Surpassing America

The further downward spiral in US-China relations since House Speaker Nancy Pelosi’s visit to Taiwan has laid bare how central the rivalry with the US is to much nationalist sentiment in China. Many Chinese see the US as the only thing preventing the realization of their long-cherished dream of bringing Taiwan under mainland control. But this is a problem that time will solve: once China is big enough and strong enough, it will not have to defer to the US any longer, and can finally exercise its will. One of the most direct expressions of this way of thinking came from prominent Renmin University professor Wang Wen (quoted in a useful summary by Tuvia Gering):

The crux is that China needs to outperform the US in terms of economic power, attain financial and military strength comparable to that of the US, and develop an overwhelming capacity to counter international sanctions. By doing this, the US will no longer be able to form an external force to interfere in our affairs after the reunification and in the long run.

The idea that it is necessary for China to overtake the US as the world’s leading economic and military power has a long history. Perhaps the earliest and most forceful expression came in a speech by Mao Zedong on August 30, 1956, entitled “Strengthen Party Unity and Carry Forward Party Traditions.” In that speech Mao called for China to overtake the US, specifically in steel production, but also in more general terms:

Once built up, China will be a great socialist country and will radically transform the situation in which for over a century it was backward, despised and wretched. Moreover, it will be able to catch up with the most powerful capitalist country in the world, the United States. The United States has a population of only 170 million, and as we have a population several times larger, are similarly rich in resources and are favoured with more or less the same kind of climate, it is possible for us to catch up with the United States. Oughtn’t we catch up? Definitely yes. …

Given fifty or sixty years, we certainly ought to overtake the United States. This is an obligation. You have such a big population, such a vast territory and such rich resources, and what is more, you are said to be building socialism, which is supposed to be superior; if after working at it for fifty or sixty years you are still unable to overtake the United States, what a sorry figure you will cut! You should be read off the face of the earth. Therefore, to overtake the United States is not only possible, but absolutely necessary and obligatory. If we don’t, the Chinese nation will be letting the nations of the world down and we will not be making much of a contribution to mankind.

As William Callahan explains in his short intellectual history of Mao’s speech–“Surpass“, a chapter in the 2019 anthology Afterlives of Chinese Communism–Mao was here making an early expression of the radical ideas that would in 1958 become the Great Leap Forward. Although more cautious planners in the party criticized Mao for promoting a “rash advance” that ignored social and economic realities, Mao would ultimately be able to prevail and implement his vision of rapid development through mass political campaigns, with disastrous results.

What’s interesting is that the tragedy of the Great Leap Forward and the mass famine that followed did not completely discredit Mao’s vision of surpassing the US. According to Callahan, the 1956 speech was left alone for decades, but enjoyed something of a revival among nationalist intellectuals in the 2000s. China’s rapid economic growth had made it seem plausible that it would eventually become a larger economy than the US, and some thinkers appreciated that Mao had early on “dared to dream” of China as the world’s top power. Here are a couple of examples:

Mao is heroic for [military intellectual Colonel] Liu [Mingfu] because he dared to craft a grand plan to surpass America, stating again that beating the US would be China’s great contribution to humanity. Liu is fascinated by the Great Leap Forward, seeing the outrageous ambition of this Maoist mass movement as the key to China’s success in the twenty-first century. …

[Economist] Hu Angang also quotes the “Strengthen Party Unity” speech at length to argue that Mao and the speech are important because they created “the strategic concept of catching up to, and then surpassing the US.” He elaborates on Mao’s materialist quantitative way of measuring power and status, quoting him to explain that because of its large territory, large population, and superior socialist system, China is the only country in the world that is capable of catching up to and surpassing the US.

The ideas of such strong-state nationalists have been quite influential over the past decade or so (see my earlier post on Who won the battle of ideas in China?), and Xi Jinping himself is reportedly quite focused on the economic competition with the US. What is interesting is that the government, for all its anti-American rhetoric, consistently denies that it cares about overtaking the US. Here, for instance, is foreign ministry spokeswoman Hua Chunying from May 2021:

China’s strategic intent has been open and transparent. We never aim to overtake the US. Instead, our goal is to constantly improve and go beyond ourselves, make sure that Chinese people can live a better life, and that China will contribute more to world peace and development through its own development.

A more recent example came from deputy foreign minister Le Yucheng in a speech on China’s diplomacy in January 2022 (given at the Chongyang Institute for Financial Studies, the think tank run by Wang Wen, the professor quoted above). While overall rather aggressive in tone, he reserved his strongest criticism for US rhetoric about “extreme competition” with China. And in other comments at the event, he disavowed any interest in surpassing the US economically:

Exceeding the US in GDP–we are not interested in it, and this is not what we are going after. To meet the people’s desire for a better life, this is what the Communist Party of China aims for.

These kind of statements remind me of the old journalistic adage to “believe nothing until it has been officially denied.” Of course the Chinese government is eagerly looking forward to becoming the world’s largest economy, and it’s clear that lots of people in the vast quasi-official apparatus surrounding the government think and talk about this eventuality all the time.

But someone has clearly decided that it is best not to say these things too directly. Part of the reason may have to do with the checkered intellectual history of the “surpassing America” meme and its association with Maoist radicalism, which has never been widely popular domestically. And part of the reason is probably that some Chinese politicians have realized it does not actually display great self-confidence to obsess about your country’s standing relative to other countries.

China’s housing crisis is an institutional crisis

There’s a tendency among economic and financial analysts to treat all housing crises as essentially the same. Housing is a long-lived asset purchased with leverage, therefore it’s not surprising to see a common pattern of a buildup of leverage leading to higher prices leading to excess construction, which at some gets out of hand and then is followed by collapsing prices, construction and leverage. Yet the details of housing markets do matter, and vary quite a lot between countries. As with Tolstoy’s line about unhappy families, every housing crisis is a bit different and exposes a different set of institutional flaws.

