economy. Because of this change, the official confided merrily, his life had
become a lot easier. "Now I don't have to get up at four a.m. I can sleep in
and let the market do my job for me."
I said to myself, "Can he conceivably understand what he just said?" As
markets take over, Communist Party control shrinks. The Communist system
is a pyramid in which power flows from the top. The general secretary
enables, say, ten people who report to him to have discretionary powers. Each
of them, in turn, grants discretionary power to much larger numbers directly
below them. The handoff proceeds and expands as it works its way down
to the bottom of the pyramid. The system holds together because each official
is beholden to the person directly above him. This is the source of political
power. This is how the Party governs. However, if market pricing is
substituted for any level of the pyramid, political control is lost. You cannot
have both market pricing and political control. One precludes the other. This
is already causing a serious strain within the power structure of the Party.
To date, Party elders appear to have finessed this fundamental dilemma.
Nonetheless, growing affluence is gradually freeing the Chinese peasant
from the soil and subsistence, affording him or her the luxury of being able
to protest perceived injustices. I cannot believe that the Party is unaware
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that affluence and recent education initiatives are moving China toward a
far less authoritarian regime. Today, President Hu appears to wield less political
power than did Jiang Zemin, and he less than Deng Xiaoping. And
Deng far less than Mao. At the end of this road of ever-lessening power is
the democratic welfare state of Western Europe. Along that way are the
many hurdles that still separate China from "developed economy" status,
Deng's avowed goal. Many of the huge challenges China's reformers face
are well known: the reactionary old guard; the vast rural population that
is to date barely sharing in the boom and is with modest exceptions forbidden
to migrate to cities; the huge remaining chunks of the Soviet-style
command economy, including still-bloated, inefficient state-owned enterprises;
the largely struggling banking system that serves those enterprises;
the lack of modern financial and accounting expertise; corruption, the almost
necessary by-product of any pyramidal power structure based on discretion;
and finally, lack of political freedom, which may not be needed for
markets to function in the short run, but is an important safety valve for
public distress about injustice and inequity. In addition, the Chinese leadership
has to deal with widespread envy of the newly affluent and popular
outrage at industrial pollution. Any of these factors could spark a conflagration.
Despite having opened significant parts of its economy to market
forces, China is still dominated by administrative controls, the remnants of
central planning. As a consequence, the economy remains rigid and I fear
would not be able to absorb debilitating shocks as the United States did
following 9/11.
The depth of China's remaining problems can best be seen in the difficulty
the leadership has had dismantling the remaining central-planning
controls. After the initial burst of decontrol-engendered affluence that followed
Deng's reform of the 1980s, further progress was inhibited for years.
The primary culprits were China's misdirected foreign-exchange-rate regime
and the laws that severely inhibit citizens' freedom to migrate between
rural and urban locales, or between towns and cities. A major, though
incomplete, dismantling of these two significant aspects of central planning
was required to keep China on the heightened-growth path that it had experienced
over the previous decade.
The first focus was the exchange-rate regime of China's currency, the
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renminbi, or RMB for short. No, the exchange rate was not too low; as most
complain today; in the early 1980s it was too high. Central planners had
fixed the RMB at an unrealistic rate in the face of a much lower rate that
prevailed on the black market. International trade at the official rate in the
early 1980s was understandably slow. Chinese exporters whose costs were
in RMB had to charge noncompetitively high prices in dollars to recoup. As
the contrast with the newly deregulated and thriving domestic trade became
obvious, monetary authorities progressively devalued the RMB. But
the process took them fourteen years. By 1994 it was fully freed for trade
transactions, and the black market in RMB disappeared. The RMB went
from under two to more than eight per dollar.
After an initial lag, Chinese exports exploded, rising from $18 billion
in 1980 to $970 billion in 2006, an annual growth rate of nearly 17 percent.
Well in excess of half of Chinese exports are fabricated from imported materials,
and those exports are moving to ever-higher-valued products, as evidenced
by the rise in average export prices that exceed price indexes based
on a fixed basket of goods.* What is not clear, however, is how much of the
rise in average prices merely reflects a higher quality of intermediate products
imported for assembly in final export products.
This is important, because the greater the extent to which Chinese exports
are becoming high tech, the greater China's competitive impact on
the developed world. China may be moving up on the technology ladder.
It is exporting far more sophisticated products than it did a decade ago. But
is it the Chinese who are creating the higher level of sophistication? Or is
China merely assembling more sophisticated products produced by others?
The Economist, reflecting in part the views of Nicholas Lardy of the Peterson
Institute of International Economics, commented in the spring of 2007
that "China's export model... consists in big measure of renting out cheap
labour and land to foreigners. Even China's most successful domestic computer
firm ... contracts its production out to Taiwanese companies." I assume,
however, that it is only a matter of time before China accounts for
Th e U.S. Department of Commerce, for example, calculates fixed-weight prices of goods imported
from China. In 2005, the United States accounted for 21 percent of total Chinese
exports.
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an increasing proportion of the value of its exports. I expect the Chinese to
gradually replace their imported materials with high-value-added domestically
produced components.
The rising path of exports paralleled the epochal shift of rural workers
to the cities. The rural population peaked in 1995 at nearly 860 million.
