China's Economic Miracle

Was There a Miracle? 

The facts of the Chinese economic growth after the Economic Reform started in 1978 are undisputed: From 1978 until 2013, the economy increased by about 9.5% a year and became the second largest in the world a few years ago after the United States.  In per capita, GDP in China went from below $300 to today's over $6000.  But was there a “miracle?” 

To say that what happened in the Chinese economy after 1978 was unexpected would be a vast understatement.  After a few false starts since the founding of the People's Republic, including the policy disaster known as the Great Leap Forward, it is safe to say that few in China or elsewhere believed that Deng Xiaoping had found the magic formula in 1978 when he re-introduced the goal of the Four Modernizations, of agriculture, industry, military, and science and technology, talked of building a Xiaokang Society by the end of the 20th century.  When he died in 1997, China was well on its way of achieving the income target of a Xiaokang Society and had already survived the traumatic events in 1989, yet there were still doubters at home and even more abroad who did not trust his successors to carry on further reforms to sustain the growth.

Even putting aside the unprecedented scale on which the Chinese economic growth unfolded, the Chinese economic growth after 1978 is second to none both in its explosiveness and longevity.  West Germany may have produced “Wirtschaftswunder” (German for economic miracle) in rebuilding its economy from ashes of the Third Reich, but the growth numbers pale in comparison with China, reaching 8% in the 1950's and under 5% in 1960's.  Many countries participated in the world-wide postwar economic expansion until it was snapped by the Oil Price Shock of 1973, including Greece, which grew at the rate of 7% per annum.  Closer to home, Japan was the most successful participant, growing at the average rate of around 10% from 1950 to 1973, matching the Chinese development in speed but not in duration.  Continuing past the direct aftermath of WWII, the four Asian Dragons, Hong Kong, Singapore, South Korea, and Taiwan successfully maintained a rapid growth rate of more than 7 percent until 1980s.  For example, between 1952 and 1982, the Taiwanese economy grew between 1952 and 1982 at annual rate of 8.7%, which is one full percentage off the Chinese growth rate even though the Taiwanese growth lasted as long.  There have been more recent examples around the world of sustained rapid economic growth, including  the Asian Tiger Cubs (Indonesia, Malaysia, the Philippines, and Thailand), the Celtic Tiger (Ireland) and the Nordic Tiger (Iceland), but it would always be a stretch to label any of these miracles. 

How Did the Miracle Happen?

A miracle would hardly be one if there is no mystery to it.  Indeed, some observers outside of China initially denied an economic miracle happening in China by attributing the astonishing changes to the Chinese economy to massive investments by the government.  Another popular theory among the doubters was that the Chinese economy was starting at such low level of economic activities that the explosion after 1978 was nothing more than springing back after being suppressed for a long, long time.  While both arguments have grains of truth in them, they could not have been sufficient for the blast-off in 1978, let alone the almost uninterrupted 35 years of turbo-charged growth since.  After all, why didn't the Chinese economy take off before 1978? Why didn't other economies that are equally poor today as China was in 1978, such as those in South Asia and Africa, simply make those massive investments and start pulling the majority of their population out of poverty as China did?   

China's Economic Miracle could not have begun before 1978.  The miracle pulled hundreds of millions of Chinese out of abject poverty, but more to the point concerning us here, created by now more than 2 millions of millionaires (in US dollars).  Before 1978 these millionaires would be “capitalist roaders” who would be sent to jail or receive even worse treatments from the state.  Things changed dramatically in 1978 when Deng Xiaoping pushed aside Chairman Mao's anointed successor Hua Guofeng and pronounced that “Getting rich is glorious,” and “We must let some people get rich first.”  What Deng Xiaoping left unsaid in a tactically masterful way was who should be allowed to get rich first.  Looking back at the confusing times at the onset of the Economic Reform, anyone in our generation would likely recognize someone who had the audacity to seize the moment and struck gold. But for every such rags-to-riches story, there are many of those who are perceived to have been sanctioned by the state to use their privileges or connections before 1978 for a first-mover advantage over people who were less fortunate.  Some might resent such advantage as it came by birth or by “connections,” but others would argue that it was a necessary pre-condition for the onset of China's Economic Miracle. For how would Deng Xiaoping be otherwise able to persuade those with pre-existing privileges to participate in systematically demolishing the old economic system knowing that whatever they enjoyed then might be swept away?  

The ability of the Chinese government to effectively choose at least some of those to get rich first points to a reasonable conjecture of why a democratic country like India or a politically and ethnically fragmented African country like Nigeria and South Africa would not be able replicate China's Economic Miracle even with the same economic conditions before take-off.  Democracy as practiced in India makes it impossible for the government to pick winners before destroying the old system and creating a new order.  Lack of effective political and economic control by the central government in Nigeria or in Africa, due to ethnic, and in the case of Nigeria, also religious, would amount to the same barrier for the government to implement a Chinese-style opening-up of the economy.  