The housing crisis that China is now experiencing centers on its peculiar institutions for selling housing before it is built. Housing sales are plunging, not precisely because households can’t get mortgages or fear falling prices, but because they no longer trust that developers will actually complete and deliver housing bought in advance. There is good reason for that, as some of the nation’s largest developers have become so financially stressed that they have stopped construction on projects, including those that have already been paid for. Households that own units in the affected projects have tried to draw attention to their plight with online protests and threats to stop paying their mortgages.

It is a bit complicated to explain how this extraordinary sequence of events happened, but I have not yet seen a better explanation of the issues in English than in this piece from Caixin, which is worth quoting at length:

Although developers in many countries are allowed to sell homes before they finish building them, the practice in China is special in two ways.

First, homebuyers have to pay in full when they decide to buy. Usually, they produce a downpayment for a mortgage and the bank covers the rest. But in other countries like the UK, buyers of presale homes only need to come up with a deposit to reserve a property. They don’t need to pay off a mortgage until their homes are delivered. This full-payment requirement has helped developers raise cash quickly.

Second, until recently, Chinese developers had been allowed to use the bulk of their presale revenue for whatever they wanted. Although China has laws and regulations requiring developers to set aside enough money to finish construction on their housing projects, local governments and banks had allowed them to sidestep some of the rules, including the requirement that presale funds must be deposited into government-supervised escrow accounts. Instead, a vast amount of presale funds ended up in developers’ own accounts.

It didn’t really matter that developers hadn’t socked away as much money in escrow as they were supposed to. They were still able to finish their projects because they could always get their hands on more money, either through loans from banks and trust companies and issuing bonds, or by starting new projects. New homes were usually easy to sell. But when this changed, and it became harder to get financing and sell new homes, the business model fell apart.

The two issues here are that 1) China’s system for financing the construction of new housing put an unusual amount of risk onto households, 2) the legal safeguards in place to protect households from those risks were in practice routinely ignored. A recent post by Ren Zeping, a celebrity economist who used to work for China Evergrande, the giant developer whose troubles precipitated the current crisis, explains more of the background to both issues. Why does China have such a peculiar system?

The simple story is that the advance sale of commercial housing originated from Hong Kong, as a way for developers to put on leverage. In the mainland, the 1998 housing reform borrowed from Hong Kong’s experience and introduced the presales system due to the shortage of commercial housing and the shortage of funds at developers. In fact, a presales system currently exists in many countries around the world.

But here is the important point! Developed countries generally have very strict regulatory safeguards. Developers can start selling only after the project has been approved by the government, and buyers do not, as in China, pay the full amount of the purchase price at once with a bank loan after paying a deposit, but pay in installments according to the developer’s construction progress before delivery is completed. Therefore, the presales system requires strict supervision of funds with installment payments and penalties for default as safeguards.

The first cause of the current loss of faith in China’s housing institutions is thus that those institutions were poorly designed at the outset. In the early stages of the creation of a commercial housing market, when the priority was financing new construction to replace the dilapidated Maoist-era housing stock, it probably made sense to prioritize the interests of developers over those of urban households. That initial decision, however, created a path dependency, so that developers were permitted to keep transferring risk to households long after there was a reasonable justification for it.

The second cause, as the Caixin article clearly demonstrates, is the failure to enforce the rules that actually existed. When homebuyers paid in full for a housing unit that they would not take possession of for years, their interests were supposed to be protected by requirements to use those funds to actually complete the project. It was an open secret in the industry that these requirements were not enforced. Caixin quotes an executive at a property developer saying they could actually do whatever they wanted with 90% of the presales revenue they received.

Ren Zeping describes a couple of ways in which developers could get access to the funds. The property developer and the contractor could collude, with the contractor requesting more money for construction than was actually needed, and then sending the excess to the developer (which could then use it to start more projects). Or the developer could convince the local government and the bank that are supervising the funds to approve the release of money from the account, for instance by exaggerating the actual progress on construction.

There are undoubtedly many other such dodges and schemes. But the general point is that the institutions that were supposed to be protecting the interests of Chinese households in the housing market did not, and instead were corrupted by developers. It’s no wonder people are protesting. The authorities who were tasked ensuring developers met their obligations to households failed to do so until it was far too late (local governments have reportedly tightened supervision of presales funds over the past year). The current housing crisis is thus not simply a failure of technical regulation, but also a failure of ethics and the rule of law. Proposals for institutional fixes will have to reckon with this demonstrated difficulty in ensuring even-handed enforcement of rules around real estate, an area where corporate and local government interests are so strong.

The strange case of China’s self-employment statistics

It is a well-known habit of Chinese government officials to pepper their public remarks with statistics. Very occasionally, this habit leads to the disclosure of some new information. At a press conference early this year, a deputy director of the State Administration for Market Regulation (SAMR), which among other responsibilities handles the legal registration of businesses, waxed enthusiastic about the rapid growth in small businesses–specifically getihu, meaning individual businesses or sole proprietorships. In the process, he dropped some big numbers:

The Party Central Committee and the State Council attach great importance to the development of individual businesses. By the end of 2021, the number of registered individual businesses nationwide had reached 103 million, accounting for two-thirds of the total number of market entities. Passing 100 million is a historic breakthrough. Among them, 90% are concentrated in the service industry, mainly in wholesale and retail, accommodation and catering and residential services.

According to a survey, the average number of people employed by individual businesses is 2.68 people. Based on this survey, it is estimated that individual businesses nationwide provide employment for 276 million people in our country. This is very impressive.

The last two figures cited by Pu Chun are indeed very impressive: 276 million people is 37% of the nationwide employed population, an extraordinary figure. Employment by sole proprietorships, which basically means self-employment, is the most internationally comparable way of measuring informal employment. It is, for instance, the measure adopted in a recent World Bank report, The Long Shadow of Informality, which collates and compares worldwide data on the informal economy. If the SAMR figures are correct, they would indicate that self-employment and thus informal employment in China are much more prevalent than previously thought.