Eleven years later it was down to 737 million. That shift was not only the
result of people moving to cities and some definitional changes but also the
result of rural land being urbanized as new manufacturing enclaves began
to sprout up; mainly in the Pearl River delta contiguous to vibrant Hong
Kong. In the 1970s this fertile area was home to sleepy farms and villages,
but in the last fifteen years pioneering foreign investors from Hong Kong
and elsewhere have stoked the region's growth. The delta now produces
everything from toys to textiles, most of it manufactured for export. Hong
Kong's example and assistance in the development of the Pearl River delta's
economy has been striking.
When China reestablished its sovereignty over Hong Kong in 1997, I
did not hold much hope for the survival of Hong Kong capitalism. The notion
that China would honor its pledge that Hong Kong would remain a
bastion of capitalism for fifty years seemed to me rather naive. Capitalism
and Communism side by side under the same sovereign authority was just
not credible. But the decade of Deng's "One Country, Two Systems" has
turned out quite differently than I feared. China, instead of replacing Hong
Kong's culture and economy with its Communist imprint, has found itself
increasingly influenced by the culture and economic rules of Hong Kong.
The 1.4 percent annual average net shift of rural to urban population over
the last decade has measurably increased China's productivity: the capital
stock in urban areas is significantly more sophisticated than that in rural
China. That spread has created an urban output per hour more than three
times that of rural China. Special Economic Zones (SEZs) inaugurated in
1980, which focused on manufacturing exports in facilities financed by
foreign capital, have proved highly successful. Privatization of some state-
owned enterprises (SOEs) has made significant progress, and other SOEs
are undergoing major restructuring. As a consequence, employment in these
organizations has fallen sharply, an indication that creative destruction is
moving at a reasonably good clip.
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Restructuring a number of SOEs and privatizing most of the remainder
has required moving the social insurance and welfare obligations of the
SOEs to other government entities or private financing. The SOEs would
obviously not be able to compete if they had to carry the full cost of the
social safety net on their books. Padding SOE employment rolls as an indirect
form of unemployment insurance is fading. At one of those traditional
tea servings in the Great Hall of the People, Chinese president Jiang Zemin
in 1997 described to me how he had run a large state-owned steel complex.
He was proud that with significantly fewer workers he had succeeded
in producing as much steel as a rival SOE in northeast China.
It is a matter of conjecture whether the rural migration to the cities would
have been even faster were it not for long-standing restrictions on internal
migration. Such restrictions in their current form date back to 1958. Everyone
from birth is required to live in the geographic area of his or her mother.
Official permission to move is granted to only a small fraction of the population.
Such enforced immobility satisfies the need of central planners to
have the pieces of the economy stay in place to promote the outcome of the
central plan, though political control is also certainly an objective. The restrictions
on migration also effectively limit people's choice of occupation.
I cannot imagine how people can thrive in such an environment,
though I suppose it's an improvement from the nightmare of the Cultural
Revolution. The current leadership's ongoing efforts to ease these restrictions
are important and welcome. But fear of a mass exodus from farms to
cities and the unrest that could follow has inhibited change in this, as in so
many aspects of Chinese life.
However, bottling up the frustrations imposed on the average person in
rural areas, where the majority of the population still resides, is a recipe for
insurrection. As the rapidly growing economy frees large numbers of Chinese
to reach beyond the pursuit of mere subsistence, they have the leeway
to contemplate perceived injustices, real or imagined. China does not have
the safety valve of democracy to diffuse such unrest. Aggrieved people who
do not have the option to vote officials out of office tend to rebel.
The hyperinflation in China in the late 1940s is often cited as a cause
of the uprisings that brought the Communists to power in 1949, a lesson
they learned well. So it is understandable that the Communists' greatest
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economic fear is an inflation that destabilizes society. As John Maynard
Keynes noted in 1919: "Lenin was certainly right. There is no subtler, no
surer means of overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on the
side of destruction, and does it in a manner which not one man in a million
is able to diagnose."
Chinese leaders harbor a deep-seated apprehension that unless inflation
is contained, the economy will sputter, inducing a rise in unemployment
in urban areas, sparking unrest. They see a stable exchange rate as
necessary to avoid dreaded labor-market instability. They are mistaken. The
current policy of suppressing the exchange rate risks a far greater disruption.
As Chinese real per capita GDP has grown faster than that of the
country's trading partners, the result largely of technology "borrowed" from
developed economies, international competition has tended to elevate the
demand for China's currency* To offset this demand and hold the RMB
relatively stable from 2002 to 2007 has required cumulative purchases
with RMB by Chinese monetary authorities well in excess of $1 trillion.+
To sop up, or sterilize, the excess cash that the central bank has created by
purchasing foreign assets, the Chinese central bank has issued vast quantities
of RMB-denominated debt. But it has not been enough. Money supply,
as a consequence, has been growing at a rate disturbingly in excess of the
growth in nominal GDR That is tinder for inflation.
A different problem, but equally troubling to Chinese leaders, is the
rapid increase in the concentration of income. Starting from very little con
*The demand for the products of low-cost-labor countries increases the demand for the currency
of the producing country relative to all other countries. The value of the currency with
increased demand will rise relative to that of the others. And that rise will tend to continue until
the value of wages adjusted by the exchange rate (and productivity differentials) rises to the
level of that of other competing countries.
tThe Chinese political imperative to resist a rise in the value of the RMB has caused great consternation
among U.S. and other politicians; they believe, erroneously, that the suppression of
the RMB is the major cause of U.S. imports and hence of manufacturing job losses. A rise in the
