The Prospects for China
Posted April 02, 2021
The resurgence of state interference in the Chinese economy — and heightened bullying of successful enterprises — has investors worried if China will continue its extraordinary growth. We think it will.
There’s no doubt China is making problems for itself. In particular, the Xi government’s renewed affection for state-owned firms (most of them only partly state-owned these days) is reversing precisely those reforms that made those companies part of China’s growth story.
Starting in the early ‘90s through approximately 2012, the Chinese government increasingly forced state-owned enterprises to prove themselves in the market. One powerful tool was to allow foreign investment in these firms, encouraging discipline. The government largely ceased to subsidize state enterprises as sources of guaranteed employment. As subsidies disappeared, unnecessary jobs were cut as a matter of survival.
This made the state-owned enterprises more productive. Perhaps even more important, it also freed trained employees to join the private sector.
Chinese Capitalism at Work
Under Xi, China has returned to massively subsidizing and expanding state-owned enterprises, which once again use those subsidies to compete with private firms.
The eminent Nicholas Lardy of the Peterson Institute has documented the resulting significant decline in total return on capital in China. According to Professor Lardy — who has spent decades studying China — in the first decade of this century “the efficiency of state firms was rising… with average returns [on capital] reaching a peak of 5% in 2007.”
Since then, “returns have fallen relentlessly to an average of only 1.6%.” That number probably understates the problem because state enterprises include various generous subsidies in their reported net income. Lardy thinks the real figure may be as low as 1.4%. A huge swathe of state companies now lose money — destroy wealth — every year.
Does this matter? Somewhat. But Chinese capitalism was born with virtually no capital except what could be scraped together by poor farmers and villagers.
Small business in Chinese cities originated with the smallest business of all: self-employment.
Millions of young Chinese who had migrated to the cities (often illegally), but were unable to find jobs, broke the law to stay alive.
Quite illegally they set themselves as delivery men, repairmen, taxi drivers, and street merchants — soon even mechanics and computer programmers. Relieved by not having to support them, the government mostly left them alone.
The idea that wealth should come from poverty shouldn’t be a surprise. The greatest failure of economists has always been to overestimate the importance of material capital — land or currency — in launching a new enterprise.
Upholding their “materialist superstitions,” they neglect the central precepts of information economics: Information is surprise, wealth is knowledge and learning is growth.
For an entrepreneur to launch a new firm, or even a new farm, above all he must be in a position to learn. The chief advantage of freedom of enterprise is freedom to learn, freedom to try, to experiment. All that the poor in China needed to create enormous wealth was the freedom to learn how to make a living.
They did not even require the legally established rights to property or the “rule of law” cherished by libertarians as prerequisites to capitalism. Owning land was still illegal when Chinese capitalism and information surprises were well begun.
Once determined entrepreneurs gain the right and willingness to learn, it’s relatively simple for them to gather the modest resources needed to make a beginning. They begin mimetically, one ton, imitating other successes.
This is how most all great companies are started. Then they initiate innovations — zero to one, in Peter Thiel’s fortunate phrase. This twofold way, horizontal and vertical, is how most economies grow. This is how China grew.
It is unfortunate that the current Chinese regime seems so devoted to wasting so much of China’s financial capital. Yet fortunately, to launch new, fast-growing firms, the world’s entrepreneurs need only a small fraction of the capital the world’s governments destroy every year.
As long as entrepreneurs remain free to learn and to innovate, it will be difficult for any regime to derail China’s growth.
Editor, Gilder's Daily Prophecy