Prior to SAMR’s announcement, the government had not published a figure for the number of people employed by sole proprietorships for the past two years. The last published estimate by the National Bureau of Statistics was that sole proprietorships employed 177 million people as of 2019, equivalent to 23.4% of the employed population. As SAMR reported 83 million registered getihu that year, those figures imply that sole proprietorships employ an average of 2.14 people each. The most accurate estimate is probably from the 2018 economic census, a massive effort to enumerate all businesses in China conducted every five years, which counted 149 million people employed by getihu, or 21.2% of the workforce; the census figure of 63 million getihu works out to an average of 2.37 people each.

The SAMR survey cited by Pu Chun, about which no other information was disclosed, therefore implies that either roughly 100 million people moved from formal employment to self-employment in two years; or that all previous estimates of self-employment had somehow missed around 100 million people and that SAMR, an agency with no previous experience in collating employment statistics, had gotten it right. Neither of these possibilities is very likely.

SAMR itself holds the administrative records for business registrations, so there is no reason to doubt its count of the number of sole proprietorships. But its survey showing average employment of 2.68 people, 25% more than the historical data, is hard to believe. Given the recent increase in gig workers such as delivery drivers, many of whom are independent contractors registered as sole proprietorships, it’s more likely that the average number of employees per getihu is falling not rising. China’s 103 million sole proprietorships do probably employ well over 200 million people, but the 276 million figure is implausible.

What is somewhat mysterious is why SAMR officials would wish to exaggerate the extent of self-employment in China in this way. A high degree of self-employment is usually considered a sign of a less developed economy; to quote the World Bank report, “countries with larger informal sectors have lower per capita incomes, greater poverty, less developed financial sectors, and weaker growth in output, investment, and productivity.” The World Bank uses the economic census figure of 21.2% of China’s workforce being self-employed; that puts China right along the trend line of a cross-country comparison (see the chart below reproduced from the report). If instead 37% of China’s workforce is self-employed, as SAMR effectively claims, then China would actually be an international outlier with an unusually high level of informality for its level of income. Having a very high level of self-employment doesn’t actually make China look better in a global context.

The best explanation is domestic political incentives. Over the past several years, Premier Li Keqiang has waged a campaign to improve the environment for small businesses, and he never misses a chance to talk about how important they are to the Chinese economy. Li has also implemented several measures that have lowered the costs and simplified the procedure for registering businesses. Their most dramatic effect has been in new registrations of getihu, which have surged to 9-10 million per year from 5-6 million previously (see my previous post, What’s behind China’s boom in company formation?).

Since SAMR, as the agency in charge of business registrations, can take credit for this increase, it has some incentive to claim that its efforts are benefiting the economy by creating jobs. As the National Bureau of Statistics has, for whatever reason, stopped publishing the standard data on self-employment, SAMR has an open field to put its own numbers out there. The size of self-employment has thus become a figure by which SAMR can advertise its administrative accomplishments rather than an objective tool for analyzing the structure of the labor market.

It’s a pity that the it is becoming harder to understand the evolution of China’s labor market, as the changes in recent years have been dramatic. The rise in self-employment is part of a trend of polarization: there has been relatively low growth in high-paying manufacturing and service jobs and lots of growth in worse-paid labor-intensive service jobs. The key text documenting this shift is an open-access paper by Scott Rozelle and several co-authors: “Moving Beyond Lewis: Employment and Wage Trends in China’s High- and Low-Skilled Industries and the Emergence of an Era of Polarization,” much of which is also summarized in a useful CSIS briefing.

Even if the share of self-employment is not as high as SAMR claims, it has still been rising over time. Based on available data, I estimate it was about 29% in 2021, up sharply from just 17% in 2016; however, there’s a lot of uncertainty about this estimate because much of the recent surge in registered sole proprietorships could be an administrative rather than real phenomenon. Nonetheless, the trend is clearly the opposite of what one would normally expect to happen as China, already an upper-middle-income country, gets closer to high-income status.

Robots in Chinese literature circa 1902

The concept of the “robot,” a mechanical replacement for a human worker, seems to have been one of those things that was just in the air at the turn of the twentieth century, across the world. As is now well known, the English word was coined by the Czech writer Karel Capek (who credited his brother Josef for the inspiration, from the Czech word robota, forced labor). In the interesting short article, “Techno-Utopias And Robots In China’s Past Futures” in the new, free anthology Proletarian China: A Century of Chinese Labour, Craig A. Smith details the early history of robots in Chinese literature, which is not completely unlike the Western science fiction of the day. Here are some excerpts:

The idea of animated or mechanical humanoid servants and labourers appeared in classical Chinese texts. Mozi, a utilitarian philosopher active in the fifth century BCE, even created mechanical birds and beasts, and is now the namesake of a technology company. However, the concept of a ‘machine-man’ (机器人, the modern Chinese word for robot) only made its way from elite texts into the popular imagination towards the end of the Qing Dynasty.

Around the turn of the century, the entire world became fascinated with the idea of humanoid automatons and their potential for labour. The most memorable example of this in the West is the Tin Woodman from The Wonderful Wizard of Oz (1900), a depressed cyborg lumberjack yearning for a heart. Chinese fiction was in step and introduced labour automatons but with decidedly Chinese characteristics. In 1905 and 1906, the newspaper Southern News serialised a lengthy novel by Wu Jianren entitled The New Story of the Stone (新石头记).

Although other Chinese science fiction writers penned stories with automatons at the time, Wu’s novel was a wonderland, its plot following Jia Baoyu, the protagonist of the eighteenth-century Dream of the Red Chamber (红楼梦), China’s most famous novel, into a twentieth-century technological utopia. Passing through a technological device called a ‘civilisation mirror’ (文明镜), Jia enters this utopia and is immediately served tea by a talking automaton ‘boy’ servant. The journey then proceeds through a melange of advanced technologies, including flying machines and submarines.

It might have been around this time that Kang Youwei wrote the Book of Great Unity (大同书). The complete volume did not appear in regular print until 1935, eight years after his death, leading to controversy and numerous studies on the dating of the text. Tang Zhijun’s extensive research has shown that Kang most likely finished his manuscript in 1902, a finding corroborated by Wang Hui.

