Inflection point for China - And - The Most Important Point

The Communist Party of China finds itself in a precarious position these days. In some circles it's lauded for the success of the Chinese economy, but, truly, that would be sorely misplaced laudation. At best, we can stretch only far enough to credit the CPC with not quashing the groundswell of capitalism that began after Mao's death in 1976. I am certain, however, that there comes a saturation point where an autocratic rule, for the sake of its own survival, must clamp down on entrepreneurialism. It's the old adage, if you're not moving forward, you're moving backward. The years ahead will be telling...

Read the following excerpts (I highly recommend the entire piece) from Paul Gregory's excellent article China's growth: Planning or Private Enterprise? Then my follow up commentary where I get to the ultimate bottom line:

"China's private enterprise reforms began first in agriculture in 1978 and spread from there. Agriculture accounted for most of Chinese output and most of the labor force when Mao died in 1976 and the reform period could begin. The freeing of agriculture from collective farms is the most important untold part of the Chinese growth story.

Agricultural reforms began spontaneously from below, even before the "Reform" Party Congress of 1978 that installed reformer Deng Xiaping in power. A Chinese reform official later admitted: "In fact, reform wasn't discussed. Reform wasn't listed on the agenda, nor was it mentioned in the work reports."What became known as the "contract responsibility system" was sparked spontaneously by eighteen peasants from Xiaogang village in Anhui province. They secretly divided communal land in November 1978 and agreed to farm their plots individually, each contributing their share of the state quota. The state got its due and the peasants kept what was left over. The peasants' separation of their land from the collective farm was illegal, highly dangerous, and done without the approval of regional officials. Why did they take the chance?

Kate Zhou explains that the peasants had seen their parents and children die from starvation during the 1958-1961 famine of the Great Leap Forward. They understood they had to take care of themselves. The contract responsibility system spread like wildfire from village to village and from province to province, notably without endorsement by or encouragement from regional or national authorities.

As agricultural production soared, Deng Xiaping and his CPC realized that they should not resist something that was working. By 1982, more than 90 percent of rural dwellers worked under the contract responsibility system, but they were allowed only one- to three-year contracts on their land. It was only in 2003 that the state gave out longer-term leases.

The spontaneous reforms in agriculture meant that new supplies of food products needed markets and that markets needed infrastructure. Rural dwellers created a private trade network, and, within one year, most state food stores were out of business. Rural entrepreneurs then created new businesses, such as hotels, services, private restaurants, and small-scale manufacturing, through the three Fs (friends, family and fools). They bribed local officials to register their companies as "township and village enterprises." They created fake "red hat" enterprises, that is, private companies masquerading as state companies, and sham collective enterprises, or they used state enterprises to issue receipts and open bank accounts. Large private manufacturing firms developed first in predominantly agricultural provinces. China's largest agribusiness was founded by brothers who left the city to found their company in rural Sichuan. Rural entrepreneurs built the largest refrigeration and air-conditioning companies in China."

"China is, in fact, two separate economies: the private and the state. The "private" economy includes joint ventures with Hong Kong and Taiwanese entrepreneurs, medium and small manufacturing and service businesses, food-processing plants, and just about everything else. The most successful private enterprises are listed on Chinese stock exchanges. Having shareholders gives added protection from arbitrary state action. State officials think twice about alienating hundreds of shareholders versus only a few owners. The private economy has operated in a shadowy world of semi-legality and has had to survive on its own wits. It had to wait until 2007 for the Chinese legislature to recognize the legitimacy of private property.

The state sector of "national champions," run by the CPC or by closely-connected persons, is the second Chinese economy. There are more than 150,000 state-owned enterprises after the weeding out of unprofitable state enterprises under the policy of "grasping the big and letting go of the small," begun in 1998.They decided that the government would control the biggest and most important companies but let the smaller ones fend for themselves. These 150,000 companies account for only three percent of the total number of state and private companies, but for more than 90 percent of the market value of listed Chinese companies.

Many private enterprises formally operate under the legal protection of state or collective enterprises. Hence, it is difficult to calculate the shares of the state and private economies. If we adopt the broadest definition, the state economy is, at most, half.China today is split roughly fifty-fifty between the state and private economies.

We lack exact calculations of the relative rates of growth of the state and private economies, but the private economy, with an average growth rate of nearly nine percent from 1980 to the present, has grown much faster than the state sector. In 1978, state enterprises and rural communes produced all of China's GDP. By 2004, there were more than three million private companies employing more than 47 million workers.By 2011, there were 52 million private companies employing 160 million workers.Clearly, the major part of China's growth has come from private initiative.

The private economy performs better than the state economy. An OECD study finds that total factor productivity of privately controlled enterprises is twice that of state-owned enterprises.22(Total factor productivity is the amount of output for each unit of labor and capital input.) Private companies earn higher profits, and state enterprises earn a four- percent return on capital, versus much higher rates for private companies.If state enterprises average profit rates of four percent, then, whenever inflation exceeds four percent, their real profit rate is negative. Private companies borrow in private markets at rates up to 18 percent. They must earn profit rates above that if they are to continue in business."

"Some economists buy the story that one-party rule enables poor countries to make tough decisions that "messy" democracies cannot. The most developed line of argument comes from Nobel laureate Eric Maskin and his Chinese co-authors, who cite regional competition among officials as the key to Chinese success. Instead of micromanaging the entire economy, they write, the CPC appoints and monitors the bosses who run its provinces, cities, and municipalities. Because of China's size, regions are often the equivalent of medium-sized countries. Regional mayors, governors, and local party bosses run relatively self-contained and self-sufficient regions. Nearly 70 percent of total government expenditure in China takes place at the sub-national level.

The CPC, however, tightly controls appointments, promotions, demotions and firings. Maskin et al. argue that the CPC runs a tournament among regional bosses to promote those who produce high growth rates, achieve low rates of unemployment, or attract foreign direct investment. Indeed, empirical studies show that promotions of Chinese regional officials depend on relative growth and job creation.

This "efficient CPC" narrative rings false on a number of accounts. Tales of lurid corruption and excesses of princelings (children of the first-generation CPC leaders) belie the image of a benevolent CPC. That still-poor China has more billionaires than any country other than the United States raises additional suspicions. Political economists have long demonstrated that "benevolent" dictatorships are torn apart by principal-agent problems, greed, opportunistic behavior, and corruption. Why would China be an exception?"

As Mr. Gregory suggests, there's another camp that believes (or desperately wants to believe) that China's government controls and allocation of resources have much to do with its modern-day economic success. I must say that, for me [a passionate liberal (in the traditional "favorable-to-and-respectful-of-personal-rights-and-liberties" sense of the word)], both camps entirely miss the most important point. If the collectivist indeed has it right with regard to growth, I'd sacrifice any amount of GDP for personal liberty every day for the rest of my economically-compromised life. If there's one thing the big-government lobby cannot deny, it's that liberty always wanes as government gains.

But, thank God, the reality (and the true beauty) of it is, as Milton Friedman so eloquently put:

"The great achievements of civilization have not come from government bureaus. Einstein didn't construct his theories under order from a bureaucrat. Henry Ford didn't revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the grinding poverty you're talking about, the only cases in recorded history are where they've had capitalism and largely free trade. If you want to know where the masses are worse off, it's exactly in the kinds of societies that have departed from that. So the record of history is absolutely crystal clear - that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system."