If effective political and economic control by the government was necessary for igniting the economic growth in China, it was far from sufficient for the fast growth to sustain itself.  After all, one could reasonably argue that the Russian government had a similar degree of control after the Iron Curtain came down with the collapse of the Soviet Empire, for it would otherwise be difficult to explain who are the oligarchs that, through various loans-for-shares schemes, consistently came out as the winners in the massive sales of state assets otherwise known as privatization of the Russian economy.  But what happened in Russia in the 1990's should be a lesson in how not to do economic reform. Instead of making those with pre-existing privileges stake-holders in long-term economic growth as the Chinese government did, the Russians in large part simply made them over-night owners of the economy who then became more interested in finding safe havens for their new-found wealth.  The Russian privatization initially minted more millionaires than in China, especially when the energy price was high. But it didn't take long for the Russian wealth find their way out of Russia to places like London and Miami.  This did little to sustain fast economic growth in Russia.    

Much has been made in the differences between the gradualist approach in China versus the shock  approach in Russia to economic reform, but the differences could be better understood in terms of how best to use the effective control over the economy to push it onto the path of sustained rapid growth.  In China, a gradual shift from a centrally-planned, state-owned economy to one where markets and private ownership play a prominent role is institutionalized by the state in the form of dual-track system: many in our generation remember a time when chicken eggs could be bought at lower prices with coupons at government stores that frequently ran out of stock, or at local free farmer's markets at high prices.  Even today, the Chinese currency retains some of the vestiges of a dual system: it is largely convertible in current account but the convertibility is limited in capital account.  Gradualism will likely remain in China, as Deng Xiaoping, with his typical folksy wisdom, had already enshrined it in his Theory as “crossing the river by feeling the stones.”  In Russia, under the guidance of a number of academic economists educated and employed at some of the very top American universities and cheered on by the International Monetary Fund, shock therapy was all the rage in the last decade of the twentieth century.  Areas of the economy were quickly liberalized one after another through privatization, and private ownership was restored almost overnight.  The logic of the cold turkey approach appeared to be straightforward enough: if private ownership and free enterprise are drivers of successful modern economies, the sooner Russia gets there the better; even if the highly-privileged and well-connected elites, as opposed to the more innovative and enterprising citizens, bought all the productive assets in the economy, free market would ensure the latter would end up managing for the former. What was overlooked in this logic was that the elites had less subsequent interests in continuing transformation of the economy than protecting their interests as new owners of wealth. Meanwhile in China, a similar group of people were given opportunities to become stake-holders in a fast-growing economy, instead of outright ownership of not-so-productive assets.  Not surprisingly, elites in China had to rely on the ingenuities and drives of their fellow citizens to turn their opportunities into real gains. It was ironic that the Russian reform policies in 1990's aiming to make it a modern economy overnight ended up changing names of the owners of the economy but preciously little else, while the step-by-step policies in China propelled the economy to claim one new height after another. 

Can the Miracle Continue?

The Chinese economy today has reached roughly the same per-capita GDP level relative to the US level as the economies of the Asian Dragons before their take-offs.  Some optimistic observers take this comparison as a positive sign that China's Economic Miracle can continue for another twenty or thirty years, albeit at a growth rate more comparable to the 7 to 8 percent achieved by the Dragon economies than the near double-digit growth rate achieved up to until now. This overly simplistic view could be challenged on many grounds: America may finally stop buying from China through debt-financing, environment has deteriorated so much for us to afford the same breakneck growth, energy price may go up so high as to choke the growth, or further rapid growth has to come from continuously climbing the quality ladder in instead of making more of the same or similar products.  All these challenges are important, and there are surely more, but the last challenge seems to be the most relevant to the above understanding of the origin of China's Economic Miracle. Both at home and broad there have been great concerns about the Chinese economy as the advantage of low labor costs due to an extremely low starting point is now consistently chipped away as economies like Vietnam emerged from even lower positions and others like the Philippines re-emerged after being overtaken by the Chinese growth.  There has been an increasing realization that copying existing production technologies through foreign direct investment has made China the world's factory as it is today, but competition for markets and for resources in the end will limit the technology transfer by multi-nationals.  The consensus is therefore that, to sustain rapid growth in the future, Chinese industries must go through a structural transformation to prioritize research and development.  Borrowing from the experience of Japan's postwar economic miracle, the government no doubt will, and has in fact already begun to, take the lead in this transformation. There have been impressive investments in higher education, in some cases such as satellite launching, supercomputing, and green technologies the government has directly created state-controlled companies with technologies that compete successfully against the very best internationally.  However, even the best universities in China cannot catch up quickly enough with leading universities worldwide in providing the basic knowledge and research for Chinese industries to take advantage of.  Moreover, the few success stories of state-sponsored innovations cannot mask the paucity of general research and development in Chinese industries, nor an inherent incentive issue that was planted at the birth of China's Economic Miracle.  If using its effective political and economic control allowed the Chinese government to create stake-holders in the continuously growing economy, we may have come to a point where many areas of the economy have been opened up so that stake-holders have emerged and become entrenched.  While potential stake-holders have every incentive to push for opening up and fast growth, entrenched stake-holders naturally are more interested in protecting their current positions, or even leveraging their positions to undeveloped areas of the economy.  Further transformation of the Chinese economy needs innovators and entrepreneurs to drive the economy forward, by churning out new ideas and products and trying out in the market, but would they be allowed to threaten the positions of the entrenched stake-holders?