Building on a few short chapters from [the Confucian classic] The Book of Rites (礼记), and contextualising these ideas within the modern reality of nation-states and new political economies, Kang envisioned a future world with no suffering. He saw robots playing an important role in his Confucian utopia, yet his position as a member of the literati class shaped his understanding of how robots would bring an end to the traditional hierarchies: ‘There will be no slaves or servants, but their functions will be performed by machines, shaped like birds and beasts.’

Kang imagined that ‘in the time of the Great Peace, there will be no suffering. Labourers will only find enjoyment.’ This will be possible because they will only put their skills to use in creating works of
art, as the heavy lifting will all be done by robots. Like H.G. Wells, Kang saw technological advancements bringing an end to toil and opening the door to universal leisure: ‘One will order by telephone, and food will be conveyed by mechanical devices—possibly a table will rise up from the kitchen below, through a hole in the floor. On the four walls will be lifelike, “protruding paintings”.’

This great trust in the emancipatory potential of science continued throughout the twentieth century, and revolutionaries, including Mao Zedong in his youth, found Kang’s work inspirational. However, largely
due to his promotion of constitutional monarchy, Kang is now remembered as a conservative opponent of revolution.

What’s unprecedented about China

I’ve been struck recently by how often Western observers are describing China’s current political-economic-social model as unprecedented. The first example comes from the eminent economic historian Joel Mokyr, in a very good interview with Allison Schrager. Although China is not the main topic of their discussion, she does ask him this question: “Do you think the culture they have now is conducive to innovation?”:

That is a really hard question and I go back and forth on it. But my sense . . . I was in China about 12 years ago and I taught a long course in Shanghai at Fudan, and at that time I actually would’ve answered that they could. I would’ve been very bullish about China. It was before the authoritarian crackdown of Xi Jinping, and I become more skeptical about China because I actually think that a society that penalizes people for thinking in ways that are not convenient to the government, those societies in the end will not be nearly as creative as societies in which there’s some freedom of thought in which the government basically shrugs and takes an agnostic view, and you can say and think whatever you want. If the market for ideas accepts your idea, good. If they don’t, that’s your problem, and we’re not going to put you in jail for saying things to annoy us.

Now, that wasn’t the case in Stalin’s Russia or in Brezhnev’s Russia for that, and as a result, they fell behind radically behind the West in this 1970s, 1980s, and eventually their system collapsed. What China is trying to do is to have it both ways, to let people think relatively free about things that are technical and don’t matter, and suppress people who come up with social-political ideas, which they don’t like. And whether that model actually works, I am doubtful about, but the truth is we haven’t actually tried anything like that in human history. It has nothing really to go by.

I mean, in Stalin’s Russia it wasn’t just social and political ideas were suppressed, they actually took an active interest in science, and they basically decided what science was good, what science was bad. The same was true for a shorter time, with similar results, of Hitler’s Germany. They suppressed large amounts of physics because it was Jewish science. I mean, if you start thinking like that you are going to fall behind.

The economist Chang-Tai Hsieh takes a different angle, in a very interesting short piece called “Two Strong Hands: China’s Vision for the Private Sector” that analyzes the “the political foundation for China’s support of the private sector” (there is also a video presentation on the themes of the article that is worth watching). In it he tries to explain the apparent contradiction between the government’s crackdown on large companies and its support for small ones:

The Party has targeted large private firms, not because of a desire to return to Mao’s socialist economic vision, but due to fear that their growing power threatens Party control. At the same time, there is a widespread recognition that without a vibrant private sector, the economy will wither and the Party cannot survive. The result is what I call a strategy of using “two strong hands”: The first involves eliminating all threats to the Party’s control, while the second lends support to private firms that serve its interests by delivering growth, jobs and innovation — without becoming too powerful.

The default view of Chinese economic reformers is that the ‘two strong hands’ strategy will not work long-term, because total Party control will eventually undermine the market economy. Smaller companies might stop investing to grow, for fear of becoming ‘too big’ and hence finding themselves in the Party’s firing line. In this view, the ‘two strong hands’ are thus fundamentally incompatible.

The default view of Western political scientists is similar, albeit coming from a different angle. They would argue that the ‘two strong hands’ will come into conflict with each other, as millions of entrepreneurs and a rising middle class will eventually threaten the Party’s control of the political sphere.

Whether or not the ‘two strong hands’ can co-exist successfully is ultimately an empirical question. If the Chinese economy can maintain its private-sector driven growth momentum while the Party consolidates its power, the strategy will be judged a success. The key unknown is whether the Party’s efforts to support its favored parts of the private sector can spur enough growth to outweigh the negative effects of its crackdown on other, less favored areas. How much is lost if entrepreneurs know that it could be dangerous to be the next Alibaba, and how much is gained by the creation of millions of new small firms? Can a private sector of many “million-dollar companies” drive an economy with fewer “billion-dollar companies”?

What’s clear is that this model has never been seen before: a market economy with a large private sector under the control of the Communist Party. China has returned to a Maoist model of political control, but not the Maoist economic model of central planning and reliance on state-owned firms.

Both of these interventions are useful in clarifying points of tension in China’s current approach: can the government control political discourse without dampening scientific discourse? can the government limit the power of large firms without harming incentives for entrepreneurship? These are indeed empirical questions that cannot be answered a priori, although it’s clear where the sympathies of both authors lie.

Yet I can’t imagine that calling their strategy “unprecedented” would be received as a criticism by China’s Communist Party leaders, who since their abandonment of the Stalinist and Maoist models have never claimed to be following a predetermined blueprint. They have always said they are exploring their way to a new development strategy based on China’s actual conditions. And of course, similar questions were raised in earlier decades about the attempt to combine socialism with market economics; no one less than Janos Kornai thought their halfway house was inherently unstable and would soon collapse. Chinese officials are no strangers to the simultaneous pursuit of apparently conflicting ideals.

