Category / China

by Andrew

Ren Zhiqiang has an acerbic take on Xi Jinping’s urban planning

There’s been an extraordinary amount of hype about the government’s plan to build a new city southwest of Beijing; some are saying it could be China’s biggest public-works project ever. The plan for the Xiongan New Area was personally overseen by Xi Jinping himself, according to an official account, and it has been lauded as a qian nian da ji, or roughly a “great plan for the next millennium.”

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Xi Jinping inspects the Xiongan New Area

Xiongan is the latest development in the Beijing-Tianjin-Hebei integration plan, a pet project of Xi’s that aims to develop the regions around the capital. The official line is that the creation of the new city will ease Beijing’s pollution and congestion problems by allowing some less essential facilities and functions to be relocated out of the capital. But the enormous propaganda blitz has not permitted much detailed discussion of the specific benefits and costs of these initiatives.

So this seems like a good moment to air some critical views, which are not being permitted much space domestically. The piece below was published by the outspoken property tycoon Ren Zhiqiang in August 2015, before Ren was censured for his public criticism of Xi Jinping’s policies. The article has been repeatedly deleted from Chinese internet sites, though it can still be found by searching for its title. Since the Xiongan announcement, the piece has been getting forwarded around again, and its argument is still relevant.

Here is my somewhat abridged translation:

Once again a new wave of construction is being prepared, in the name of Beijing-Tianjin-Hebei integration and to support the development of the capital. It has really made everyone excited! But after reading these propaganda documents and summaries, I do not see there is anything that should make people happy.

China has shouted out the slogan of “urban-rural integration” before, but why was there no way to achieve such a goal? The root cause is that there was no way to break down the restrictions on free movement and migration in the hukou system. And this has produced a whole series of related problems.

In the planned economy era, population movements were restricted, and the people’s communes used the so-called “integration of government administration and economic management” to tie farmers to the land. After the reform of the household responsibility system and national identity cards, farmers could leave their land and go to the cities. But the hukou system did not allow them to change their identity as peasants. “Rural migrant workers” took the place of the working class. Social security, healthcare, education, housing, family–all are still linked to the land.

Whenever I see these slogans of “urban-rural integration” and “Beijing-Tianjin-Hebei integration” I think, if we cannot make human rights equal, and completely eliminate all vestiges of these differences [created by the hukou system], then how can we discuss integration? Can Hebei and Tianjin people equally share all the rights of Beijing hukou holders? Can they share Beijing’s benefits of education, health care, social security, employment and so on?

This so-called integration is nothing more than Beijing squeezing out the industries, businesses, and people that it doesn’t want, and arranging them in Hebei and Tianjin. In this way Beijing can still enjoy the goods and services they provide, but does not have to bear the burden they put on Beijing. The end result of this so-called integration is to dump a big burden on the surrounding areas, in order to ensure that Beijing can meet its goal of strictly controlling its population.

Even the purchase of housing in Tongzhou [a suburb of Beijing where some city government offices are being relocated] by people who have a Beijing hukou and pay taxes in Beijing has become a barrier that integration cannot cross. So how can the population of Hebei and Tianjin be integrated?

Urban density is the result of market competition, and also the result of a choice between urban and rural areas. Not to acknowledge the role of competition and choice, and to attempt to use the government’s administrative power to force integration, must result in failure.

Market competition necessarily leads to concentration of technology, resources, human capital and innovative capability; these resources will be matched with the most advantageous areas, where their returns are highest. Currently they are being concentrated in cities, especially large cities. No administrative power can change these flows and this concentration. Economic rules cannot be changed by decree.

Some people say the equalization of public services and public resources can solve this problem. Can public services really be equalized? Yes, they can. But this requires the whole society to have reached a relatively high level of economic development. Currently even developed countries like the U.S., U.K., Germany, and Japan cannot achieve this goal, so how can China in its current circumstances achieve it?

Let me ask a question: to punch someone with the most force, do you open your fingers, or close them into a fist? If we took those great professors who are concentrated in Peking University and Tsinghua University and “equalized” them by sending them to backward regions, would this raise or lower the overall level of education? If all of Beijing’s good doctors were “equalized” out into backward areas, would this improve the level of health and research capabilities?

Does the process of “integration” and “equalization” raise the efficiency of resources? Or is it just the use of [political] authority to redo the allocation of industries and human resources? And will the market agree?

When Tongzhou prevents people who do not have a local hukou from entering, can it develop talents on its own? It is hard to see how blocking talented people from moving in can benefit Tongzhou’s overall development. When Beijing strengthens these kind of restrictions in order to control its population, can it attract talented people? How can you know who can become a great entrepreneur or political leader?

When urban incomes are so far above rural incomes, when incomes in Beijing are so far above those in Hebei and Tianjin, how can people not be allowed to seek those high-income jobs? 38% of China’s rural population is engaged in agricultural work, but this only generates 9.5% of its GDP. This is root cause of the urban-rural divide and income gap. If urbanization cannot be used to lead more farmers to change their economic role, how can this income gap be eliminated?

All countries in the world have faced the same conflicts in the process of urbanization, but there is not one that has used administrative power to limit urbanization. All have dealt with it by using market methods and allowing people to freely choose. And in fact when people in the cities can get along harmoniously, this raises the efficiency of cities. …

After many years of reform in which China has moved from complete public ownership to allowing some private ownership, most people have already become property owners. Even more people are working hard in hopes of becoming property owners. So the allocation of financial and other assets is decided by their owners, not by administrative power. If it limits property owners’ freedom to deploy their assets, then they will have no choice but to move abroad.

The backward areas of Hebei may feel that these industries that Beijing is getting rid of are actually an advance for them. Those industries that Beijing thinks use too many resources and generate too much pollution can perhaps generate higher incomes than agriculture. But is it only possible to reduce pollution in advanced regions, or is it also possible to reduce pollution in backward regions? Is this kind of transfer of industries being more responsible to society and to nature, or is it just passing off responsibility?

