- NBR - The National Bureau of Asian Research

Author's Response: China Has Grown Because It Has Grown More Capitalist

Nicholas R. Lardy

Nicholas R. Lardy is the Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics.

This is one of six essays in the book review roundtable on Nicholas R. Lardy's Markets over Mao: The Rise of Private Business in China.

The five thoughtful essays reviewing Markets over Mao: The Rise of Private Business in China remind us of the complexity of China and the seeming inevitability of widely varying interpretations of contemporary economic trends and events. Different perspectives stem from varying disciplinary backgrounds, research agendas, and a host of other factors. Thus the review essays are a useful guide to perspectives that are sometimes different from those articulated in Markets over Mao.

As is suggested by the subtitle, the central theme of the book is that China's rapid growth after 1978 is largely the consequence of the growing role that markets play in resource allocation and the rapid expansion of private businesses that have operated increasingly successfully in this new emerging environment. The reviewers agree that private firms are more dynamic and thus have largely displaced state firms in broad swaths of the economy. They argue, however, that the book understates the influence of the state, and some of the reviewers even imply that the book argues that China's economy is entirely market-driven. But the book also points out that the state still controls fully one-third of all investment and demonstrates clearly that the role of the market is very attenuated in upstream oil and gas, electric power, and modern businesses services, such as finance and telecommunications, largely because the government has severely limited entry by private firms in these domains. The incumbent state firms in these sectors, shielded from competition, have become extremely inefficient and, in fact, are an increasing drag on China's economic growth. Thus the analysis in Markets over Mao shows that China remains short of a liberal market economy. The book concludes that the way forward is to implement the two key economic reforms embraced at the Third Plenum of the 18th Party Congress—i.e., eliminating most monopolies and fostering increased competition so that the market becomes the dominant force in the allocation of resources throughout the economy.

How then do we measure the role of the party-state in the economy other than by ownership and the control of investment? Kellee Tsai in her review notes that the top management of the largest state firms is appointed by the Organization Department of the Chinese Communist Party, which is a point made in Markets over Mao. But the 53 firms for which this is the case lie almost entirely in the segments of the economy that have never been opened up to competition from private firms. As a result, the role of the party there tells us little about its role in China's private sector, which in 2012 consisted of 6.5 million private enterprises and 40.6 million household businesses (the latter not organized under the Company Law and thus not classified as enterprises).

Yukon Huang argues that the competition among provincial and local governments in attracting foreign and domestic investment to promote growth is unique to China and demonstrates that the state plays a major role in shaping growth that goes beyond its direct ownership of enterprises. Yet competition among U.S. states to attract foreign and domestic investment is pervasive, demonstrated clearly, for example, in 2013 when 22 states offered tens of billions of dollars in subsidies in an attempt to attract a new Boeing aircraft production facility. Huang also argues that private firm access to credit “depends on relationships with the party system.” Yet he presents no evidence that this is the case, and it seems unlikely that the party could exert much detailed control of the roughly 15 trillion renminbi in bank loans outstanding to the millions of private firms and household businesses in 2012.

Joseph Fewsmith believes that the government regulatory and approval process is another mechanism through which the state exerts control of private firms. But the extent to which these approvals are substantially more onerous than in market economies is not clear. Food trucks, a prime example of entrepreneurial activity in Washington, D.C., and many other large U.S. cities, require not only registration of the vehicle and licensing of the driver, but registration of the retail food business, approvals from the local health authorities, and so forth. Real estate is an even more highly regulated industry in most jurisdictions in market economies. In Washington, D.C., for example, developers not only must comply with local zoning laws; they also must acquire appropriate building permits for a project of almost any size, ranging from new construction to attaching an awning to an existing building; acquire a separate raze permit if the project involves tearing down a previously existing structure or building (and show a certificate of insurance for $500,000 in coverage to raze a structure larger than 500 square feet); acquire public space permits if the project requires a dumpster in a public space, any sidewalk construction or repair, or the erection of flag poles, planter boxes, and so forth in public space; acquire additional separate water and sewer excavation permits for projects involving water and sewer pipe installation or connections to same in the street; and acquire supplemental system installation permits for projects involving the installation of air conditioning, refrigeration systems, plumbing fixtures, or electrical and gas appliances. Property developers must also comply with regulations and acquire separate permits for projects that involve asbestos, lead, and other toxic substances or could affect storm water management or water quality. In addition, developers must comply with regulations defining legal construction hours and submit to recurring safety inspections to ensure that the project is in compliance with applicable construction codes. Complying with these regulations and obtaining the relevant permits involves a number of separate local government agencies, including the D.C. Office of Zoning, the Department of Consumer and Regulatory Affairs, the District Department of Transportation, the District Department of the Environment, and the D.C. Water and Sewer Authority. Wang Jianlin, the chairman of China's largest real estate development company, may complain that in his business it is impossible to ignore the Chinese government, but if his firm entered the property development business in Washington, he probably would feel right at home.

