution of income is income directly received from labor and capital, while the secondary distribution of income results from the government redistributing that income through taxes and spending. The tertiary distribution of income refers to the additional redistribution achieved through private charities. Ou said the government will “support the role of charity and other forms of tertiary distribution, and give full play the role of charitable organizations” in supporting the poor, elderly and sick. That suggests a desire to keep some of the costs of political promises off the government’s books.

The finance ministry does sound as if it is getting ready to toughen enforcement of China’s rather lax personal income tax system, and bring many of the high-income individuals that now successfully evade taxes into the tax collection net. Ou spoke of establishing “personal income and property information systems,” and of the need to “appropriately regulate excessively high incomes, outlaw illegal income, and curb income obtained through monopoly and unfair competition.” It does sound like the new era of common prosperity will be one of tougher legal and political scrutiny of high-income and high-net-worth individuals.

The most substantive commitments to inequality-reducing policies were in Ou’s pledges to “Increase financial support to less developed regions and gradually achieve equalization of basic public services” and to “further tilt transfer payments to central and western regions and depressed regions.” China’s government has long preferred to treat poverty and inequality as problems of geography: if poor people tend to be in certain places, just give those places more money. Raising fiscal transfers to lower-income provinces could certainly help those areas, and given that it uses existing institutions, would also be a relatively easy policy to execute. But there has already been a lot of regional aid in China in recent decades, and using government-sponsored investment projects as a tool of regional development has at best a mixed track record.

The definitive book on China’s industrial policy is also free

Once an obscure topic, China’s industrial policy now gets attention from heads of state. The entire US-China trade war waged by the Trump administration was, in formal legal terms any way, justified as a response to distorting industrial policy. Understanding industrial policy seems to be a requirement for participating in current intellectual debates about China.

Thankfully, Barry Naughton has written a short and highly readable book, The Rise of China’s Industrial Policy, 1978 to 2020, that explains its history and functioning. Even better, it is available as a free PDF download from the Centro de Estudios China-México at the Universidad Nacional Autónoma de México. Based on a series of lectures, the book has a conversational tone and jargon-free style that is rare for this subject matter, a topic both highly technical and highly politicized.

Naughton’s argument is plainly stated in three short sentences:

Until 2006, China never had “industrial policy.” Since about 2010, China has had industrial policy on a massive and unprecedented scale. The outcomes of post-2010 industrial policy in China have not been adequately studied and are as yet unknown.

A prominent economic historian of China–his textbook The Chinese Economy is the standard–Naughton argues that industrial policy on its current grand scale is a very recent development in post-1978 China, and not at all part of the “China model” responsible for its decades-long growth miracle. He sees current policies as a departure from past practice, rather than as part of the deep structures of Chinese socialism.

Powerful targeted industrial policies in China have been generally absent (1978-2005) and have sometimes been overbearing (2010-present), but they have never been a crucial component in explaining rapid Chinese economic growth. That doesn’t mean that government doesn’t matter, or that distinctive Chinese approaches have not been important: it does, and they have been. Indeed, it should be intuitively obvious that the impact of a large-scale fixed investment effort, massive investment in human resources, and the presence of thousands of growth-promoting local governments competing with each other will be much greater than the impact of government efforts to directly intervene in the sectoral development pattern of the economy. Of course, these are not mutually exclusively choices. But targeted industrial policy is still utterly unproven in terms of its impact on China’s development. It may turn out, 20 years from now, to have been a huge success, but as of today, there is very little evidence for its importance or success.