Perhaps the final goal is still to integrate Beijing, Tianjin, and Hebei, and to optimize the city of Beijing. But this goal is not one that can be decided by administrative power.

Today China Mobile just canceled roaming charges among the three regions [of Beijing, Tianjin, Hebei]. But how many restrictive policies have not yet been canceled? Can cars without Beijing license plates freely enter Beijing? Why can Beijing create restrictions, but Tianjin and Hebei cannot? Can this lead to integration?

When a society based on small farmers modernizes, individuals become the main actors in both economic production and social life. The prosperity of a region or a city, and even of a nation and a people, depends on the innovative capabilities of individuals, and is decided by the depth and extent of innovation. It is not something that can be decided by administrative power. When any administrative official limits or blocks an individual’s innovative capacities and ability to choose their environment, it must weaken the spirit and development of innovation, and harm the overall economy.

This so-called integration is not a market-based process. A shift to rely once again on administrative power to arrange the pattern of economic development must ultimately be a failure.

In conclusion, when CCTV is cheering for Beijing-Tianjin-Hebei integration, a rational understanding of the story behind it may be necessary. A clear head leads to fewer mistakes.

I don’t really agree with Ren’s market fundamentalism, which is rather explicitly a counsel of despair for everywhere but the most developed urban centers. It is however another example of how economically-liberal thinkers in China are increasingly hostile to the government’s regional development policies, which they see as a huge waste of resources recalling the failures of the planned economy.

But I think Ren is right to call attention to how the grand plans for “integration” call for lots of more-or-less forcible relocations of people and industries, but do nothing to break down the hukou system’s institutionalized discrimination based on geographic origin. On the whole I think China could do with less focus on building new development zones and more focus on liberalizing migration.

by Andrew

Nobody is worried about South China anymore

Over at The Economist, Vijay Vaitheeswaran has a special report on the Pearl River Delta that is almost unrelenting in its enthusiasm. The conventional wisdom on South China now seems to have come full circle–there’s not a lot of stress anymore about its manufacturing being hollowed out by competition from low-wage manufacturers. Instead, South China’s future looks solid (at least, as long as it can hold off rising sea levels). There are some nice examples in the piece:

When wages shot up, many pundits predicted a bleak future for the delta, with factories decamping en masse to cheaper places in Asia. … Many firms have considered leaving, and those in highly labour-intensive industries (such as low-end textiles or shoes) have indeed left. But most firms have stayed, keeping the bulk of their operations in the delta but hedging their bets by investing in cheaper regions. Some have set up factories in cities in China’s interior, others in South-East Asia.

Tommi Laine-Ylijoki, who manages the supply chain for the consumer business at Huawei, a Chinese multinational based in Shenzhen, emphatically rejects the idea that rising costs might force him to shift manufacturing out of the PRD. He says he did look into moving inland, but found that the cost differential was only 20-30%—and his entire supplier base is in the delta. He also wants his factories and suppliers to be close to his R&D team because he believes that “collaborative manufacturing” promotes innovation. Huawei outsources the production of most smartphones, but keeps about a tenth in-house to maintain the “touch and feel” of mass manufacturing. Given the PRD’s outstanding logistics, manufacturing and supply chain, he says, “I can’t think of a better place to be in the world to do this.”

…

Wong Chap Wing, a native of Hong Kong, runs a factory in Dongguan, an industrial city north of Shenzhen. Hip Fai, his privately held firm, stamps metal parts for things like printers and copiers. The energetic septuagenarian started dye- and mould-making in 1966, and recalls a time when migrants were grateful for a job. “There are not enough technical workers now,” he complains. Young people turn up their noses at factory work. He used to pay 600 yuan a month, but now they demand 5,000.

The future is not bright for workshops that cannot upgrade. Mr Wong looked into shifting to a cheaper location inland but decided that the savings were too small. He says that many low-end subcontractors in his area are closing down. Looking at the antiquated equipment and the throngs of workers in his factory, it seems this greasy and noisy place, too, may face extinction.

Turn a corner, though, and you spot the future: a hybrid assembly line where shiny Japanese robots are mingling with human workers. Mr Wong spent 200,000 yuan on each robot but expects to get his money back within three years because his reconfigured assembly line is much more productive. Looking back, “I could not imagine my factory full of robots,” he reflects. “I came here for the cheap labour.”

The reasons the interviewees give for this continued strength are by now familiar ones: the potential labor cost savings in other places are small relative to the advantages from Guangdong’s network economies, and those labor cost issues can anyway be dealt with through technological upgrading and automation. Vijay also makes some of the same points Dan Wang did about Shenzhen’s manufacturing base increasingly becoming a hub for hardware innovation.

But if these factors are good news for South China, they are not really such great news for the rest of the country. The downbeat view that South China would find its advantages competed away over time was at the same time an optimistic view that other regions would be able to rise. If other regions can’t effectively compete away South China’s advantages, then it’s going to be harder for them to replicate South China’s path to prosperity.

Vijay’s piece asks “what the country can learn” from the Pearl River Delta, but doesn’t really answer the question other than to issue one of his magazine’s usual exhortations for government to “stay out of the way” of entrepreneurs. Aside from the fact that that’s not what the government actually did, it’s not very helpful. The usual hands-off policies are just a recipe for entrenching developed regions’ existing advantages. China is generally not very interested in hands-off policies anyway, and is doing a lot to try to help its disadvantaged regions–but it’s not obvious the current approach is the right one either.

