The Dialectic of Development
The Dialectic of Development
Industrial Policy and the Living Legacy of Internal Colonization
⚠️ Reader discretion advised: this is a long essay on an academic subject ⚠️
Part 1: The Maoist Heritage
Can a Leninist single Party move the People’s Republic of China (PRC) toward an innovation-led economy? It’s a question whose answer the Communist Party of China (CPC) very much hopes is yes. It’s also a question I wrote a long essay about a year or so ago. I didn’t arrive at anything approaching a decisive conclusion, but I did lean to one side. A year on, and I’m tempted to lean in more.
There’s this idea, perhaps most cleanly formulated by economist William Baumol, that entrepreneurs are always with us seeking out wealth and prestige in its various guises. It’s just a matter of how society's entrepreneurial energies are funneled. Under a Leninist party, the incentives for entrepreneurial rent-seeking via state-patronage are high—and that is likely to complicate a state-led push toward an innovation-led economy.
Yet, intriguingly, while Xi Jinping is gearing up for a big state-led innovation push, he doesn’t seem too concerned about entrepreneurial rent-seeking. As the Atlantic recently reported, Xi “told entrepreneurs to model themselves on Zhang Jian, an early-20th-century businessman who made substantial amounts of money not by innovating, but by sucking up to China’s government.”
We don’t have to merely take Xi at his word. In fact, his policies and actions have been consistent in their intent to increase Party-state influence over and within the private sector. And even more, we can look at research that is finding that entrepreneurs are spending more and more of their time schmoozing with the Party, rather than doing innovative work. Many signs point toward the Baumol-based hypothesis that the Leninist single Party is like a black hole at the center of the universe systematically pulling entrepreneurial incentives away from the market and toward itself.
But what does this have to do with a ‘dialectic of development’?
Xi Jinping’s much advertised push for an indigenous innovation oriented economy doesn’t merely impact entrepreneurs. As the cornerstone of Xi Jinping’s emerging political economic model and his massive industrial strategy, its efficacy has ramifications for the entirety of the Chinese populace. Whether it is successful or not matters not just for wealthy urbanites, but also for the hundreds of millions of China’s still impoverished rural citizens. This is where the dialectic of development comes in. Xi Jinping’s newest industrial strategy, his eager desire to build up an indigenous innovation based economy, is the newest fusillade in an ongoing saga that pits the PRC’s urban and rural development in dialectic antagonism.
Lenin, Stalin, Mao and Internal Colonization
Leninism is an ideology created in ostensible opposition to imperialism and colonialism. Indeed, its primary ideological extension of Marxism was arguing that exploitative, bourgeois countries can sustain capitalism by extracting ‘super profits’ via their colonial possessions, sending them back to the metropole wherein elites could then buy off the proletariat. Capitalist exploitation under Marxism-Leninism was thus a global phenomenon that saw inherent conflict—a dialectic—between capitalist exploiter countries and pre-industrial exploited countries. In Lenin’s view, he could undermine this system by exporting revolution around the world, which would result in ‘progressive’ uprisings that would end the super profits sustaining capitalism and thus bring capitalism’s entire exploitative edifice crashing down.
It is more than a bit ironic, then, that Lenin’s Communist Party of the Soviet Union (CPSU) would resort to what can only be described as internal colonization to support its own existence. Alvin Gouldner, a once well-known American sociologist and activist, cogently described this phenomena that began under Lenin but became fully formed under Stalin:
“At first largely dominated by highly educated revolutionary intellectuals of predominantly urban origins, the party leaders barricaded themselves in the towns and cities against the rising resistance of the vast rural majority. The fundamental structure, then, was not simply one of a "differentiation" between town and country, but of a sharp and growing cleavage between them. What had been brought into being was an urban-centered power elite that had set out to dominate a largely rural society to which they related as an alien colonial power ; it was an internal colonialism mobilizing its state power against colonial tributaries in rural territories. Here, internal colonialism refers to the use of the state power by one section of society (the Control Center) to impose unfavorable rates of exchange on another part of the same society (e.g., the Subordinate Remotes).”
He goes on:
“In effect, [one of the CPSU’s key theorists developed] a deliberate policy of internal colonialism in which "exploitation" of the peasantry was expressly foreseen. While rejecting looting, in principle, [this CPSU theorist] held that "the idea that a socialist economy might be developed without tapping the resources of the petty bourgeois and, above all, of the peasantry can only be described as a reactionary petty bourgeois daydream." Obviously, however, once Soviet agriculture had been collectivized, what was involved was not the exploitation of pre-socialist forms but of a socialist system and it cannot, then, be characterized as "primitive socialist accumulation," in [the theorist’s] sense. It is more accurately described as an internal colonialism.”