State capacity and the income tax

State capacity is a difficult concept to make concrete: a government’s ability to do stuff is obviously important, but how to tell if it is high or low? As a useful overview over at the Broadstreet blog shows, the most common way to measure state capacity in general is to measure fiscal capacity: the government’s ability to extract revenue from the economy. This makes sense historically, as the growth over the last few centuries of governments’ ability to do things like wage wars and provide social benefits went hand-in-hand with the development of tax systems and debt markets.

For the 20th century onward, the authors suggest a more precise metric: “To measure the fiscal capacity of the modern state, we use the share of income tax revenue in total tax revenue, as the collection of the income tax calls for high administrative capacity to ensure compliance.” This is an interesting choice, as on this measure China is a real edge case. Taking a quick look at the OECD Global Revenue Statistics Database, which covers over 100 nations, here is a list of the dozen countries with the lowest share of individual income tax revenue (for China only a 2019 figure is available, the others are the average of 2015-19):

CountryIndividual income tax,
share of tax revenue
Côte d’Ivoire0.3%
Bolivia0.8%
Paraguay1.7%
Antigua and Barbuda1.8%
Guatemala3.4%
China4.8%
Costa Rica5.7%
Colombia6.2%
Nicaragua6.3%
Togo7.0%
Cameroon7.0%
Mali7.3%
Source: OECD Global Revenue Statistics Database

A measure of state capacity on which China underperforms Nicaragua and Mali is probably a measure that is not capturing some important dimensions of actual state capacity. To take just some of the most obvious physical manifestations of administrative and technical ability, the governments of the other countries on this list are not operating their own rovers on Mars, or managing massive numbers of infrastructure construction projects both domestically and across borders. And whatever you think of China’s zero-Covid policies, it is unquestionable that local governments are displaying extraordinary logistical capabilities in organizing the mass testing of millions of people on short notice. The common claim that these policies demonstrate “China’s strong capacity for resource mobilization” is certainly correct (whether resources are being mobilized in the best way is another question).

Why does this measure get China wrong? To some extent, the focus on income taxes overly privileges a particular set of institutions as representing capacity. The actual structure of taxation reflects more than just administrative ability: which taxes are levied is a political decision. In recent decades, China’s government has consistently made the political decision to exempt most of the lower classes from income taxes, and to tolerate plenty of tax evasion by the upper classes.

It would indeed be difficult for China to build the administrative systems to levy a more broad-based income tax, but probably not impossible. China has, for instance, successfully administered a broad-based value-added tax for more than two decades. If you were to rank countries instead by the share of value-added taxes in total taxation, then China’s share of 30.2% would put it comfortably above the OECD average of 20.3% (and the US, of course, would be at the bottom with zero, as it has consistently made the political decision not to levy a VAT).

Nonetheless, there is still some useful information in the fact that China is an outlier in terms of this particular measure of state capacity. It suggests that the nature of China’s state capacity is different from that of your common or garden-variety Western social welfare state. The Chinese government’s ability to extract and mobilize resources does not work primarily through formal fiscal channels. It is well known that off-budget instruments like local-government land sales and the operations of state-owned enterprises are extremely important in the economy.

More broadly, both the strengths and the weaknesses of the Chinese state are tied up with its peculiar institutional structure and political heritage. China is a Leninist party-state that penetrates the private sector and civil society, operates more through political directives than formal legal instruments, and regularly undertakes mobilizational campaigns to achieve society-wide transformation. The capacity of its Leninist institutions is hard to measure precisely because they often hide behind conventional state forms, but is no less real for that.

What’s behind China’s boom in company formation?

Here is an interesting empirical fact about the Chinese economy that does not easily fit into the usual narratives: under Xi Jinping, more new private-sector companies are being created every year than at any period in its modern history. This of course is exactly the kind of factoid China’s government regularly trots out to demonstrate the vitality of its private sector. In March, the People’s Daily published a front-page article extolling the fact that the number of private companies had quadrupled from 10.9 million in 2012, when Xi took office, to 44.6 million in 2021. (I don’t actually read the People’s Daily every day, but I do subscribe to Manoj Kewalramani’s invaluable Tracking People’s Daily newsletter). Company formation is one of the ways of tracking what is usually called business dynamism: how much entrepreneurial activity is happening in an economy.

The figures are even more interesting than the propagandists seemed to realize. While the official publication of company registration data has been intermittent at best, the People’s Daily article and accompanying chart allow some of the holes in that published data to be filled in. The combined data provide a picture of private-company formation in China over roughly the past two decades. Before 2012, the population of private local companies was increasing by around 1 million or less every year (this is the net increase; there is even less data available on the gross number of new company registrations). Net company formation accelerated over 2013-15, and since 2016 has been running steadily around 4 million or more per year. There’s been an even more dramatic acceleration in the formation of new sole proprietorships (getihu: not companies with a separate legal existence, but businesses run as part of a household): the net increase was over 10 million in both 2020 and 2021, up from around 3 million in 2021.

That is a pretty dramatic change in the trend. The cause is well-documented: a systematic official effort, beginning around 2014 and continuing through the present day, to lower the costs and simplify the process of forming new companies (I wrote a piece about it back in 2014). The OECD is one of the few organizations that have attempted to systematically evaluate the effects of these changes (the much-maligned Doing Business survey of the World Bank was another). Here is some commentary from its just-published 2022 Economic Survey of China, which quantifies the administrative burdens on start-ups relative to other countries:

Enterprises in China are subject to somewhat lighter burden than in the average OECD country, though higher than in Japan, Germany or Italy. In some major non-OECD economies, such as Brazil or South Africa, the burden is much higher than in China. … Only one institution needs to be contacted to start a business in China, compared with the OECD average of around four. This is the same as in the frontrunner countries of Australia, Canada, Greece, Korea, Latvia, Lithuania or New Zealand, where to set up a new firm it is also enough to contact a single institution. There is neither minimum capital requirement nor monetary costs for registering a limited liability firm in China, which is in line with the best practice in OECD countries.