With its entrenched regional disparities, it seems like China could be suffering from some of the same issues as the eurozone–but in reverse. In the currency union, the prosperous core dominates the setting of monetary policy, which means it has generally been too tight for the troubled periphery. In China, nationwide monetary policy is easy in order to aid troubled inland provinces, which means it is probably too loose for the prosperous coast. Indeed, one of the main macro risks in China at the moment is the overheating of property markets in prosperous coastal cities, which with decent fundamentals do not really need all that much stimulus.

by Andrew

Layoffs and the limits of state-enterprise reform

I recently came across an interesting paper by Daniel Berkowitz et al. entitled “Recasting the Iron Rice Bowl: The Reform of China’s State Owned Enterprises” (here’s a working paper version). They come up with a fresh interpretation of the peak period of SOE reform (roughly 1997-2007), arguing that the main effect of reform was to greatly lessen the political pressure on SOEs to hire lots of employees. Once that pressure was released, SOEs could become more profitable by laying off workers and spending on new capital rather than new employees; as a bonus, the remaining SOE employees got much higher wages.

We find that SOEs profitability increased primarily for two reasons: first, because the elasticity of substitution between capital and labor exceeds unity and SOEs had preferential access to capital, SOEs could become profitable by increasing their capital intensity: And, second, the state placed its SOEs under less political pressure to hire excess labor. We also find that, with the exception of the top central SOEs, in general SOEs became profitable without having impressive productivity gains. …

It is striking that overall employment in SOEs during 1998-2007 fell by 62.9%, while employment within private and foreign firms grew by 644% and 202%, respectively. It is also striking that SOEs increased the capital intensity of their production processes more aggressively than private and foreign firms. During 1998-2007, the aggregate capital intensity grew by 34%; however, the 127% growth within SOEs was much more rapid than the 68% growth within private firms and the negligible (-6.7%) growth within foreign firms. While the capital intensity for SOEs in 1998 was 0.89 and comparable to the foreign firms (0.99) and higher than private firms (0.48), by 2007 the SOEs’ aggregate capital intensity of 2.03 was roughly 2.5 times and 2.2 times higher than in the private and foreign sectors.

There are two other noteworthy patterns for labor and wages. First, the overall real wage in manufacturing grew by 162%, and these gains were most pronounced within SOEs (228%), then within private firms (136%) and, lastly, within foreign firms (114%). State-sector real wages in 1998 were close to private-sector real wages and roughly one-third lower than foreign-sector wages. By 2007, state-sector wages were roughly equivalent to foreign-sector wages and almost 50% higher than private-sector wages. Second, labor’s share of value added fell by 7.9 percentage points. This change was most pronounced for SOEs (a 14.1 percentage point decline) and then private firms (a 6.7 percentage point drop), and negligible within the foreign sector. Thus, labor’s share within SOEs fell because the declining rate of employment exceeded the increasing rate of wage growth.

Ending the state sector’s historic role as an absorber of excess labor was an important achievement. But having too many workers was not the only thing dragging down SOE performance. The important corollary of these findings is therefore that the internal restructuring of SOEs was rather limited despite apparently impressive improvements in profitability.

On the authors’ analysis (which is confined to the industrial sector) SOEs became more profitable but not much more productive. SOEs that were privatized did become more productive than SOEs that were not privatized. Since privatization largely stopped after 2007, this channel for improving productivity went away.

I have previously argued that calling a halt to SOE privatization was a policy mistake that should be reversed, and this paper supports that line of argument. The deterioration in both SOE profitability and productivity since 2008 by themselves make a strong case that the achievements of the 1997-2007 reform period were less substantial than widely perceived at the time. In hindsight the cyclical boom in the economy was probably much more important.

The paper’s data on the decline of SOE jobs and rise of SOE wages also help shed light on other questions. In more recent years there has been a fair amount of public resentment of the high salaries of SOE employees. It seems plausible this was aggravated not just by SOE wages moving higher, but also by SOE jobs becoming much fewer and harder to get. The pattern of keeping discipline on employment and focusing on capital-intensive expansion strategies has, at least in my impression, continued since 2007. There has been some increase in total SOE employment since 2010, but a very modest one.

SOE-employees

by Andrew

Is it too late for China to reverse the over-concentration of elite education?

China has devoted an enormous amount of resources to improving transportation and other infrastructure in its historically poorer inland provinces. The theory was that this would remove the physical barriers preventing these places from developing. It’s a theory that looked plausible in the 1990s but feels less so today, as big regional gaps remain after almost 20 years of big-budget infrastructure projects. The infrastructure in even poorer Chinese provinces is already quite good; the problems that remain are unlikely to be caused by a shortage of transport links.

As the structure of the economy shifts, gaps in physical infrastructure may be getting even less relevant. The government likes to highlight the fact that China’s services sector is now larger than the industrial sector, and is growing faster. But for a government strongly concerned about regional inequality, for good reasons, this structural shift is a mixed blessing. All the evidence suggests that the high-technology and modern services sectors that the government is so eager to encourage have a much greater tendency to cluster in a small number of places. This type of clustering seems to be driven more by access to skilled employees and networks of related companies than transport costs for shipping containers. So the changing structure of the economy seems likely to reinforce existing regional inequalities rather than narrow them.

To me that suggests that China’s government should start focusing more on equalizing the distribution of universities than of highways. It is of course true that China has massively expanded the availability of university education across the country. But the country’s top universities–the kind that are most likely to generate superstar researchers and entrepreneurs–are still extremely concentrated in just a few places: Beijing above all, and also Shanghai and neighboring Jiangsu province. The table below I compiled from Shanghai Jiaotong University’s standard ranking of Chinese universities:

It’s striking how the current distribution of top universities perpetuates patterns around a century old: China’s first Western-style universities were founded in places with more Western influence, which meant coastal cities. The main elite (indeed only) universities pre-1949 were in places like Beijing (Peking University and Tsinghua), Tianjin (Nankai), Shanghai (Jiaotong, Fudan, Tongji), Jiangsu (Nanjing University), Zhejiang (Zhejiang University), Guangdong (Sun Yat-Sen University). The main exception to this rule is Wuhan in Hubei province, which was the site of one of China’s first modern universities and still has a decent cluster of good schools.

