China’s economic evolution from Deng’s vision to Xi’s divergence

Author: Richard Katz, Carnegie Council for Ethics in International Affairs

Had Deng Xiaoping not sought and received advice from Japan and Singapore in his creation of ‘socialism with Japanese and Singaporean characteristics’, China’s economic miracle would have been less miraculous. China’s current economic woes stem largely from Xi Jinping’s abandonment of this paradigm.

When Mao Zedong died in 1976, China was the second poorest among 140 countries. Deng Xiaoping proclaimed a remedy of ‘reform and opening up’ to foreign countries, drawing from previous Asian success stories.

During an October 1978 trip to Japan, Deng met with business leaders, toured a Nissan auto plant and saw China’s future. ‘We are a backward country, and we need to learn from Japan’, he told a press conference in Tokyo. His first official foreign economic advisor was Saburo Okita, one of the legendary architects of Japan’s economic miracle. Over the years, 22,000 advisors from Singapore came to China.

Instead of Mao’s command economy dominated by state-owned enterprises (SOEs), the government adopted a Japan-style industrial policy. Deng combined various governmental measures to direct resources to modern industry, leveraging the efficiency of private firms.

To avoid the pitfalls associated with economies favouring a single ‘national champion’ across assorted industries, it becomes imperative for private companies to engage in healthy competition. By 2018, SOEs dwindled to 12 per cent of urban employment and exports and one-third of business investment. SOEs never could have created the economic miracle. Nearly half of SOEs regularly run losses, causing the economy to shrink every time they make a product. Even profitable SOEs create less growth than private companies for every yuan invested.

In a reversal of that record, Xi is resurrecting SOE dominance. In 2012, before Xi ascended, only 32 per cent of bank loans went to SOEs. By 2016, SOEs received 83 per cent, but these loans took a while to translate into a stronger presence in investment and employment. This policy reversal stemmed from the Chinese Communist Party’s (CCP) worries that private companies could become a separate locus of power. In addition, Xi has compelled many private companies to accept interference from CCP branches in their management decisions, resulting in declining efficiency, as measured by return-on-assets.

Equally indispensable to growth are the foreign companies that transfer technology and drive exports. As in Japan, exports facilitated industrialisation because, when Deng began, China’s people were still too poor to buy modern factory goods and could not yet produce goods that were competitive in the global market.

Singapore proposed to Beijing its own a strategic solution — bring foreign companies to China to make and export products. By 2000, according to the International Monetary Fund, foreign multinationals produced half of China’s exports, especially high-tech items. Foreign companies exported 100 per cent of computer products, compared to 40 per cent of clothing. This process transferred knowledge to all new private companies that supplied 80 per cent of the content of these exports and even to unrelated firms.

While Xi does not want to isolate China, he believes China would be more secure if it were less dependent on foreign technology and firms. He asserts that China no longer needs foreign technology as much as before.

Xi is miscalculating. In 2015, he launched a ‘Made in China 2025’ program aimed at becoming self-sufficient and achieve global supremacy in several pivotal technologies and products. The program has fallen short. For example, China’s tax breaks for companies issuing lots of patents caused them to shift from high-quality patents to lower-quality ones. That has actually reduced innovation, according to a study by Chinese academics. While China has made tremendous strides in some technologies and created some world-class companies like Huawei, driving away foreign firms hurts innovation and growth.

Before Xi’s rise, foreign firms suffered procurement discrimination and intellectual property theft, but the situation has escalated in both frequency and severity. It now includes arrests of foreign personnel on dubious charges of espionage, along with demands that foreign firms involve CCP branches in business decisions. As sales in China decrease, companies are less willing to tolerate such impositions. Foreign direct investment into China from all countries plunged by 8 per cent in the first eight months of 2023.

The clampdown on private and foreign companies couldn’t come at a worse time. With the labour force shrinking and private investment decelerating, China cannot grow well unless it increases growth in total factor productivity (TFP) — more output from those labour and capital inputs. During 1980–2010, TFP accounted for about 40 per cent of the growth in GDP per worker. Under Xi, the TFP growth rate has plunged by two-thirds, which is one of the biggest drivers for China’s per capita GDP growth halving from 9 per cent in the decade before Xi ascended to a forecasted 4 per cent or less in the coming five years.

Rather than correct this productivity drop, Beijing tried to boost growth by building a surplus of ‘apartments for no one’, financed by excessive debt. This has resulted in financial turmoil and demonstrations from buyers still waiting for their homes.

Xi is either deceiving himself about the causes of China’s economic headwinds or demonstrating his willingness to sacrifice economic growth to pursue political goals at home and abroad. The effect of weaker growth on political stability is yet to be determined.

Richard Katz is Senior Fellow at the Carnegie Council for Ethics in International Affairs.

A version of this article was first published here in Japan Economy Watch.

The post China’s economic evolution from Deng’s vision to Xi’s divergence first appeared on East Asia Forum.

from East Asia Forum