Published on Taipei Times
http://www.taipeitimes.com/News/editorials/archives/2007/05/06/2003359733

China's evolving economic system
By Assar
Lindbeck

Sunday, May 06, 2007, Page 8

It is generally agreed that China's impressive economic achievements
during the last three decades are largely the result of the radical reform
of its economic system. While private ownership of firms hardly existed
when these reforms started, private firms today account for about 60
percent of total production.

Ownership, however, is only one dimension of an economic system.

China's economic system has changed just as drastically in other ways
as well. Decision-making regarding consumption and production has largely
been decentralized to individual households and firms, respectively;
economic incentives, markets, competition and internationalization have to
a considerable extent replaced command, administrative processes, monopoly
and autarky.

Generally speaking, China's reform period has been a stark contemporary
illustration of the historical lesson that unleashing individual
initiative tends to boost economic development.

How, then, should the Chinese economy be characterized today? Some
observers describe the economic system as "state capitalism"; others
(including China's rulers) call it "market socialism."

Both labels mislead. One reason is the domination of private firms on
the production side. Another is the fact that "socialism" usually does not
rely upon strong economic incentives and competition, which are the
dominant economic factors in today's China.

In fact, China is a type of mixed economy, with a number of specific
features, some of which favor GDP growth, while others have not dragged
down the economy to any considerable extent so far. But this situation is
likely to change. So further reforms will be decisive in determining the
future performance of the economy.

Although internationalization of the economy has served China well, it
is unlikely that the current 35 percent share of GDP claimed by exports
and the heavy reliance on foreign technology are sustainable in the long
run. Tension between widespread private ownership of firms and pervasive
public ownership of assets is another specific feature of the economic
system that looks similarly creaky.

For example, by disfavoring lending to private firms, state-owned banks
distort the allocation of resources.

Agriculture provides another example of tension between private
entrepreneurship and public-sector ownership of assets. In particular,
public ownership of land harms the investment incentives for family farms
and reduces their chance of consolidating land holdings in order to
exploit economies of scale.

Reducing this tension over ownership of firms and assets is imperative,
because the entry and expansion of small private companies will be
increasingly important when China's domestic markets and domestic
innovation need to play a greater role.

Thus, for China to gain maximum advantage from private
entrepreneurship, it is important to continue shifting the share of
financial assets and land holdings out of the public sector.

This would also help address the endemic corruption that is also a
specific feature of the Chinese economic system.

Corruption is difficult to reduce drastically so long as politicians
and bureaucrats have much "to sell" to firms and individuals -- including
rationed loans from public-sector banks and regulatory permits of various
types. In rural areas, corruption emanates from frequent expropriation of
land-lease contracts held by farmers working on collectively owned land,
which local officials then turn over to non-agriculture land developers.

In both cases, reducing corruption will require not only government pep
talks against bad ethics, but also institutional reforms, including
deregulation, stronger property rights and more privately owned assets.
Free media would also help.

No doubt, some types of corruption, including "asset stripping" in
connection with the privatization of public-sector firms, has speeded up
the emergence of a class of private capitalists and entrepreneurs. But if
corruption becomes a permanent element of China's economic system, it is
likely to both reduce the efficiency of the allocation of resources and
damage the legitimacy of private entrepreneurship.

China also needs to shift from its highly "extensive" (resource
consuming) growth strategy to a more "intensive" development path.
Although high growth requires large-scale capital formation, the relation
between investment in real capital assets and human capital in China seems
to be out of proportion. This is reflected in the current investment ratio
for real capital assets of 43 percent of GDP, compared to 4.3 percent
investment in human capital in the form of education. China's growth would
be more efficient if these proportions changed in favor of education,
including vocational training, which is very poorly developed.

Moreover, eliminating today's vast wastage of natural resources, which
underpins exceptionally high levels of pollution, will require a reformed
regulatory framework, including higher user prices for energy, raw
materials and environmental resources.

By shifting to a less resource-dependent development strategy, more
resources would be available for improvements in the country's much
neglected social arrangements, particularly among rural citizens and
"urban outsiders" (individuals in informal urban sectors). This includes
addressing China's patchy arrangements for income security, as well as its
unevenly distributed provision of social services, such as health and
education, in particular, in rural areas.

The case for combining further government withdrawal from the
production system with more engagement in the social field is compelling.
China's leaders seem to be promising this by voicing their concern for
domestic entrepreneurship, social arrangements, rural development and
environmental protection. Only time can tell to what extent, and how fast,
such promises will be fulfilled.

Assar Lindbeck is a professor of international economics at
Stockholm University.

Copyright: Project Syndicate

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