The overwhelming dominance of Beijing in the list above is also hard to miss. It’s not just that it is home to both of China’s top two universities, but that it has so many other top-ranked schools as well. I think this is a post-1949 phenomenon, part of the enormous bulking up of Beijing that has occurred in the last few decades. While the Communist Party did make conscious efforts to redistribute resources to some inland provinces, it also transformed Beijing from a mostly administrative center into a major economic one. Beijing gets an enormous amount of government favoritism (the Summer and Winter Olympics, to take just one example) because, as the capital, its glories are automatically the nation’s glories.

While having a top university does not guarantee that a particular place will become a high-tech hub, it at least increases the odds. But with so many top universities concentrated in so few places, other cities face very long odds in challenging the current high-tech dominance of Beijing, Shanghai and Shenzhen. Note in particular how six of China’s poorer provinces, with large ethnic-minority populations, do not have even a single one of the nation’s top 200 universities. Shifting this pattern is not easy, since elite universities are not formed overnight or by government decree. But supporting educational experiments, like private universities or partnerships with foreign schools, in places outside the existing club of top cities could be a start.

by Andrew

Fu Chengyu’s frank talk on SOE reform

China’s annual legislative session, which closed last week, was not a particularly newsworthy event despite being the subject of many news stories. It featured many unedifying public displays of loyalty to General Secretary Xi Jinping, and even less dissent and debate than than usual.

In the current Chinese climate where frank discussion of economic problems and constructive criticism of economic policy is very rare, the intervention during the session by former SOE executive Fu Chengyu was I thought fairly noteworthy. Fu previously ran two of China’s biggest SOEs, CNOOC and Sinopec, and was widely considered an effective, forward-looking and market-oriented executive.

It’s not surprising that Fu is critical of the current program of state-owned enterprise reform; just about everyone who has looked at it has come away pretty depressed. What’s interesting is that he is both willing and able to speak his mind. The following is my translation of his statement on March 9, as reported by Xinhua (the Chinese original is here); it’s a bit dense with Chinese policy jargon, but the main thrust is still pretty clear I think.

1. We cannot confuse reforming the supervision of state assets and enterprises with the reform of state enterprises themselves, and we cannot use reform of the supervision of state assets and enterprises to replace state-enterprise reform.

Today there are some prominent and widespread phenomena in the national implementation of state-enterprise reform. The first is a focus on reforming the supervision of state assets and enterprises, and a weakening of the reform of state enterprises’ own management and operational systems. In some places this supervisory reform has replaced enterprise reform. The second is that the Third Plenum’s call for a transition from “managing state assets” to “managing state capital” has been weakened. The third is that “mixed ownership reform” is seen as a restricted area, and so reform is excessively timid and cautious. The fourth is that internal reforms for the vast majority of state enterprises, particularly reforms to allow the market to play a decisive role in the allocation of resources, have basically not gotten off the ground. Lots of people are watching from the sidelines and not many people are doing anything; most enterprises are waiting and few enterprises are actually trying something.

2. It is not clear who should be the main actor in state-enterprise reform, and an impetus for reform is lacking among enterprises. First, in terms of reform implementation, different levels of government have in reality already become the main driver of reform, while enterprises are just implementing the reforms. When enterprises are not fully participating in the design and planning of reforms, it is difficult to be optimistic about the results. Second, reform in fact means innovation, and innovation cannot be ordered from the top down, but must be explored from the bottom up. Regulatory agencies cannot control every aspect of reform, and cannot just issue a lot of documents to direct state-enterprise reform. Third, because the agency for reform has been moved up to the government, this has created a discordant situation: what the government wants to change is very difficult to change, while what enterprises want to change they dare not change.

3. We lack an environment that protects enterprise leaders who undertake reform, so state-enterprise executives have many concerns about reform. In surveys a very common reaction is heard: “if I do a good job I get no recognition, if I do a bad job I get a bad assessment; if there is a conflict I have no protection, if there’s a problem it’s my responsibility; if I do a lot there are a lot of problems, so not doing anything is the best option.” …

Fu Chengyu

Therefore I suggest the following:

First, clarify the main actors in reform and highlight the main goals of reform. The principle of the separation of ownership rights and operation rights should be followed to allocate responsibility for state-enterprise reform. The regulatory agencies at different levels of government are the owner’s representative for state-owned assets and have regulatory responsibility for state-owned assets and state-owned enterprises, so they should be the main driver for reforming supervision of state assets and state enterprises. State-owned enterprises are the responsible authority for operating state-owned assets, so they should be the main driver for reforming operation and management, and should take responsibility for state-enterprise reform. I suggest that the regulatory agencies at different levels of government delegate authority for reforms internal to state enterprises to the enterprises themselves. Government agencies can handle the overall direction and principles, and be in charge of supervision. Enterprises should be allowed to draft their own reform plans, in accordance with national laws and regulations and relevant policies on state-enterprise reform, so that responsibility for reform passes to enterprises and their executives.

Second, create an environment that creates incentives for reform and protects those who take the initiative. The glorious achievements of state enterprises over more than 30 years of reform, and the important contribution of enterprise leaders to state enterprises’ development, should be fully affirmed. Policies to encourage and protect enterprise leaders who undertake daring reforms should be drafted, to create a specific, feasible, and fault-tolerant system. I also suggest that auditing, disciplinary and personnel agencies develop related policies to incentivize reform and protect initiative in their respective areas.

Third, focus on making breakthroughs in mixed-ownership reform. The Central Economic Work Conference proposed mixed-ownership reform as an important opening for a breakthrough in state-enterprise reform, and this is very significant. I suggest that the scope of enterprises in trials of mixed-ownership reform be expanded, and that the current trials of mixed-ownership reform at third-tier subsidiaries be expanded to second-tier subsidiaries and even to the group level. This will increase the dynamism of state enterprises’ own reforms, and also show China’s efforts at deepening reform; it will also attract large amounts of private capital back to the real economy, thereby lowering financial risk.

