Demystifying China’s growth story

Justin Lin, World Bank’s chief economist is the economist to read on China and its development.

In this paper, Lin gives a short and excellent review of China’s development since the last 30 years. Apart from this, he looks at other important questions as well:

In this paper I try to provide answers to five related questions: Why was it possible for China to achieve such extraordinary performance during its transition? Why was China unable to attain similar success before its transition started? Why did most other transition economies, both socialist and nonsocialist, fail to achieve a similar performance? And can other developing countries achieve a similar economic performance? 

All have very interesting answers.

Let’s first take the question of why did development start only after 1979 ? The answer is policies were poor. In the first phase from 1950-78 Chinese policies looked at developing large tech-oriented industries which were not competitive and were still run as government supported them.

Lack of industrialization—especially lack of the large heavy industries that were the basis of military strength and economic power—was perceived as the root cause of the country’s backwardness. Thus it was natural for the social and political elites in China to prioritize the development of large, heavy, advanced industries after they won the revolution and started building the nation. In the 19th century the political leaders of France, Germany, the United States, and other Western countries pursued effectively the same strategy, motivated by the contrast between Britain’s rising industrial power and the backwardness of their own industry (Gerschenkron 1962; Chang 2003).

Starting in 1953, China adopted a series of ambitious Five-Year Plans to accelerate the building of modern advanced industries with the goal of overtaking Britain in 10 years and catching up to the USA in 15 years. But China was a lower-income agrarian economy at that time. In 1953, 83.5 percent of its labor force was employed in the primary sector, and its per capita income (measured in purchasing power parity terms) was only 4.8 percent of that of the United States (Maddison 2001). Given China’s employment structure and income level, the country did not possess comparative advantage in modern advanced industries of high-income countries, whether latent or overt, and Chinese firms in those industries were not viable in an open competitive market.

One can’t miss the India similarity. We also moved into large industries which were not to our advantage. All these industries were based on market distortions which led to misallocation of resources.

To achieve its strategic goal, the Chinese government needed to protect the priority industries by giving firms in those industries a monopoly and subsidizing them through various price distortions, including suppressed interest rates, an overvalued exchange rate, and lower prices for inputs. The price distortions created shortages, and the government was obliged to use administrative measures to mobilize and allocate resources directly to nonviable firms (Lin 2009; Lin and Li 2009).

Thanks to these interventions, China was able to quickly establish modern advanced industries, test nuclear bombs in the 1960s, and launch satellites in the 1970s. But the resources were misallocated, the incentives were distorted, and the labor-intensive sectors in which China held a comparative advantage were repressed.

🙂 Again it is all so similar to Indian policies as well. The same was followed in other developing and transition economies. They also adopted similar strategy that of China.

The next question is why China developed after 1979 and others continued to struggle? The answer is other countries tried to change their system overnight in 1980s and 1990s and liberalised extensively once crisis hit. As the sudden change would lead to lot of distress as well, they also continued to run the non-efficient firms via hidden subsidies. Hence, they suffered on both fronts and had lower growth in 1980s and 1990s than 1960s and 1970s.

What did China do differently?

During the transition process China adopted a pragmatic, gradual, dual-track approach. The government continued to provide necessary protections to nonviable firms in the priority sectors. At the same time it liberalized the entry of private enterprises, joint ventures, and foreign direct investment in labor-intensive sectors in which China had a comparative advantage but that were repressed before the transition.

This transition strategy allowed China both to maintain stability by avoiding the collapse of old priority industries and to achieve dynamic growth by simultaneously pursuing its comparative advantage and tapping the advantage of backwardness in the industrial upgrading process. In addition, the dynamic growth in the newly liberalized sectors created the conditions for reforming the old priority sectors. Through this gradual, dual-track approach China achieved “reform without losers” (Lau, Qian, and Roland 2000; Lin, Cai, and Li 2003; Naughton 1995) and moved gradually but steadily to a well-functioning market economy.

Lin points Poland, Slovenia and Vietnam also followed China’s strategy and were successful.

Can China’s lessons be adopted now?

Can other developing countries achieve a performance similar to that achieved by China over the past three decades? The answer is clearly yes. Every developing country has a similar opportunity if at each stage of its development the country knows how to develop its industries according to its comparative advantages so as to tap the potential of the advantage of backwardness in its technological innovation and structural transformation. A well-functioning market is a precondition for developing an economy’s industries according to its comparative advantages, because only with such a market can relative prices reflect the relative scarcities of factors of production in the economy. Such a clear functioning market naturally propels firms to enter industries consistent with those country’s comparative advantages.

In the process it is desirable for the state to play a proactive, facilitating role in compensating for externalities created by pioneer firms in the industrial upgrading and coordinating the desirable investments and improvements in soft and hard infrastructure, for which individual firms cannot internalize in their decisions.

Through the appropriate functions of competitive markets and a proactive, facilitating state, a developing country can tap the potential of the advantage of backwardness and achieve dynamic growth.

Hmmm. Overall Lin says China took advantage of its backwardness and adopted best practices from the world which helped them grow. Then state played  a positive role as well:

After the transition was initiated by Deng Xiaoping in 1979, China adopted the opening-up strategy and started to tap the potential of importing what the rest of the world knows and exporting what the world wants. This is demonstrated by the rapid growth in its international trade, the dramatic increase in its trade dependence ratio, and the large inflows of foreign direct investment. While in 1979 primary and processed primary goods accounted for more than 75 percent of China’s exports, by 2009 the share of manufactured goods had increased to more than 95 percent. Moreover, China’s manufactured exports upgraded from simple toys, textiles, and other cheap products in the 1980s and 1990s to high-value and technologically sophisticated machinery and information and communication technology products in the 2000s. China’s exploitation of the advantage of backwardness has allowed the country to emerge as the world’s workshop and to achieve extraordinary economic growth by reducing the costs of innovation, industrial upgrading, and social and economic transformation.

Much of this is known but Lin tells the story really well. He is taking these Chinese lessons quite seriously and has created a stir in world economy by highlighting the important role State can play in development (see this).

3 Responses to “Demystifying China’s growth story”

  1. sadok driss Says:

    Each school of thought provided its own interpretation of the Engine of
    Growth ,i.e,Physiocrats stressed agriculture,Mercantilists,trade,the
    Classical School empasized the market,while the Neo-Classical School
    mentioned the entrepreneur,whereas Fabiens stressed government,
    Stalinists stressed Industrilaisation,and in the early 1960s,the University
    of Chicago did highlight education.Perennial questions are still being
    asked,even nowadays.Should we invest in machines or human beings,
    to paraphrase Arnold C Harberger,from the University of Chicago,and
    his colleagues,then,Professor Theodore W Schultz and Professor Gary
    Becker,both of them Nobel Prize Winners in Economics,in 1979 and 1992.
    China has been the focus of attention,as polemics are unavoidable.In
    line with Emile Durkheim,French sociologist,”To better understand the
    future,one must study the past.”Lessons need be learned,sooner or
    later,yet,generalisations are to be avoided.Jacques Ellul, a prominent
    French writer,author of”The Technique,ou Enjeu du Siècle”once said,
    “thinking globally,while acting locally.”Success stories registered in
    Scandinavia or North America,in educational matters,are hard to replicate
    elsewhere,due the divergence in social and institutional areas.

  2. Industrial Policy revisited « Mostly Economics Says:

    […] in this paper did explain why China’s 1950s industrial policy failed. The policy was based on nurturing […]

  3. eft,feelings,emotions Says:

    eft,feelings,emotions…

    […]Demystifying China’s growth story « Mostly Economics[…]…

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