Print Page

Hot Topics in Economics

Is China Headed for Stagnation?

January 28, 2013
Kip Beckman
Principal Research Associate,
Economic Services

Last year, economists Daron Acemoglu and James Robinson published their ground-breaking analysis of the crucial role that institutions play in determining economic development. One of the boldest and most controversial claims made in Why Nations Fail: The Origins of Power, Prosperity, and Poverty is that the Chinese economy will stumble badly, leading to sharply lower growth. The authors don’t put a fixed date on when this event will occur, but they are not talking simply about growth slowing from the 8–10 per cent range to the 4–6 per cent range (something that most economists believe is inevitable as the economy matures). Instead, Acemoglu and Robinson contend that China is in for the type of economic stagnation that the Soviet Union experienced before its collapse or that Japan has been experiencing since the early 1990s.

China's Economic Growth

What do the authors base this claim on? They have two closely related insights. The first is that institutions are important for economic growth, and the second is that the degree to which a country develops sound institutions depends on the political system that evolves in a country over time. Bad institutions are a result of political systems that generate huge financial gains for the elite members of society at the expense of everyone else.

The contrast between North and South Korea also illustrates the effect that political and economic institutions have on economic development. South Korea has what the authors refer to as “inclusive” political and economic institutions that attempt to distribute power evenly in society and try not favour one group over another. Political power rests with a broad range of interest groups. South Koreans have access to proper education and are permitted to own property, start a business, or obtain a mortgage. This contrasts sharply with what the authors refer as extractive political and economic institutions in North Korea that narrowly concentrate political power and that force people to toil mainly for the benefit of the country’s ruler and a small segment of society with ties to the ruling party.

China certainly has extractive institutions. The country still does not have well-defined property rights and it remains a communist dictatorship. Stories in the media about sudden expropriations of farmers’ land by government to build a factory or make way for a dam are still common. The farmers who are displaced have little recourse in these situations.

The authors cite the arrest of Dai Guofang by Chinese leaders in 2003 as evidence of the serious flaw in China’s institutions. Dai’s crime was to start up a low-cost steel company that could compete with Communist Party-sponsored operations. The ruling party in China won’t permit companies with crucial links to the Communist Party to fail even if they are inefficient and lose money. And because the Chinese government will not permit these inefficient companies to fail, the economic system in China will never innovate to the degree essential to generate sustainable economic growth. Eventually growth will grind to a halt as the productivity gains realized by massive numbers of people moving from rural to urban parts of the country start to wane.

Critics of the authors’ views on China point out that for over three decades the Chinese economic model, which combines some elements of a market economy with weak political institutions that protect the interests of the Communist Party, has generated rapid economic growth and lifted millions of people out of poverty. There is no reason why this can’t continue, they argue, although it is widely agreed that more modest growth will eventually occur in China.

The authors agree that it is possible for a country to attain high economic growth with less than ideal political institutions for a long period of time—but not indefinitely. They point out that the former Soviet Union’s economy initially experienced rapid growth despite having weak institutions that protected the interests of Communist Party members at the expense of the rest of society. In fact, between 1928 and 1960, national income in Russia grew by an average of 6 per cent per year.

In 1956, then-Soviet leader Nikita Khrushchev cited the rapid economic growth in his country and boasted to Western powers that “We will bury you!” Soviet leaders were able to engineer high economic growth by undertaking a massive program of industrialization. However, a lack of economic incentives and innovation in the Soviet system meant that economic growth couldn’t be sustained once the shifting of resources from rural to urban areas of the Soviet Union had been completed. A similar fate awaits China, according to the authors of Why Nations Fail.

It is possible that China could still avoid that fate if its leaders gradually introduce democratic reforms that lead to more inclusive political institutions the authors say are crucial for long-term economic growth. Perhaps Chinese leaders will eventually follow the South Korean model, in which a dictatorship initially implemented economic reforms that resulted in surging economic growth. That was gradually followed by reforms, which eventually led to a successful democracy taking hold in South Korea. Skeptics correctly point out that, to date, the Chinese Communist Party has given no indication that it intends to reform itself out of existence. However, the country does have new leadership, and we should soon have a clearer idea about the path that China will follow.

References

Daron Acemoglu and James Robinson, Why Nations Fail: The Origins of Power, Prosperity, and Poverty (New York: Random House, 2012); Francis Fukuyama, “Acemoglu and Robinson on Why Nations Fail,” The American Interest (March 26, 2012).

 

Monthly Newsletter

If you enjoyed this article, get regular updates by signing up to our monthly newsletter.
 
 
 

Learn more about Conference Board Webinars


 

Webinar calendar