None of Fu’s proposed changes are particularly revolutionary, but they still prompted rather hyperbolic praise from Li Jin, a prominent commentator on SOE reform, which I interpret as relief that rational criticism and policy discussion still seem to be possible:

If our delegates all spoke as directly as Fu Chengyu, pulling together public opinion so that the soul of the people can develop, then there would be great hope for China’s state-enterprise reform, and the dream of the rejuvenation of the Chinese nation will eventually be fulfilled. I hope China will have more heroes of reform like Fu Chengyu.

by Andrew

The continuing relevance of Kornai for China

It’s feeling like something of a Kornai moment to me: not long after finishing a nice book covering Kornai’s influence on China of the 1980s, I have stumbled across an excellent discussion of Kornai’s ideas apply to China today.

In the latest issue of the Journal of Economic Literature, Xu Chenggang reviews János Kornai’s Dynamism, Rivalry, and the Surplus Economy. Kornai calls the 2013 book a sequel of sorts to his 1992 classic The Socialist System, as it lays out a conceptual framework for understanding capitalism in contrast to socialism. But Xu also uses the review to think through China’s current situation in the context of Kornai’s framework, especially the key concept of the soft budget constraint:

Two pairs of concepts highlight the analytical framework for contrasting capitalism to socialism: shortage economy versus surplus economy and soft budget constraint (SBC) versus hard budget constraint (HBC). Compared with the distinctive feature of socialism called chronological shortage, which was first pointed out by the author in the 1970s, capitalism is characterized as chronological surplus, which means excess supply, including excess capacity and excess inventories, and labor unemployment. …

One of the major challenges beyond understanding “pure” systems is the hybrid system, which covers most of the economies in the world. China presents an interesting case of such a challenge. The pre-reform socialist China was a shortage economy, which is exactly consistent with Kornai’s predictions. Since the reform, China transformed into a particular type of hybrid system, that is, state capitalism, similar to that in Vladimir Lenin’s New Economic Policy. …

The Chinese economy is a super-surplus economy featured by massive over-capacity, which exceeds the over-capacity problem in all leading capitalist economies in the world. Such an extraordinary over-capacity problem is concentrated in the state sector with SBC. The SBC syndrome and the “forced growth” behavior of the SOEs create shortage under the socialist system. This phenomenon raises the issue of why SBC under state capitalism is associated with surplus. …

In contrast to private firms in capitalism, state firms under state capitalism continually produce and expand unwanted and obsolete products because they are protected by SBC (i.e., no “destruction” policy). The monopolistic power and government protection provide SOEs with the privilege of heavily subsidized capital. They imitate other innovations at extremely low costs because of favorable technology transfer deals from advanced multinational firms that are supported by the government and the monopolized super-large scale of the market (e.g., high-speed train technology). …

In socialism, SBC and lack of competition create shortage. Moreover, SBC is a mechanism that hampers competition. Indeed, market competition was weak in the Central and Eastern Europe and Former Soviet Union (CEE–FSU) reformed economies when central planning was replaced by market mechanisms. Different from CEE–FSU reforms, the large-scale entry of nonstate firms, particularly private firms, makes market competition the norm in the Chinese economy. Even SOEs, which are subject to SBC, are driven to fierce market competition and regional competition.

When high-powered incentives associated with these competitions are given to the CEOs of SOEs for market share or for profits and when SBC serves as insurance against insolvency, SOEs are induced to take bold risks in competition for market shares. This situation seems to be the force that produces extraordinary surplus. Thus, the coexistence of fierce product market competition and severe SBC could trigger more drastic over-capacity problems.

This phenomenon in which SBC under fierce competition may exacerbate surplus can also be observed in leading capitalist economies. Examples include the bad loan problems in Japan and the sub-prime mortgage problem in the United States. If the essential mechanism of SBC is the moral-hazard problem created by the removal of bankruptcy threat (broader than bailing out by an ex ante identifiable agent), the sub-prime mortgage scheme in the United States can be regarded as a sophisticated variation of SBC in advanced capitalism.

Like most of Xu’s work, the whole review is worth a read. I also happen to think that Xu’s 2011 article “The Fundamental Institutions of China’s Reforms and Development” is one of the single best things ever written about the Chinese economy; it and other pieces are at Xu’s profile and bibliography page.

by Andrew

What happened to the Chinese arguments for inland infrastructure investment?

There is a pretty overwhelming consensus these days that China is wasting huge amounts of money by building lots of unneeded infrastructure projects in its less-populated inland provinces. A lot has been written on this theme since the 2009 mega-stimulus that launched the infrastructure spending boom, but one of the more recent examples is this piece by Trefor Moss in The Wall Street Journal; here’s a sample:

While President Donald Trump says the U.S. urgently needs to invest in its decaying transport systems, China, if anything, faces the opposite problem of profligate infrastructure spending, according to some economists. Yet after years spent building airports, roads and railways, Beijing outlined plans for more of the same in a recent policy paper.

Under the plan, China would have 260 commercial airports by the end of the decade, up from 207 in 2015. Additions include a second major airport in Beijing at a cost of $11.7 billion, and a second airport for the western city of Chengdu for $10.2 billion. …

Three-quarters of Chinese airports—and virtually all the country’s regional airports—lose money, the then-chief of the civil aviation authority, Li Jiaxiang, said in 2014, in the agency’s most recent public comment on the issue. The agency spent $191 million last year subsidizing loss-making airports.

Airports in far-flung parts of western China are especially vulnerable. The $57-million Libo airport in Guizhou, for example, drew media attention in 2009 for handling just 151 passengers, yet the zombie facility hasn’t been allowed to close.

