25 March 2019

The Chinese Economy

Adaption and Growth

Barry Naughton
MIT Press, 608 pages,
ISBN 9780262534796

Reviewer: Lavan Mahadeva, Research Director, CRU

In the quarter century from 1990 to 2015 in China, about 15% of the entire world’s population,  more than three quarters of a billion people, were permanently lifted out of extreme poverty (data follow World Bank measures). Barry Naughton’s book is about how this happened.  

The book begins with China’s geography and its economic history in ancient times and under Socialism. The aim is to identify the legacies of China’s past for its recent growth experience. We learn, for example, that a large share of China’s lands (to the West) is rugged and not economically productive, and so natural resources are relatively scarce compared to labour. The market economy was co-opted because the post-1977 reformers realised that was the only way to growth was to raise employment and personal income. (Labour abundance also means that in the future, China’s growth must be human capital or knowledge-intensive).
Some of Naughton’s explanation of China’s socialist economic past would be familiar to a student of Soviet Union economics. As explained in Francis Spufford’s highly entertaining book, “Red Plenty”, or in Justin Yi Fu Lin’s “New Structural Economics: A Framework for Rethinking Development and Policy”, a socialist economy can reach high growth rates for quite a few years through the pursuit of capital-intensive industrialisation. But that growth model breaks down inevitably because it fails to ignite productivity in agriculture and in the workforce.

China was, therefore,  left far from the economic frontier in 1977. One view is that its subsequent growth miracle was just a catch-up, notable because it was scaled up over an enormous population.  We know from the historical experience of other Asian countries like South Korea that a first phase of catch-up is possible even under regimes that are led by a small group of individuals (“Why Nations Fail?” Acemoglu and Robinson). But, as not all countries that are far from the frontier do catch up, we should still want to know how this happened in China.

Perhaps, then, the most crucial part of the book is an explanation of market transition that catapulted China from its backward state in 1977 to become what it is now: one of the world’s most important countries with vibrant capitalism mingled socialism.

This turns out to be a complex story with ups and downs and experimentation. No one factor and no one single policy was responsible.  To cover all the drivers, Naughton’s book is well organized with chapters on each relevant sector or factor that played a role in the remarkable story.

Market reforms were crucial, but these were gradual, and allowed for the entry of private sector firms rather than privatizations of state firms. This has left a mixed landscape. While most Chinese now work for the market, the state in one form or another controls a large and crucial part of the economy. In some sense, market reforms were a means to an end, with the end still being defined.

Also crucial was a massive sectoral shift from rural to urban. Agricultural reforms raised farm incomes and boosted farm productivity; enabled industrial centres to spring up in rural areas; and allowed a vast urban floor space to be built in a few decades to absorb rural migrants. There was also the fostered injection of investment and know-how from Hong Kong and China into China’s Special Economic Zones that kick-started China’s massive exporting manufacturing sector. Naughton also analyses how a one-child policy and a fall in fertility, supported by a favourable health and education levels, created a productive and mobile workforce for the window of a few decades.

It is also important that China’s policy allowed for an unusual degree risk-taking and experimentation, often at a decentralized and local level. Mistakes were made but its leaders were good at learning from failures. While decentralized local governments had substantial freedom, they were also set growth targets and monitored against them, so that they would not act against the growth imperative.

Importantly, Naughton does not shy away from describing the worrying legacies of China’s growth spurt or what has now changed. He analyses China’s very rapid rise in inequality, distinguishes severe environmental constraints, discusses a hangover of large corporate debts and quantifies the future demographic challenge. These aspects are taken up by George Magnus’ book “Red Flags”, recently reviewed for the SPE by Keith Wade.

Naughton does not fly the flag for any single theoretical explanation for China’s success: there is no one thesis whose name we can attach to this book. Nor does he make any prediction for the future; the book is mostly a forensic dissection of China’s past. It is not anecdotal, as many books on China are. Rather, it makes use of aggregate data and interprets them with standard economic frameworks.  I liked this approach: I found it refreshing to leave my preconceptions about China at the door yet find familiar economic tools inside once I entered. It is an important book and distils many years of research and study into China.