Substantially reducing the barriers to company formation to close to rich-country levels is a pretty decent accomplishment. It’s not a bad legacy for Premier Li Keqiang, whose signature initiative this has been and who is finishing his last year in office. What’s curious, though, is that the enormous boom in private-company formation in recent years has not had very visible macroeconomic effects. Economic growth is not any faster: growth in labor productivity has averaged 6.6% annually in the seven years since 2015, compared to 8.4% in the prior seven years. Of course, a lot of factors have combined to slow China’s economic growth recently, so growth might have slowed even more without this boom in company formation.

But there also hasn’t been any noticeable change in the structure of national income. Since barriers to company formation have fallen, and the pace of company formation has increased, we might reasonably think that a greater share of economic activity is now taking place inside legal corporate entities rather than in the informal economy. Yet the share of corporate profits in national income (technically, gross operating surplus in the fund of flows) has remained basically unchanged around 26% since 2015. Business profits generated by households rather than companies (through sole proprietorships, getihu), have also been stable around 5% of GDP. (The chart below uses the OECD’s presentation of China’s flow of funds, which is more standardized and easier to interpret than the one published by the National Bureau of Statistics; thanks to Bert Hofman for the pointer).

In other words, although the population of private companies in China has gotten much larger, the share of economic activity generated by those companies has not. Some of the increase in private company formation could thus be because it is now easier for people to create multiple corporate legal entities, rather than because there has been a true increase in the rate of entrepreneurship.

The flow of funds data goes only to 2019, and so doesn’t show what happened during the two pandemic years of 2020 and 2021. By all accounts, these were horrible periods for small businesses in consumer-facing services like restaurants and tourism. They lost huge revenues during the initial lockdown of 2020, enjoyed a few months of rebound in the latter half of 2020, and then settled in for months of disappointment in 2021 as waves of intermittent Covid restrictions discouraged travel and recreation. Things have obviously gotten even worse in 2022. Data from OECD countries show that new firm creation generally fell substantially in 2020, so the fact that in China net company formation actually picked up is surprising. Of course, China’s pandemic economic trajectory in 2020 was quite different from the OECD countries. But it’s also possible that the well-documented mass closures of small business during lockdowns are not fully showing up in the company registration data: companies could stop operating without canceling their registration. (Friends who have companies in China tell me that canceling your registration is difficult and time-consuming and often not worth the bother.)

The biggest surge in registrations has not been for private companies but for sole proprietors/getihu: the pace in 2020-21 was roughly double that of 2015-16. Because sole proprietorships have inherent limitations to scale (they can’t hire more than a few people) and no limited liability, they are usually more of a vehicle for self-employment. The desire to be an entrepreneur can be a reason to choose self-employment, but in developing countries like China, self-employment is often the result of a lack of more stable job opportunities. It can also be the channel for more modern forms of unstable employment: drivers for delivery and ride-hailing services often register as sole proprietors, which makes them contractors not employees. The increase in sole proprietorships does appear to be part of a broader structural change in China’s employment patterns: an important 2020 article by Scott Rozelle and colleagues documents a sustained rise in the share of employment in informal, low-wage service sectors.

It’s certainly not a bad thing that it has become easier for Chinese people to establish companies. But the rather ambiguous economic evidence suggests that the surge in private-company formation over the last several years is not a simple story of rising business dynamism.

Hong Kong in 1945

The backstory to why Hong Kong ended up still being a British colony after the end of World War II is interesting, and I did not previously know the details. At the time it probably appeared to be a small matter, but it did have big long-term consequences. This account is a from a recent review essay by Stephen Kotkin, Stalin’s biographer, in Foreign Affairs:

Arguably, with the exception of the Soviet capture of Berlin in May 1945 and the stern telegram that U.S. President Harry Truman sent to Stalin in August of that year warning him not to invade Hokkaido (one of Japan’s four main islands), the physical reoccupation of Hong Kong by the British in 1945 exceeded any other wartime episode in its strategic implications.

When Japan’s surrender suddenly appeared imminent in the summer of 1945, surprising Washington, the Truman administration hastily accelerated work on a plan for the hand-over of Japanese-occupied territories and assigned the acceptance of Japan’s surrender of Hong Kong not to the British but to Chiang Kai-shek’s Chinese Nationalist government. The British, however, undertook furious military and political preparations to reclaim Hong Kong for themselves. U.S. officials wanted to satisfy their British allies but also allow Chiang to save face, and so they cleverly suggested that the British could accept the surrender on behalf of the Chinese government. But the British refused that offer, and eventually, Washington acquiesced. Chiang acquiesced as well, dependent as he was on U.S. military and logistical support to reclaim other areas of China. The upshot was that Hong Kong passed from the Japanese back to the British and remained that way even after 1949, when the Communists triumphed over Chiang’s Nationalists in the Chinese Civil War but shrank from attempting to expel the British from the strategic southern port.

Had the British acquiesced rather than the Americans and Chiang, history would have played out very differently. As it was, the communist regime in Beijing was able to take extraordinary advantage of something it would not otherwise have possessed: a world-class international financial center governed by the rule of law. During the period of Deng’s reforms, British Hong Kong ended up funneling indispensable foreign direct investment into mainland communist China—from Japan and Taiwan, especially.

People often ask why Soviet Premier Mikhail Gorbachev, when attempting to reenergize the Soviet economy in the second half of the 1980s, did not follow the successful Chinese approach to reforms. Beyond the immense gulf between a highly urbanized, heavily industrialized country and a predominantly rural, agricultural one, the Soviet Union had no Hong Kong to attract and direct incoming investment according to market, rather than political, considerations. No British Hong Kong, no Chinese miracle.

Japan surrenders Hong Kong to the UK

Why GDP growth targets are underrated

These are not good times for the credibility of China’s GDP growth targets. Just weeks after unveiling an ambitious target of 5.5% real GDP growth for 2022, the central government effectively ensured that target will not be met by requiring local governments to impose strict lockdowns to contain the spread of Covid-19. The restrictions cover most of China’s major cities, have had a clear negative impact on economic activity in March that will only worsen in April.