In this context it was interesting for me to recently read an older book that makes a strongly argued case for doing lots of infrastructure investment in inland provinces, with plenty of statistical evidence and full consideration of the relevant economics literature. The book is The Political Economy of Uneven Development: The Case of China by Wang Shaoguang and Hu Angang; it was published in 1999 but is a translated and revised version of a Chinese book composed in 1995. Therefore it very much predates the launch of China’s “develop the West” drive in 1999, and indeed the book seems to be a key source for the intellectual arguments driving that program and subsequent efforts to close the gap between the coast and the inland.

I would summarize Wang and Hu’s main arguments as follows:

  • There is no natural trend for regional disparities to be narrowed through a process of convergence. Market forces do not necessarily cause factors of production to spread evenly around the economy, but can concentrate them in areas that possess initial advantages. And in fact, regional inequality in China in the early 1990s was rising sharply.
  • Regional inequality in China was already extremely high by any international standard, which poses risks to national unity and political stability. (“The China of 1994 would undoubtedly have higher levels of regional inequality [if properly measured using units of similar size] than did Yugoslavia in 1988, just a few years before its disintegration.”)
  • The different endowments of China’s provinces–geography, economic structure, human capital, etc.–are either a function of differences in per-capita GDP or have no statistically significant relationship with per-capita GDP. In fact the numerous historical, geographical and cultural differences among provinces are less important than gaps in transportation infrastructure.
  • Differences in economic growth rates across China’s provinces are mainly driven by differences in investment, and differences in investment are mainly driven by differences in provinces’ local savings. Since local savings levels are themselves determined by the level of economic development, higher-income provinces have a natural tendency to grow faster.
  • These natural advantages could be offset by a capable and committed government that organized inter-provincial capital flows. But policies in the 1980s and early 1990s lead to fiscal decentralization and favoritism for the rich coastal provinces, aggravating rather than alleviating regional inequality.
  • The solution then is for the central government to stop unnecessarily favoring coastal provinces, and instead organize large fiscal transfers and investment programs in inland provinces in order to compensate for their lower savings, boost their growth and put them on a more equal footing with the coastal provinces.

Compared to most academic policy recommendations, these were almost unbelievably influential: two decades of large investment programs for inland provinces have followed. Yet the regional gaps that so worried Wang and Hu have not closed; indeed recently they have widened again. I would be surprised if many people these days would argue that the problem with inland provinces is that they aren’t getting enough infrastructure investment.

So what went wrong? I can think of a few possibilities, which are not mutually exclusive:

  • The differences in endowments among provinces were more consequential than expected, and could not be equalized simply by building more transportation infrastructure in poorer inland provinces. Coastal provinces’ real advantages may have been less about geography, infrastructure and transport costs, and more about greater access to social and business networks abroad, stronger entrepreneurial experience and traditions, and higher levels of education and human capital. Lowering transportation costs for the inland provinces helps, but it isn’t everything.
  • All investment is not created equal — public-sector investment in infrastructure and private-sector investment in manufacturing are not substitutes. Boosting public-sector investment in the inland provinces may have added to their GDP in the short run, but it did less to change their growth potential and economic structure than private-sector investment would have. High rates of public investment also risk entrenching dependency rather than ending it, in much the same way that huge amounts of foreign aid are not always helpful for poor countries.
  • The infrastructure investment boom was in practice not a centrally-organized transfer of capital designed to narrow regional gaps, but more of a nationwide epidemic of soft budget constraints.
by Andrew

The real story of how China took over the world of metals

The fact that China is the world’s largest producer of steel and many other metals is by now one of those ordinary pieces of background information, so unremarkable that is mentioned in passing in news stories without further explanation. Yet it is still a fairly amazing fact, and I suspect that most people, if asked to explain how it happened, would not be able to come up with more than a mix of “China is big,” “government subsidies” and some hand-waving.

The real story is much more interesting, and is well told by my friend Michael Komesaroff in a new paper published by CSIS: “Make the Foreign Serve China: How Foreign Science and Technology Helped China Dominate Global Metallurgical Industries.” The details are the heart of the tale, so it’s hard to summarize, but here are some excerpts to give a flavor of the conclusions:

Since 1978, China’s metallurgical industries have undergone rapid modernization, and they are now characterized by facilities that are among the largest and most technically advanced in the world. For example, in 2015, China turned out 31.67 mt of primary aluminum, accounting for 54.7 percent of world production. In 1990, the average size of China’s aluminum smelters was 22,000 tons per annum (tpa), much smaller than the 190,000 tpa that was then the average for smelters outside China. In 2015, the average Chinese smelter was rated at 330,000 tpa, much larger than the rest of the world where the average was 260,000 tpa. Currently six of the world’s 11 largest aluminum smelters, including the world’s two biggest, are in China, and some of them are equipped with advanced technology that has yet to be used on a commercial scale outside the country. … The examples of aluminum and steel are replicated in many other metallurgical sectors, including magnesium, gold, bismuth, cadmium, copper, lead, nickel, stainless steel, rare-earth elements, and zinc.

china-world-steel

In most cases the rapid transformation of China’s metallurgical industries can be traced to technology acquired in the 1980s and 1990s when Chinese state-owned enterprises (SOEs) purchased obsolete plants from failing foreign peers. The plants were dismantled and transported to China for reassembly. The underlying technology for these facilities was more efficient than what was then being used in China, but from a foreign perspective the plants were small and the technology was usually relatively old and not rated as the world’s best practice. However, for China, the purchase of transplanted foreign facilities was a cost-effective means of growing their understanding of more-advanced metallurgical technologies and this strategy contributed to the country’s emergence as the global leader in the production of most metals.

