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China has grown fast not because of, but in spite of the unlimited government and the large inefficient state sector.

Explaining China’s Economic Miracle

By Rainer Zitelmann @RZitelmann

As recently as 1981, 88 percent of the Chinese population was living in extreme poverty; today it is less than one percent. How was this possible?

Never in the history of the world have so many hundreds of millions of people risen from abject poverty to the middle class in such a short time. China’s development shows that rising economic growth – even accompanied by rising inequality – benefits the vast majority of people. Inequality in China has risen, but no one would choose to go back to the time of Mao, when the Chinese were more equal but, above all, poorer.

Today, there are more billionaires in China than in any other country in the world, with the exception of the United States; Beijing is now home to more billionaires than New York. This confirms the inherent fallacy of anticapitalist “zero-sum thinking,” which claims that the rich are only rich because they have taken something away from the poor. The reason hundreds of millions of people in China are much better off today is not despite the fact that there are so many millionaires and billionaires, but precisely because after Mao’s death, Deng Xiaoping adopted the slogan: “Let some get rich first.”

In his 2020 book Ideas for China’s Future, the Chinese economist Weiying Zhang writes that Deng Xiaoping is referred to as the “architect” of reform in China. “However, Deng Xiaoping understood that economic and social reforms are different from constructing buildings. They cannot be built according to predesigned blueprints. Instead a ‘cross the river by feeling the stones’ approach must be taken.”

Deng, Zhang argues, implemented reform through experimentation. Nothing that mattered was simply decreed – not price reforms, labor market reforms, tax reforms, or foreign trade reforms. Deng always tested new approaches in certain areas or sectors (e.g., special economic zones). If his reforms succeeded on a smaller scale, they were expanded; if not, they were ditched. Much of China’s success was the product of initiatives “from below,” which were encouraged as an alternative to decrees from central leadership. Deng’s decisive ability was, as Zhang puts it: “Deng Xiaoping knew what he did not know!”

Deng was right to prioritize economic development, as can be seen from the following facts: The Chinese provinces where poverty has declined the most in recent decades are the same provinces that have experienced the greatest economic growth. Zhang, who is certainly the smartest analyst of the Chinese economy, dismisses the notion that China’s extraordinary success is a result of the significant role played by the state. This misinterpretation is widespread in the West, but it is also increasingly prevalent in China, where some politicians and scholars believe that the explanation for the country’s success lies in a particular Chinese model. “The advocates of the China model are wrong because they mistake ‘in spite of’ for ‘because of.’ China has grown fast not because of, but in spite of the unlimited government and the large inefficient state sector.”

In fact, “marketization” and “privatization” are the driving forces behind China’s tremendous economic growth. Zhang analyzed data from different regions across China and concluded that “the more the market-oriented reform a province had implemented, the higher economic growth it had achieved, and laggards in marketization reform are also laggards in economic growth.” The areas where market-oriented reforms had been implemented most consistently, i.e. Guangdong, Zhejiang, Fujian and Jiangsu, were also those that had delivered the greatest economic growth.

Here, and this is a key insight, “the best measure of reform progress is the changes in marketization scores in the concerned periods, rather than the absolute scores for a particular year.” The growth rate is greatest where private companies play the decisive role. Zhang’s data prove it: “The provinces whose economies are more ‘privatized’ are likely to grow faster. It is non-state sectors, rather than the state sector, that have driven the high growth.”

The reform process in China over the past decades has never been uniform, never just in one direction. There were phases in which market forces quickly became stronger, but there were also phases in which the role of the state was reasserted. Even if over the longer term the main tendency was “state-out-and-private-in” (guo tui min jin), there were also periods and regions in which there was a backward trend, i.e., “state-in-and-private-out” (guo jin min tui). Zhang examines the different growth rates in the “state-out-and-private-in” regions and the “state-in-and-private-out” regions. Again, the results are clear: economic output grew significantly faster in the “state-out-and-private-in” regions. As Zhang explains, this proves “that China’s rapid growth of the past four decades has been driven by the power of the market and the non-state sectors, rather than the power of the government and the state-sector as claimed by the China model theorists.”

The degree of innovation is crucial for the further development of the Chinese economy. An analysis of the research & development intensity in industry, patents granted per capita and percentage of sales of new products in total industrial revenue makes it clear that all these key figures for innovation clearly correlate positively with the degree of marketization.

When I met Weiying Zhang in Beijing he stressed the major danger of misunderstanding the reasons for China’s growth, not only for China, but also for the West. If people in the West mistakenly conclude that China’s economic success is founded on some unique “third way” between capitalism and socialism, also known as “state capitalism,” Zhang worries that they will draw the wrong conclusions for their own relations with China. In Ideas for China’s Future, Zhang uses a very apt metaphor: “Imagine seeing a person without an arm running very fast. If you conclude that his speed comes from missing an arm, then you naturally will call on others to saw off an arm. That would be a disaster … Economists must not confuse ‘in spite of’ with ‘because of.’”

Advocates of a strong state in Europe and the United States want everyone to believe that China’s economic success confirms that economic growth is inextricably linked with a strong state. The analyses of Weiying Zhang prove that exactly the opposite is true. Are the Chinese themselves forgetting the roots of their success? Over the past four decades, there has been a constant struggle between two economic ideologies – the socialist against the capitalist. Sometimes the free market’s supporters have gained the upper hand, at other times it has been the supporters of the state. This struggle continues, and its outcome will determine China’s future. The way China deals with its recent real estate crisis will provide an indication of whether China – like Europe and the United States – follows the path of state interventionism or is courageous enough to implement market-based alternatives. Developments in recent years tend to indicate that in China (as everywhere else in the world today) faith in the state is stronger than faith in market forces. In the short term this may alleviate the latest dramatic crises, but in the long term it will create even greater problems.

This article was originally published by the Institute of Economic Affairs.

Dr Rainer Zitelmann is the author of the book “The Power of Capitalism”.

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