Naughton admits his own skepticism of the benefits of large-scale industrial policy, but his main point is that neither scholars nor the Chinese government have a solid understanding of the actual consequences. The scale of resources being mobilized by industrial policy is enormous, and thus clearly poses some economic risks. He thinks that China was well on its way to being a global technological powerhouse before the introduction of all of these industrial policies, thanks to its highly competitive manufacturing sector and skilled technical workforce. So to him, it is not obvious those risks were worth taking:

It is unclear to what extent Chinese policy-makers have considered the technological, economic, and international risks of their
industrial policies. It appears rather that policy-makers have been seduced by the vision of a technological revolution and a substantial re-ordering of global strategic relations and have rushed ahead with an aggressive and decisive round of industrial policies. At a minimum, this is an enormous gamble. As stated repeatedly in this essay, Chinese would in any case have emerged as a technology giant over the next decade or two. It is not necessarily beneficial to have government forcibly attempt to accelerate the process, creating substantial additional risk, waste, and conflict. Indeed, it may end up seriously retarding the global benefits that are potentially available from new technologies, particularly if the world ends up partitioned into competing technological blocks.

Plainly, the Chinese government thought that the risks of not carrying out industrial policy were also great. And Naughton does a good job of explaining the intellectual framework that has justified their large-scale interventions. I found the book helpful and clarifying.

Is China experiencing an advance of the state sector?

That was the question I was asked by Jude Blanchette at an excellent CSIS panel on China’s state capitalism. It’s a reference to an old debate over the phenomenon known pithily in Chinese guo jin min tui, and less concisely in English as “the advance of the state and the retreat of the private sector.” As Jude remarked, it certainly feels like this has been happening in China in recent years, with the government proudly celebrating its state-directed economic model and the contributions of state-owned enterprises. The below are my notes, in which I try to pull together a concise answer to this vexed question:

The answer is yes and no. That’s not a cop-out. I say that because there’s a couple of different ways of looking at the advance or retreat of China’s state sector: you can look at it in a purely domestic context, or in a global context.

I’ve crunched a lot of numbers to get a handle on the economic size of China’s state sector. What I’ve found is that the value-added produced by state-owned enterprises has usually been in the range of 25-30% of China’s GDP. And what’s really striking about those numbers is that they just haven’t changed very much over the past 25 years. The share of China’s economic output being produced by SOEs today, under Xi Jinping, is not significantly different than it was under Hu Jintao, or even in the later years of Jiang Zemin.

In a purely domestic sense, then, there hasn’t been a major change in the balance of the economy between state-owned and private enterprises. I think that’s evidence that there’s some pretty strong continuities between the approach of the Xi administration and that of previous administrations. Xi certainly did not invent the idea that SOEs are and should be a central part of the Chinese economy, and he hasn’t actually taken huge parts of the economy away from the private sector and handed them to SOEs.

What I think has changed more under Xi is not so much the relative size of the state and private sectors, but more the political context in which both private-sector and state-sector firms have to operate. These days, both types of companies are expected to follow the government’s guidance more closely.

But the trajectory of China’s state sector looks pretty different if you look at it from the perspective of the world economy. Let’s not forget the obvious fact that China’s economy has been consistently growing much, much faster than the rest of the world. Since the share of SOEs in China’s economy has been basically stable, that means SOEs have also been growing quite fast, just as fast as the private sector. And that means China’s SOEs have gotten a lot bigger in absolute terms, and a lot bigger relative to the world economy.

The arithmetic here is pretty simple. At the turn of the century, China accounted for about 3.5% of global GDP. Now, China is about 17% of global GDP. The SOE share of China’s economy is about the same today as it was 20 years ago. Therefore, the share of global GDP produced by China’s SOEs has substantially increased: on my estimates, China’s SOEs account for about 4.5% of global GDP now, compared to about 1% back in 2000. I would point out that 4.5% of global GDP is a lot; it is more than the entire GDP of the UK, France or India.

So for those of us outside China, it is very much the case that China’s state sector is advancing. Chinese SOEs are a much bigger part of the global economy than they were before, and their international activities have also become much more important. I think it’s obvious that the rise of China’s SOEs represents a very substantial change in the structure of the world economy, and it should not be at all surprising that there is a lot of debate in other countries about how to respond to that change.

My contribution was pretty small, but the folks on the second half of the event tackled that exact question–how the US should respond–and generated a very useful discussion. I recommend watching the video.