The government is now in a lose-lose situation: if it stimulates growth enough to actually meet the target, then it will overheat the economy (as it did in 2020); if it doesn’t, then its growth targets become less credible. The credibility was already not high after the 2021 target was set a 6.0%, a figure so disconnected from the reality of a cyclical bounce that delivered 8%-plus growth as to be almost meaningless in practical terms. If China’s government doesn’t even try to ensure that GDP growth is close to its target, then why bother having a target in the first place?

These kind of problems are among the reasons why well-meaning economists have for years been urging China’s government to give up GDP growth targets. They don’t seem to actually function well as a guide for macroeconomic policy. And the crude focus on increasing economic aggregates has been blamed for everything from worsening environmental pollution to driving the unsustainable accumulation of debt. The conventional wisdom about China’s GDP growth targets was well captured in this piece from 2014 by an old colleague at The Wall Street Journal:

The target is a relic of the Stalinist planned economy, the basis on which the government planned the allocation of scarce resources for industrial production. Its continued existence is testament to how far China has to go to fully embrace a market economy, one that operates according to market signals.

While this is an understandable view, I believe the events of recent years have strengthened rather weakened the case for GDP growth targets. Given China’s actually existing political economy, GDP targets are, if not exactly optimal, then certainly a reasonable second-best policy framework. And so far their track record is better than the alternative.

The belief of most economists, both Chinese and Western, that I have interacted with over the last couple of decades is that China would be better off moving away from GDP growth targets, as doing so would improve economic management and lead to more rational policymaking. So when Xi Jinping opened his second term in 2017 by announcing that the government would in future focus less on the quantity of GDP growth and and more on its quality, there was a general feeling that this was a natural, inevitable and generally positive evolution.

I did not have such a good feeling about this shift. Back in 2017 I wrote a piece for my employer arguing that if growth targets were de-emphasized, “then what’s left will be a confusing welter of political, social and environmental mandates.” Rather than being a victory for rationality and reform, the de-emphasis on growth targets was actually a signal that economic decision-making would become more politicized:

Xi now wants to orient the government around delivering a “better life” for people rather than economic growth alone. But determining what exactly a “better life” consists of is a top-down process managed by the Communist Party leadership, rather than a bottom-up process driven by local exploration. It is very unlikely to mean a more hands-off attitude towards economic management: Xi’s administration has shown a decreasing tolerance for volatility in economic growth and market prices. Since he doesn’t trust local governments to do the right thing, Xi actually wants to have more centralized direction of the economy in the future, not less.

I think it’s fair to say this prediction has been completely vindicated, particularly by the “regulatory storm” of 2021 with its multitude of highly interventionist policies aiming to reshape entire industries. Limiting the power of large private companies was even a fairly explicit goal: it’s probably not a coincidence that the main targets of last year’s political-regulatory campaigns were real estate and the internet, the two economic sectors that have created the biggest private-sector fortunes. All of this was certainly enabled by Xi’s dictum that there are more important things than GDP growth. The costs and economic downsides of the regulatory storm were put aside in favor of other goals.

What should now be clear is that GDP growth targets were not actually the main cause of excessive or ill-considered government intervention in the economy. That tendency comes from something much more fundamental: China’s Leninist political system, which is organized around mobilizing officials to direct social transformation. As Ken Jowitt put it: “The definitional tendency of Leninist regimes [is] their attempts to control and specify the substantive dimensions of social developments, not merely the framework within which such developments occur.”

De-emphasizing GDP growth targets would have done what liberal reformers hoped for if had been accompanied by fundamental political changes in the mission of the government. That is, if the government had accepted a role as a more neutral regulator and provider of public goods, and been content to provide a framework in which private actors could pursue their own goals.

Instead, what happened is that Xi Jinping carried out a grand project to reorient the Communist Party’s mobilizational machinery away from the pursuit of economic growth and toward a broader set of goals, which can be summarized as the pursuit of “national greatness.” These include things like technological independence, greater income equality, and a better natural environment. Xi’s idea that there is more to life than economic growth seems to be long-held and sincere: he articulated it back in 2001 when he was a mere provincial governor. But the shift to goals defined more by political and social values rather than quantitative measurements has led to economic management occurring through politicized campaigns.

The trick about GDP targets is that they are compatible with both the Leninist focus on achieving society-wide goals, and the liberal preference for allowing individual agents to pursue their own goals. Growth is a collective accomplishment for which the government can take credit, but the exact means by which growth is achieved can be left up to individual actors.

The focus on growth thus functioned to smuggle some liberalism into China’s Leninist political system. When Deng Xiaoping formally shifted the Party’s goal from class struggle to economic development back in 1978, he opened up much more space for individual choice and decentralized action in China than had previously existed. Entrepreneurs and local governments could pursue their goals without having to check them for ideological consistency.

As Joseph Fewsmith has argued, this process eroded the effectiveness of the Leninist political machinery, something that Xi has worked hard to fix. The de-emphasis on GDP growth, rather than being a technocratic or pro-market reform, is fully consistent with Xi’s renewed focus on ideology and political discipline.

But Xi also knows that continued GDP growth is necessary for his project of achieving national greatness to succeed, so he can’t completely ignore economic realities while pursuing his transformational political campaigns. By the end of 2021, the economy had slowed sharply enough that it was becoming obvious that a change of course was necessary. In December, when when Xi chaired the annual Central Economic Work Conference, the signal was clear: the priority is now the “stability” of the economy.

Since then, various political slogans and campaigns have been much less in evidence and the focus has been on more practical short-term measures. Senior officials have even promised not to introduce policies that “adversely affect market expectations”–effectively admitting that they had been doing just that in the recent past. Veteran economist Li Yang, in a commentary in January, seemed to breathe a sigh of relief at the change in policy tone:

At the beginning of reform and opening up, our Party clearly proposed to change its focus from “class struggle” to “economic construction.” This shift was a milestone: it brought us forty years of rapid growth that made China’s economy the second largest in the world and made China a country that the world does not dare to underestimate. However, this phrase has been said less often in recent years, and this meeting reiterated it, which is quite significant.