One indirect indicator of the role of the party-state in the Chinese economy is the pace of private business formation. As already noted, millions of private firms had been established in China by 2012. Markets over Mao analyzes the acceleration in the formation of private businesses in response to the government's reduction of the minimal capital requirements to register a business and its reforms of the administrative examination and approval system, both of which were launched in mid-2013. In the twelve months ending in February 2015, 3.8 million new enterprises were created, an increase of 50% over the previous twelve-month period. More than 90% of these firms are private. It seems very unlikely that entrepreneurs would be rushing headlong to establish new private businesses if the party-state were exerting undue negative influence on existing private firms. Indeed, one of the contributions of the book—acknowledged in both Charles Freeman's and Joseph Fewsmith's essays—is its demonstration of the many ways in which Chinese party-state policy evolved from being almost entirely hostile to private business in the early 1980s to expanding the role for markets and facilitating the emergence of an increasingly robust private sector.

Contrary to Michael Pettis's assertion, the book does give some attention to the liability side of the Chinese economy. I note the huge buildup of debt starting in the fourth quarter of 2008 and analyze the challenges this debt poses for financial stability. But in Markets over Mao I point out that China differs in several critical respects from other countries where rapid debt buildups have precipitated financial crises. To begin with, China's national saving rate, reflecting the combined savings of households, corporations, and the government, approaches 50% of GDP, significantly higher than any other economy in recorded history. Like households, countries that save more can sustain higher debt burdens. Second, the vast majority of this debt is in domestic rather than in foreign currency. Indeed, the ratio of China's gross external debt to GDP is far and away the lowest of any Asian country, and of course on a net basis China has long been a very large creditor to the rest of the world. Thus, its debt does not involve any significant currency mismatch, a major contributor to many financial crises. Third, the majority of this debt has been extended by banks, and China's systemically important banks are financed entirely by deposits rather than through the wholesale market, where sudden stops in funding can precipitate a crisis, such as in the case of the spectacular collapse of Lehman Brothers in 2008. Moreover, the loan-to-deposit ratio is approximately 75% for the banking system as a whole. In short, there is ample liquidity and relatively little leverage in the banking system compared with other countries that have had banking crises. Finally, the government has enormous scope to further increase bank liquidity should that become necessary. Other factors, too numerous to list here, also suggest that a banking crisis is far from certain in China. Thus, unlike Pettis, I do not believe that a dramatic further decline in China's growth rate to an average in the low single digits over the next five years is inevitable.

Finally, what are the prospects that the reform agenda of the Third Plenum will actually be implemented? Kellee Tsai argues that the obstacles go beyond the vested interests that I discuss in Markets over Mao, particularly the reluctance of the party-state to relinquish control of strategic sectors. Yet it would be easy to overestimate this constraint. A decade ago the chairman of the State-owned Assets Supervision and Administration Commission (SASAC) identified steel as a “pillar industry” requiring “strong state control.” At the time, the share of output produced by state steel companies had already slid from close to 100% when reform began to 47%. As pointed out in Markets over Mao, by 2011 the state share had fallen to only 37% of output. Since the book was completed, new data shows the share sinking further to only 33% in 2013. The SASAC identified civil aviation and the defense industry as even higher priorities—so-called strategic sectors in which the state must “guarantee absolute controlling power.” But top leaders in the Aviation Industry Corporation of China, which is the country's leading aerospace and defense company, now recognize that sustainable development of the commercial aviation industry in China requires the active participation of Chinese private enterprises. Even the military industry is coming under some pressure from private firms after the General Armament Department (GAD) of the People's Liberation Army in early 2015 launched a procurement website that, according to the director of the planning department of the GAD, “aims to get qualified, private businesses involved in weapons research and production in a bid to improve competitiveness and efficiency.” [1]

All these developments suggest that as the party-state weighs the complex trade-offs between state ownership and control, on the one hand, and efficiency and growth, on the other, it is not uniformly deciding in favor of the former and against the latter. As I wrote in the concluding paragraph in Markets over Mao, I believe that a party that has staked its legitimacy on delivering sustained growth of income and rising living standards will increasingly opt for efficiency and growth rather than state ownership and control.


[1] “China Starts Military Procurement Website to Boost Transparency,” Bloomberg, January 5, 2015,