Pei Responds

Pei Responds

by Author(s): Minxin Pei

DEBATING TOP-NOTCH economists, especially a highly respected and knowledgeable one like Jonathan Anderson, apparently borders on intellectual masochism for a political scientist. But because most economists are handicapped by an intellectual tunnel-vision problem—they tend to use economic growth as the only mark of social progress and ignore the overall context in which economic development takes place—this contest is not only winnable, but also can be intellectually fulfilling.

Jonathan starts out by using what he calls “hard data” to argue two points. First, on the economic front, he points out that China’s economic growth for the past thirty years has been driven by productivity growth (hence, it is of high quality), and that its state-owned enterprises have become market oriented and more profitable, on average, than private-sector firms. Second, Jonathan sees the risk factors that could derail China’s growth as “moderate”; he believes that social tensions in China are driven primarily by economic factors that will be easily fixed with China’s continued growth (poor social services in cities and low income growth in the countryside); and, that the lack of democracy rather than being a real danger is instead “one of the best predictors of success” in Asia.

Unfortunately, Jonathan makes three mistakes that undermine his optimistic forecast of China’s rosy economic future. First, the data he cites as “hard” are actually quite subjective. At best, they paint an ambiguous picture of China’s economic performance. Second, he understates the degree to which the Chinese state is entrenched in the economy and overstates the level of performance by the SOEs. Finally, in typical economist fashion, he ignores the so-called elephant-in-the-room risk factors—environmental degradation, high socioeconomic inequality and corruption—and downplays the future impact of an aging population and the potential for social conflict. It is not just the economic fundamentals that he has misjudged but also, perhaps more importantly, China’s societal and political weaknesses.

MEASURING ECONOMIC performance is hard, even for economists. One of the best yardsticks is, as Jonathan points out, total-factor-productivity growth. Unfortunately, estimates of China’s TFP growth are highly contestable. Based on research by leading American and Chinese economists, China’s TFP growth rate has been declining in the past decade, so using the average TFP growth data for the past three decades is not a reliable way to forecast China’s future growth. It merely spreads the gains out over time, thereby masking the recent downturn.

Further, it is probably too generous and truly unrealistic to use TFP data alone to assess China’s economic performance. TFP marks productivity gains, but what if such gains do not accrue to the average Chinese citizen? What if rapid GDP growth is not accompanied by commensurate growth in household income and consumption? This is where China comes up short. While its GDP growth for the last three decades approached 10 percent a year, the growth of household income was lower (the weighted household income rose at about half of the per capita GDP growth rate in rural areas and at roughly 75 percent of the per capita GDP growth rate in the cities). Simply put, an average Chinese does not have the money to buy Chinese products (especially since he must also save for health care, education and retirement due to a tattered social safety net). This has led to a level of consumption that has shrunk to a historical low in recent years. Such evidence suggests that China may have a large economic output, but it has not been fully translated into increased individual welfare, hindering the growth of domestic demand and the overall health of the economy.

When it comes to Jonathan’s assertions about the state’s role in the economy, he again looks to data rather than nuance. The influence of the Chinese state in the economy vastly exceeds the direct output of SOEs. Jonathan argues this number runs to about 25 percent of GDP. In actuality, SOEs account for a much-higher percentage of the economy; my debating partner has not included many companies in which the state has a controlling interest. Even more so because the Chinese government controls the price of capital and land, and limits entry to strategic sectors of the economy, its influence in the marketplace is far more extensive and potent than most people realize. Chinese SOEs are also not as productive as Jonathan tries to show through his data. Their profitability comes from their monopoly status, not from their competitiveness. In fact, 80 percent of SOEs’ profits come from a handful of giant state monopolies, such as China Mobile, China National Petroleum Corporation (CNPC) and Sinopec. Research shows that, in terms of marginal capital output, SOEs are about half as efficient as private and foreign firms operating in China.

Finally, Jonathan should have taken into account the impact of environmental degradation and rising social injustice (compounded by inequality and official corruption) on China’s economic future. Given the extent of environmental pollution and the costs of mitigation and protection required to make China a country in which people can breathe, drink and eat without getting poisoned, no economic forecast of China’s future will be persuasive if it downplays or overlooks the environmental risk factor. And above all, while the normal ebbs and flows of an economic cycle may help explain social grievances, they are not the sole cause and it would be wrong to ignore other factors. In fact, in many recent large-scale riots, economic factors were conspicuously missing. What is important is that when a fast-growing society is perceived by its people as unjust, as China is today, its rulers are sitting on a ticking time bomb.

That is why Chinese leaders are calling for a “harmonious society.” Regrettably, even the best economists have missed the political warning signs.