The specific strategy adopted by China when rebuilding the transplanted facilities was to confine any modifications to those necessary to simplify the process and adapt them to Chinese conditions. Having adapted the imported plants, engineers set out to fully understand the technology before initiating a series of continual incremental enhancements that improved performance. The continual improvements were helped by a rapidly expanding economy with an almost insatiable demand for metals that supported a sustained construction program. Learning from each new project helped China’s engineers make further small enhancements as well as lowering construction costs. The consequence of this strategy is that now China is able to build simple, low-cost metallurgical plants that they staff with abundant low-wage workers performing simple and repetitive tasks. This is the opposite to the West, where capital costs are high because there are few projects, each with a different technology that tends to be complex so it requires highly paid skilled workers. …

Purchasing obsolete foreign metallurgical plants for transport and re-erection in China appears to have been a haphazard, though pragmatic practice that was not Beijing’s official policy; however, the central government did readily give its support when an SOE sought approval for such projects. … For China the timing of these changes was fortuitous in that they followed the oil shocks of the 1970s when the price of oil shot up from $3 to $37 per barrel in a decade, forcing steel and other energy-intensive industries to close or relocate to countries where energy was much cheaper. It was this restructuring of heavy industry that was the prerequisite for successful implementation of China’s policy. China’s abundance of low-cost, relatively skilled labor was another fortuitous factor favoring China because it made the dismantling and re-erection process a viable and competitive option that other countries could not have emulated even if they had wanted the facilities.

The lucky coincidence of a global restructuring of basic industries and the availability of a cheap skilled workforce is unlikely to be repeated, making it highly unlikely that China’s successful heavy industry development model will be replicated anytime soon. It is also unlikely that China could successfully recycle the model for use with anything other than a basic industry that produces a standard product to an international specification. There are examples, such as kaolin and titanium dioxide, where China acquired Western plants or technology designed to produce consumer goods, but was not able to successfully operate their acquisition. Consumer goods have a wide variation in characteristics that are custom designed to appeal to final consumers. …

Much of the criticism leveled against Chinese metals producers is that as a result of Beijing’s support they have built new capacity even when there is no economic justification and that such nonmarket forces have encouraged an enormous increase in new capacity. Because of the global nature of most metallurgical industries, critics argue that excess capacity in China has displaced production in other regions, resulting in localized job losses and even bankruptcies. While the logic of this argument is sound, the facts that justify the argument are questionable on at least two counts: first, China is not alone in subsidizing its metal producers, and second, irrespective of any government support, Chinese capacity is generally newer, more efficient, and cheaper to build than comparable foreign facilities.

by Andrew

The lasting influence of “Kornai fever” in China

Julian Gewirtz’s new book, Unlikely Partners: Chinese Reformers, Western Economists, and the Making of Global China, has gotten rave reviews from plenty of people smarter and more important than me, but I am happy to add my voice to the chorus. It is an excellent general history of economic policymaking in the first fifteen or so years of the reform era (1978-1993), focusing particularly on the intellectual exchanges between a group of Chinese intellectuals and various foreign economists. The “western” in the title should be interpreted very broadly, as the stars of the story are in fact mostly lesser-known scholars from what used to be called the Eastern Bloc.

At the center of this tale is the great Hungarian economist János Kornai, who incisively analyzed the nature and problems of socialist economies. With detailed research and interviews, Gewirtz nicely uncovers the chain of encounters that led to Kornai’s ideas getting wide exposure in China:

Kornai’s major idea presented at the [1981] Athens conference was his analysis of the “soft budget constraint.” This crucial concept showed that, under a planned economy, the firm “is not limited by fear or loss of failure”–in more practical terms, loss-making in the firm’s finances does not bring negative consequences to the firm. … Kornai’s presentation drew a sharp rebuke from V.R. Khachaturov, president of the Soviet Economic Assoication and a vehement supporter of the socialist planned economy. … But an unlikely voice, not heard previously in the conference discussions, spoke up in Kornai’s favor: Wu Jinglian. “In his paper, Professor Kornai had analyzed the functioning of a specific model of a socialist economy. Chinese experience made it easy to understand his analysis,” Wu said. Chinese economists had observed these issues, especially the “paternalistic relationship” of the government and enterprises, “serious waste” in enterprise management, and “the disappearance of the function of prices as carriers of information about supply and demand.” Wu praised Kornai for providing a rigorous conceptual apparatus. …

While at Yale University’s Department of Economics in 1983-1984, the 53-year-old Wu had read Kornai’s Economics of Shortage. Returning to China in 1984, Wu stashed a copy of Kornai’s book in his luggage and, at home, excitedly circulated sections of the book among friends and colleagues. In the minds of this small, elite group of Chinese economists, Janos Kornai seemed like an unexpected friend. …

[in 1985] Kornai had come to China as part of a distinguished group of economists from Europe and North America who would gather with many of China’s leading economists and economic policy makers. … The ostensible topic of his presentation was “could Western policy instruments (especially monetary and fiscal policies) be effective in socialist countries?” Kornai’s career, built on applying sophisticated economic analysis to the economic problems of socialist countries, clearly suggested an affirmative answer to this question–although this idea was relatively new to China. Since arriving in Beijing, Kornai had been listening carefully to discussions of China’s problems, including economic “overheating” and fears of inflation, as well as to the Chinese economists’ sense that they did not have in mind a goal model for the reform. Listening to such discussions, he wrote in his memoirs, “I felt…that I was at home in China, despite the distance and the historical and cultural differences. All the phenomena that came up and the cares and woes were familiar.” …

Kornai’s ideas, transmitted through diverse channels, flooded into Chinese debates, including the 1986 publication of the Chinese translation of Economics of Shortage. Dozens of articles in periodicals introduced an even wider readership to what Dushu, then a prominent liberal magazine, called the “enlightening” views of Kornai, whom they dubbed “the economic theorist that reform cried out for.” “Kornai fever” would go onto fuel sales of over 100,000 copies of the Hungarian economist’s book. Kornai was mentioned hundreds of times in academic and research journals in the period 1986-1989, including in regional and provincial journals in areas as varied as Guangxi, Hubei, Anhui, and Heilongjiang. …

These authors placed particular emphasis on two related aspects of the book: why the shortage economy was innate to socialism and how enterprise behavior under socialism created shortage phenomena—focusing, as a result, on Kornai’s arguments about the “soft budget constraint” and “paternalism.” These ideas, which the reviewers defined as priorities to address in future reforms in China, would remain the most salient aspects of Kornai’s thought for Chinese economists.

