In 1978, the groundworks for the greatest economic miracle of the 20th Century were laid down. The inhabitants of Xiaogang, ravaged by famine, devised a plan to rebel against the Communist Party’s oppressive collectivised farming system by withholding grain from government authorities to protect the village from starvation.
Five years later, its standard of living had grown 20-fold and far magnified its agricultural output. China’s bureaucracy soon caught onto Xiaogang’s success and quickly discovered its secrets. Luckily, instead of punishing the farmers, Chairman Deng Xiaoping learnt from their initiative, and swiftly abolished collectivised farming in China, seeking to modernise the economy. Farmers could now produce and sell as they wished.
This triggered a wave of free-market reforms under the Communist Party, who proceeded to remove significant obstacles to the movement of capital, goods, and people, both within and outside of China. Fast forward forty years, the country boasts perhaps the strongest economic growth in the world and the alleviation of half a billion people from poverty.
Yet despite China’s embrace of capitalist principles, many still contend that the country owes its success to central planning and state management (even though government spending has barely increased on net since the 1980s).
This is far from the case.
In fact, two large-scale areas of reform alone can explain much of China’s economic convergence with the West – privatisation and labour reforms.
Privatisation
Claims often pervade that despite the introduction of free-market policies, China’s economy is still essentially state-driven. However, a glance at the data on who exactly employs Chinese workers reveals this to be false. In 1978, zero percent of the Chinese workforce was under private sector management.
But things shifted seismically with an aggressive privatisation drive that accompanied the reforms: in ten years alone, 100,000 state-owned enterprises (SOEs) were sold off, such that by 2010, 8 in 10 Chinese workers were employed by a private firm.
Privatisation is necessary for a host of reasons, but the biggest one is its productivity-enhancing effects. As decades of public choice literature (and real-world experience) have indicated, the private sector must earn its money in a competitive marketplace, while SOEs are guaranteed to be backed by the state regardless of performance, meaning that the incentives for efficiency and productivity are overwhelmingly dominant in the former.
China is no exception: according to World Bank data, firms which were privatised grew their productivity by an average of more than 170%. Such a figure doesn’t even count the large indirect benefit of the privatisation program: liquidating SOEs meant laying off many workers to maintain efficiency, including high-skill ones. Given how many state employees there were in China, privatisation released enough people from unproductive employment and pushed them to invest their talents more suitably, namely in entrepreneurship.
As one NBER study finds, Chinese entrepreneurship flourished thanks to the privatisation drive, as once-state-employed managers flooded the start-up markets to make what they could of the coming golden age.
Labour Reforms
Those who praise China’s economic performance point to its fierce wage growth as evidence that growth has been broadly equitable. Few, however, truly understand the exact causes of this. While the government’s massive investment in education would indeed contribute to wage growth through strengthening human capital, those productivity gains could not be realised in the form of higher wages unless the market was allowed to reward greater skills, and workers were permitted to migrate to productive areas.
China, like many countries, bears testament to this, as the returns on education have increased 5-7-fold since the reforms began. Clearly, just increasing the sheer amount of education hasn’t driven up living standards, but rather education has become a much more efficient tool for poverty alleviation, compelling us to unpack the institutional reforms that have made attending school worthwhile.
Before liberalisation, the central planners were the ones to determine wages. They tended to reward workers mainly based on seniority, making it difficult for the benefits of increased education to materialise through higher wages. The reforms changed this, and newly privatised firms were able to set wages however they liked: now, the competitive hand of the market meant that schooling at last bore fruit, as firms avidly demanded skilled workers. This was only the first major reform the state made in the way of the labor market.
The second, arguably, was more consequential. The communists imposed the hukou system – an identity card which virtually prevented any citizen from migrating outside their immediate locality. A key step in the reforms was to relax this, and importantly so – for if workers are unable to escape poor rural areas and migrate into productive urban ones, their wages will be choked by a lack of competition for labour and access to opportunity. The relaxation of the hukou has revolutionized China’s economic geography, bringing millions of rural workers to relocate to the cities (159 million in 2011 alone), and doubling the percentage of rural workers engaged in non-farm work. Wages aside, liberalising internal migration has dealt wonders for economic growth, since cities are inherently more productive than rural areas, the ballooning of urban populations logically raises output. Economists even find that strict barriers to mobility within the US (such as unaffordable housing) have served as a giant bottleneck on growth since the 60s.
Of course, China’s government remains heavily interventionist. But another thing must be said to the claim that the country owes its rags-to-riches story to heavy-handed statism: consider the counterfactual. Since the country’s growth didn’t take off until it made some basic liberal reforms, it’s highly credible that if the state downsized much further, it would prosper even more. Empirical research consistently and unashamedly indicates that liberal economic policies are a key ingredient for economic growth. China has already made great strides in reducing state control of the economy, but it still needs to go further.