Such cautious optimism that the pendulum was swinging back to the “good old days” of more growth and fewer political campaigns has probably not survived the drastic Shanghai lockdown, which is widely perceived as being driven by a political imperative to demonstrate victory over the virus rather than pure public-health considerations. Covid policy is being personally directed by Xi, who used a Politburo meeting in March to require “perseverance” in the strict approach. The Party’s propaganda system also continues to churn out material supporting Xi’s long-term shift of aspirations away from simple economic development toward the more values-based “better life” framework.

In this context, the more that China’s government talks about how to keep economic growth humming, the better for business and investor confidence. A policy framework that focuses on steady growth in national income over time is certainly better than a policy framework that lurches from campaign to campaign. The debate over whether the government can achieve this year’s GDP target is a sideshow: it probably can’t, and it won’t cause a crisis of confidence to admit that. What’s really important is whether or not the government is re-committing to a growth-based policy framework.

What happened to common prosperity?

Xi Jinping rolled out his new slogan of “common prosperity” with great fanfare in 2021, using it to declare inequality a “major political issue” that would not be permitted to worsen further. The term was written into the five-year plan, highlighted in major speeches, and constantly promoted in state media. Common prosperity looked like one of the key concepts that would govern Chinese policy in Xi Jinping’s third term.

Yet the slogan of the moment is almost completely missing from the government’s official policy agenda for 2022, at least as it is presented in the documents for the annual legislative session that got underway this weekend. Premier Li Keqiang’s government work report, for instance contains exactly one mention of common prosperity (共同富裕), which is rendered as “prosperity for all” in the official English translation. And it’s a pretty generic statement:

We must act on the people-centered development philosophy and rely on the efforts of everyone to promote prosperity for all, so as to keep realizing the people’s aspirations for a better life.

The Ministry of Finance’s budget report also contains exactly one mention of common prosperity, which is simply a note of a provincial initiative: “We supported Zhejiang in be coming a leader in the exploration of new ways to promote common prosperity through public finance at the provincial level.” But the budget sets no goals for the central government relating to common prosperity, which is a bit strange as the Ministry of Finance would be in charge of any changes in taxes or spending to narrow income inequality.

The National Development & Reform Commission, the super-ministry that coordinates much economic policy and planning, seems to be taking the slogan more seriously: its annual development report does mention common prosperity a few times, and calls it a “major goal”. But the priority does not seem particularly high: common prosperity is listed as the last of the 10 tasks for its work in 2022, as an umbrella term for improving public services:

With a correct understanding of the main goal of common prosperity and the way to reach it, we will do everything possible within our means to constantly improve public services and resolve issues affecting the wellbeing of the general public.

This is all a bit puzzling coming after the massive propaganda push for common prosperity in 2021. It seemed reasonable to think of common prosperity as one of the planks in Xi’s “re-election campaign” for the 20th Party Congress later in 2022. He could argue that one of the reasons why it is important and necessary for him to have a third term is so that he can deliver common prosperity and solve the problem of inequality. Therefore I expected the messaging around common prosperity to ramp up this year, and get more specific and ambitious over time. Instead, it has turned more low-key.

Partly I think this reflects some of the incoherence that has been part of this slogan from the beginning. The rhetoric of common prosperity has simultaneously featured a call for revolutionary change and a denial that any fundamental change to China’s system is needed. As I wrote in an earlier contribution to a CSIS discussion on common prosperity:

It is remarkable how much of the official discussion of common prosperity consists of listing the things that cannot and should not change. Xi states that the common prosperity campaign cannot be allowed to hurt incentives for entrepreneurship, innovation, and hard work, nor can it be the occasion for the government to make “promises that cannot be fulfilled.” In other words, Xi is going out of his way not to promise a “new deal” for Chinese citizens, even though he has pledged to increase transfers to lower-income regions, adjust taxation, and boost the level of public benefits. There is thus something of a mismatch between common prosperity’s very broad political goals and the constrained policy instruments available to achieve them.

These contradictions make it hard to propose specific policies that would actually achieve the objectives of common prosperity, and even to articulate concrete objectives in the first place. That’s why I think common prosperity is more of a political campaign of gestures and symbolism than a technocratic economic agenda. Barry Naughton’s take is probably even more cynical than mine; as he said at UCLA event in February:

As a first approximation, the role that ordinary working people have in the Chinese Communist Party’s policy formulation is zero, and this is not an overture to them. It’s an effort to do two one things: one is to slap down this new capitalist elite and tell them you should know your place, and it’s not at the top, and the other is to put together a nice program that sounds good going into the 20th Party Congress.

So one interpretation of the recent downplaying of common prosperity could be that the rhetoric is simply collapsing under the weight of its own internal problems and difficulties. Yet I don’t think we’ve seen the end of common prosperity: the government is still pledged to deliver a plan for common prosperity, a process that will force it to articulate a somewhat more coherent agenda. The NDRC’s approach suggests that will center around improving the social safety net, an objective with plenty of political support.

Xi himself has certainly not abandoned the term; in a meeting during the legislative session, he said “As long as we consistently follow the road of socialism with Chinese characteristics, we will be able to continue to realize the people’s aspirations for a better life and continue to advance the common prosperity of all people.” I’d expect Xi to still use the common prosperity slogan prominently in his speeches around the Party Congress.

A different, though not incompatible, interpretation would be that the political context for this slogan has changed more than originally expected. Common prosperity probably made sense as a slogan during the triumphalist year of 2021, when China’s growth was strong and long-term goals seemed within reach, but perhaps makes less sense during the worrisome year of 2022, when growth is sliding and the world is in turmoil.

Xi Jinping’s most prominent public remarks at the legislative session this week have focused food and energy security, themes he has long favored but which now have much greater resonance as oil and commodity prices spiral upward. As Li Keqiang said in his work report, in a classic piece of understatement, “this year our country will encounter many more risks and challenges.” Common prosperity probably needs to go on the back burner for a bit while leaders deal with more urgent short-term concerns.