This jibes with my own experience; I discovered Kornai’s work from Chinese references to the term “soft budget constraint” in writings on state-owned enterprise reform. But while the soft budget constraint is brilliantly useful conceptual tool, being able to identify the problem of soft budget constraints has not enabled China to solve it. In fact the simplest diagnosis of the problems of the post-2008 Chinese economy is probably that budget constraints, which had been getting harder, became a lot softer.

Kornai’s most important contribution may actually have been to articulate the idea a market economy could still be regulated or managed by the government through indirect means–the fiscal and monetary policies used in Western economies–rather than the direct planning characteristic of socialism.

There is much testimony that Kornai’s presentation on this theme at the 1985 Bashan conference helped many Chinese reformers clarify the direction in which they wanted to head. They knew that they didn’t want a planned economy any more, but they were also very uncomfortable with the idea of an economy completely driven by random market forces. Kornai’s presentation helped square the circle, and Gewirtz shows how the deceptively simple concept of a “market economy with macroeconomic management” eventually became an official goal and (more or less) a reality. Kornai himself recognized how unlikely this whole chain of events was:

It’s very strange that in my own little country [I was ignored] most of the time, and in this giant country I was able to speak at a certain historical moment when one billion people wanted to hear exactly what I wanted to say. That was a very rare moment, and good luck.

by Andrew

Xi Jinping is a giant Deng Xiaoping fanboy

I have long been uncomfortable with the widespread view that Xi Jinping is effectively the second coming of Mao Zedong. With his ever-growing list of titles and powers and overwhelming presence in official propaganda, Xi is regularly accused of undermining the collective leadership system instituted by Deng Xiaoping and returning to an era of one-man rule and personality cults.

I think this view is less an actual historical analysis than an attempt to find a way to criticize Xi in a way that resonates within the Chinese political context. Since “everybody knows” that Mao was bad and Deng was good, saying that Xi is like Mao but not like Deng is just a way of expressing disapproval of the things Xi is doing.

While I’m not a huge fan of all the things Xi is doing either, I think we have to recognize that a lot of what he is doing draws very much on Deng Xiaoping’s legacy rather than Mao’s. Xi’s obsession with high economic growth targets is, for instance, clearly an attempt to show that he is Deng’s successor and is fulfilling the great goals passed down from the previous generation of leaders. I’ve also argued that Xi’s treatment of Mao’s legacy is very much in line with Deng’s own.

Even Xi’s obsessive power-gathering, culminating in his recent official recognition as the “core” of the leadership, can be justified as a Dengist move. While Deng always emphasized that China’s top leadership was collective, he knew that he was the core of that leadership, and he did not think the system could function without a core. Deng did not want arbitrary one-man rule but he did not want squabbling and indecision either. His most direct statement of this was in famous remarks made to senior officials in the Party, a couple of weeks after June 4, 1989 and the designation of Jiang Zemin as the new core leader (Chinese original here):

A collective leadership must have a core; a leadership without a core is unreliable. The core of our first generation of collective leadership was Chairman Mao. Because of that core, the “cultural revolution” did not bring the Communist Party down. Actually, I am the core of the second generation. Because of this core, even though we changed two of our leaders, the Party’s exercise of leadership was not affected but always remained stable. The third generation of collective leadership must have a core too; all you comrades present here should be keenly aware of that necessity and act accordingly. You should make an effort to maintain the core — Comrade Jiang Zemin, as you have agreed. From the very first day it starts to work, the new Standing Committee should make a point of establishing and maintaining this collective leadership and its core.

In this vein I have to recommend a new and brilliant piece by Alice Miller, the doyenne of Chinese politics-watchers, which provides a comprehensive assessment of Xi’s governing style and its relationship to Mao and Deng. She comes down firmly on the Dengist side, as is clear from the title “What Would Deng Do?“; here is an excerpt from the conclusion:

Much commentary among observers on Xi Jinping as the new Mao in Chinese leadership politics portrays him as ruthlessly asserting dictatorial power by purging political adversaries on charges of corruption and by assuming command over all major policy sectors as the “chairman of everything.” Xi has thus overturned the norms of collective leadership installed by Deng Xiaoping 30 years ago to inhibit the rise of another Mao, and he has begun building a cult of personality resembling Mao’s, despite a formal ban in 1980 enacted by the Deng leadership. On this view, Xi Jinping has emerged as the most powerful Chinese leader since Mao himself.

As prominent as this understanding of the Xi leadership has become, it nevertheless suffers from serious flaws. For one thing, several of its specific assertions are simply not the case. Judging by available evidence, Xi has not superseded normal Politburo processes as they worked under his predecessor Hu Jintao and, before Hu, Jiang Zemin. As attested to by public appearances of members of the Politburo Standing Committee, the key decision-making body, the division of policy labor—an intrinsic element of the collective leadership system that Deng Xiaoping implanted—remains in place. …

A more efficient reading of the dynamics of the Xi leadership arises out of the documents of the 18th Party Congress that installed him as top leader in 2012. … The upshot is that Xi and his Politburo Standing Committee colleagues received a mandate at the congress to press a broad array of renewed reforms deemed essential both to China’s advance toward the “double hundred” goals and ultimately to the party’s survival amid a rapidly changing society. To strengthen the ability of the new leadership to press the mandated reforms, the congress downsized the Politburo Standing Committee to make it easier to break the deadlocks that appear to have stymied reforms in Hu Jintao’s later years. And to the same end, Xi was given enhanced public prominence as the front man leading the reform movement, though not at the expense of the collective leadership system that Deng implanted. …

Xi’s model is not Mao Zedong, but rather Deng Xiaoping, the leader who launched the reforms that triggered China’s rise and whose transformative impact Xi and his colleagues hope to emulate.

Mao and Deng

Mao and Deng