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China’s Retreat from State-Directed Capitalism

Article by Ike Brannon March 9, 2012 //   5 minute read

Two recent announcements regarding Chinese economic policy are worth noting — because they have strong implications not just for the prospects of that country but for the tenor of policy discussions in the rest of the world as well. The first announcement was that the target growth rate for the Chinese economy is now 7.5%, which marks the lowest target in the post-reform era of the Chinese economic miracle. On the heels of this announcement was the highly-anticipated release of a World Bank report — co-written with a Chinese think tank with ties to the government — recommending that China begin turning away from state-run capitalism and allowing market forces to play a greater role in allocating resources and investment in the economy, in order to continue the strong economic growth of the previous decades. The implicit message behind this report — namely, that an economy in which the government directs investment can no longer be relied on to deliver robust economic growth — is one that should be broadcast far and wide, because there is no shortage of people in the United States agitating for more government-directed investment. For fully three decades the Chinese economy has been growing at an annual clip exceeding 10%, something that has no precedent on the planet. China’s success was based on its ability to attract foreign investment, which it coupled with a diligent and relatively well-educated labor force aching to escape the poverty of the hinterlands for a chance at the middle class. Since the late 1970s, hundreds of millions of Chinese have moved to urban areas to take factory jobs, and this rural exodus — and explosion of capital investment — has transformed the country’s economic fortunes. However, this formula looks to be wearing out. China is rife with the consequences of dubious investments — from a real-estate bubble that dwarfs our own to entire ghost cities, infrastructure investment of questionable value and quality (the high-speed rail network touted by our own President moves relatively few people and much of it needs to be completely replaced), and a possible dearth of peasants ready to leave the hinterlands for a low-paying factory job. In other words, China will soon be in the same place that many other countries have found themselves in, namely having to produce economic growth via increased worker productivity, much like a developed country. And that is no mean feat, as the plight of any number of countries shows us. France had its Les Trente Glorieuses of postwar economic growth following a path of state-directed investment before stalling, leading its government to respond by nationalizing major industries and then retreating (at least somewhat) while expanding the welfare state. France remains an economic basket case 30 years later. The Japanese economy of the 1980s, also driven by state-directed investment, was the envy of the world and held up by no small number of economic sages in the U.S. as a superior economic model, the manifestation of successful government-directed investment. Two decades of malaise have followed the Japanese postwar miracle, and no one’s seriously suggesting that more government involvement in investment is the answer. State-directed investment invariably fails, history shows, and China’s the rare country to acknowledge that before being confronted with the evidence in its own backyard. While we can look at the ignominious failures of our Wall Street denizens and acknowledge and bewail the manifold sins and wickedness of their ways leading up to the Great Recession, the truth is that people with their own wealth on the line will always produce a more efficient allocation of capital than will some bureaucrats for whom the success of any investment is but one factor in a laundry list of goals — and usually not near the top. The question du jour is whether those of us on this side of the Pacific are paying attention to China’s clarion call for less government investment and more capitalism as the route to continued economic growth. It sure doesn’t seem like it.