How China Grew Rich

By Tim Harford For most of the 20th century, China was poorer than Cameroun. The Peoples Republic of China came into being in 1949, but was torn by civil war and ruled by a communist dictatorship. In 1950s, millions of Chinese died in a famine induced by the failed policies of the Chinese communist government. In the 1960s, the Chinese university system was destroyed by the Cultural Revolution, when millions of educated citizens were forcibly relocated to work in the countryside. After all this, how did China become the greatest economic success story in history? China currently has a world class and excellent infrastructure, an excellent education system, and has a lot more women in the work place with the bulk of the workforce in their middle age saving for the future. The vast savings of the Chinese people have provided the investment money for the world class and excellent infrastructure. China has the human resources, infrastructure and financial capital required by traditional models for economic growth. China's initial development efforts were two-pronged: massive investment in heavy industry such as steel, plus application of special agricultural techniques to make China self sufficient in food production. The Great Leap Forward as this two-pronged push was called, was the greatest economic failure the world had ever seen. The industrial policy was a farce, while the agricultural policy was a tragedy resulting in a famine that claimed 60 million lives. Following the death of Mao in 1976, and the ascension of Deng Xiaoping to power in 1978, by 1983 the change in China's economy was incredible. By 1983, China's agricultural output had grown by 40% because Deng had introduced a price system that encouraged farmers to grow more by abandoning the collective system of farming. The success of the agricultural reforms created the momentum and popular support for Deng to continue. To construct the buildings, railways, roads, factories, homes, that have sprung up all over China required enormous investment, capital that sustained such development. All sustained development needs capital, which can come from private investors, both domestic and foreign, who hope to recoup profits. Capital can also come from the government, either by taxing people and investing the proceeds, or by a government program of compulsory saving. If you want to be richer tomorrow than you are today, you should invest money rather than spending it on goods and services to be enjoyed immediately. If you consume less today and invest the money, you will be richer tomorrow - if the investments are good ones. An unmysterious chunk of the development of countries is based on the same principle that saving and investing today makes you richer tomorrow. Most people don't bother saving in poor countries as they have few ways to recoup investments in basic infrastructure like road, and little confidence that they will be allowed to do so if they build factories and shops. The few exceptions, such as the mobile phone sector has been a resounding and stunning success because it is funded by pay-as-you-go cards. Many poor economies seek foreign investment but cannot even retain the confidence of their own citizens, who are eager to invest monies overseas. This explains why savings rates in these countries are low, and the percentage of those savings invested inside those poor countries lower still. Without offering a secure environment for investment, the government of poor countries can do little to encourage it. This was not the case in China as it's socialist government had no problem with access to capital. China's socialist government had no problem with access to capital which came from government programs, as it simply took money from government or state-owned corporations and from the pockets of individuals and invested it on their behalf. Unlike a socialist economy, a market economy cannot simply decide to save and invest more. In China, there was plenty of capital available and a third of national income was saved rather than consumed. In a poor country where few people have cars, telephones, electricity or running water, the right investments can achieve very high returns by providing such basics of modern life. Command economies lack the information necessary for making the right choices. Incentives alone are not enough to drive investments, you need the price system because it generates information about the costs and benefits of all kinds of goods and service. Command economies provide the incentives for investment but not the information necessary to use the investments correctly. Investment capital should respond to the demands from world markets and not from those in government. The Chinese government had to begin a gradual shift to a market system to get any value out of the vast sums of investment capital available. With a command economy, the process of making wise investments becomes increasingly difficult as the economy grows and changes. Markets work well with market-supporting institutions: in a market economy, people need banks for commercial loans, contract law to resolve disputes and confidence that their profits will not be confiscated. Extreme reforms offend many vested interests. Political leadership must understand the value of political credibility. Marginal costs and marginal benefits are what really matter for the efficiency of an economy. A market system limits the scarcity power of firms; most firms face competition, and sectors of the economy that are not very competitive tend to attract new competition over time. The competition and free entry of new firms, by limiting scarcity power, pushes powerfully towards efficient production, new ideas and consumer choice. Rapid liberalization is a dangerously unpredictable strategy. China started out by improving the performance of the state sector, introducing new public sector companies as competitors, and gradually fostering a private sector before slowly opening up to international competition. The Chinese economic miracle was not really about privatization or who owned the companies, but that the companies were forced to compete in a relatively free market, driving down scarcity power and bringing in the information and incentives of the world of truth. High profits are often a signal of scarcity power, and when new entry and stronger competition remove the scarcity power, we expect profit rates to fall. As economic reforms begin to bite, profits start to fall; profits also start to converge, as the most profitable sectors face fierce competition. This reduces waste, gives customers better return for their money and makes that nation a potential player on the world markets. Scarcity power disappears. The dramatic entry of China onto the world's economic stage has been one of the last acts of China's economic reform. There are three reasons why China needed the world despite having a population of over a billion people that seemed better placed to make it self-sufficient. First, China could tap into world markets for labor-intensive goods: toys, shoes and clothes. Second, the foreign currency these exports earned could be spent on raw materials and on new technology to develop the economy. Third, by inviting foreign investors in, the Chinese could learn modern production and business techniques from them. One advantage of Foreign Direct Investment is that it supplies capital to an economy that cannot be instantly withdrawn if investors get nervous. Purely financial investments like loans can he rapidly withdrawn in a mass panic. FDI expands the future capacity of the economy, providing not only capital but expertise as well, eg expertise in quality control and logistics. Foreign investment has been a major factor in keeping China's reforms on track through foreign firms bringing capital, foreign firms bringing expertise, foreign firms bringing connections to the world economy, foreign firms continued the competitive process of the earlier reforms by competing with China's domestic firms, driving them to continue their efficiency. Foreign investors were attracted to the substantial and rapidly growing domestic Chinese market. Chinese commitment to education ensured there was a huge reservoir of skilled and potentially productive workers, waiting to flood the economy with talent when the dam of the command economy burst. Through mainland China's links to Hong Kong and Taiwan, the often-painful process of international economic engagement was made smoother and more effective. Countries that are rich or rapidly growing have embraced the basic lessons of economics fight scarcity power and corruption, correct externalities, try to maximize information, get the incentives right, engage with other countries, embrace markets, which do most of these jobs at the same time. Poverty cost lives - because poverty kills- and it also robs people of their autonomy and ability to make meaningful choices about their own lives. Economics is about people, and economic growth is about a better life for individuals - more choice, less fear, less toil and hardship. Economics is about choice