That’s Not How China Works

As the financial crisis has developed, a certain strand of China punditry has developed along with it. This punditry starts with the assumption that China runs an economic system called “state capitalism.” This economic system, recognizable from previous developing Asian states, pushes the economic structure in a certain direction through targeted subsidies, public works projects, and various macro-economic controls. The pundits usually go on to say why this means China will be the greatest country in the world or why China’s economy will collapse, and then draws parallels to America’s own debate over budget deficits, stimulus measures, state support for innovation, or general concerns over American power.

The problem is that this isn’t how China works.

It’s easy for visitors to get an inflated impression of the governments involvement in the economy. After all you are usually taken from one major public works project to another, often via a third public works project. Your guide usually takes you to see “sample projects,” usually examples of government subsidies being used to produce high-technology products or to reduce poverty, and you spend most of the your time in Beijing and Shanghai where state projects tend to congregate.

Very rarely do you go to Wenzhou. 

Wenzhou became famous very early in China’s reform and opening because it went from being a small backwater village surrounded by mountains, to one of the world’s largest centers of light manufacturing very very quickly. It did this with no help from the government. Private entrepreneurs built almost all the roads, as well as the airport and the dock. Even today government services are almost nil, with some central parts of the city lacking trash pick up. Wenzhou has managed to develop its own banking system in order to overcome lack of support from state-owned banks. Earlier this year, when Chinese banks were lending full-on to everyone, including wealthy Wenzhounese, Wenzhou businessmen would take loans from state-owned banks at low interest rates, and then deposit them in local banks, where lending rates can hit 20%.

My contacts in Wenzhou have given me contacts in Guangdong cell phone factories, Shanxi coal mines (those privately owned mines that were shut down because they had a horrific rate of accidental death), Italian clothing manufacturers, Parisian Chinese restaurants and the Dubai property market. With one of the largest and most closely knit diaspora communities in China, currency controls are no problem for them. The net effect of this is that the Wenzhounese are very very wealthy.

Though Wenzhou is an extreme example, this phenomenon isn’t singular to the city. There is a broad swath of territory running from the Yangzi river delta in the east down to the Pearl river delta in the south, which has the highest on average standard of living in China, and is mostly lacking for government support. In return for zero subsidies, they get to operate in a regulatory and tax environment with very loose enforcement. Basically an environment that is libertarian to a fault.

That’s not to say that the state plays no part in China’s economy. It plays a very big part in developing infrastructure, and the government’s tight control over resources is both a positive and a negative for the private sector. Often state-owned enterprises will replicate what would be done by policy makers in the West, particularly in the monetary policy realm. But China’s attempt to “drive” its economy has for the most part been notorious failures – Chinese innovation policy is a mess, a number of the country’s much touted “special economic zones” are empty, and the country’s resource policy has been a drag on public budgets as well as destructive of the environment. 

China’s economic system isn’t new. Nor is China trying to make state capitalism work. China has two fairly recognizable economic systems working side by side with one another, both of which are operating more or less how economic theory predicts they would. The two systems interact in interesting ways, but perhaps the most surprising thing is how little they interact at all.