Mao’s Industrial Policies Set the Stage
Gouldner’s excellent analysis of the CPSU’s internal colonization, however, is left wanting when it moves into a comparison between Maoist PRC and the Soviet Union. While he rightly acknowledges that the relationship between the Party-state elites and the peasants was quite a bit more amicable in the PRC prior to 1957, he utterly fails to recognize the analogous colonization that would in fact come to characterize the peasant-state relationship during the Great Leap Forward.
Thomas Bernstein, Professor Emeritus at Columbia and expert on communist systems, writing six years after Gouldner in 1984, aimed to correct Gouldner’s unconvincing comparison. Bernstein first acknowledges key differences between the CPSU and the CPC:
“The relationship between the Maoist state and the peasantry has long thought to have been very different from the Stalinist case, and with good reason. Relations between the Chinese Communists and the peasants had substantial cooperative and not just adversary components, stemming from a convergence of factors that ran in the opposite direction from those that operated in the Soviet Union. The Chinese revolution was based on the peasantry. In the revolutionary process, the Communists secured significant peasant support and rural organizational capabilities, which were successfully adapted to socialist transformation. Elite attitudes were not anti-peasant and there was an undoubted commitment to the improvement of peasant welfare. Most important, China's economic development problem dictated moderation in the use of agriculture to promote industrialization. Given low per capita output and rapid population growth, the central problem was not simply extraction but development, which in turn required attentiveness to peasant incentives.”
However, Bernstein then goes on to strongly suggest there’s more ‘there there’ than Gouldner believed:
“The Great Leap Forward—an unprecedentedly intense mobilization effort launched in 1958 to achieve a developmental breakthrough—suggests that the prevailing image of Maoist China as differing fundamentally from Stalin's Russia must be reexamined.”
Indeed, despite the much less antagonistic disposition of the Communist Party of China toward the peasants, and as Bernstein foreshadows, a distinct yet recognizable form of internal colonization would emerge in little brother Maoist PRC, just as it had in big brother Soviet Union. Consider this description of life during the rush to ‘socialist collectivization’ in the PRC in the mid 1950s:
“The militia movement and a small corps of trained fighters brought military organization to every commune. All over China farmers were roused from sleep at dawn at the sound of the bugle and filed into the canteen for a quick bowl of watery rice gruel. Whistles were blown to gather the workforce, which moved in military step to the fields, carrying banners and flags to the sound of marching songs. Loudspeakers sometimes blasted exhortations to work harder, or occasionally played revolutionary music. Party activists, local cadres and the militia enforced discipline, sometimes punishing underachievers with beatings. At the end of the day, villagers returned to their living quarters, assigned according to each person’s work shift. Meetings followed in the evening to evaluate each worker’s performance and review the local tactics.
Labour was appropriated by the communes, men and women being at the command of team leaders, more often than not without adequate compensation. Explained party secretary Zheng Xianli in Macheng: ‘Now that we have communes, with the exception of a chamber pot, everything is collective, even human beings.’ This was understood by poor farmer Lin Shengqi to mean: ‘You do whatever you are told to do by a cadre.’ Wages, as a consequence, were virtually abolished. Members of a production team, working under the supervision of a squad leader, were credited with points instead, calculated according to a complex system based on the average performance of the team as a whole, the job carried out and the age and gender of each worker. At the end of the year, the net income of each man was distributed among members ‘according to need’, and the surplus was in principle divided according to the work points that each had accumulated. In practice a surplus hardly ever existed, as the state came in and took the lot. Work points, moreover, devalued rapidly during the Great Leap Forward” (Dikötter, The Tragedy of Liberation, pp. 44).
Such was life for many of China’s hundreds of millions of peasants in Mao’s communist utopia. Mao routinely made paeans to the peasants in speeches and writings. He even, after copying it verbatim during China’s first five year plan (FFYP), ridiculed the Stalinist model and its tactic of rushing toward industrialization. As Bernstein notes of Mao:
“The Leap was Mao Zedong's effort to chart an independent developmental and ideological road by breaking with the preceding years of emulation of the Soviet model. "Why can't we innovate?" Mao exclaimed in 1958." But Mao Zedong also became a penetrating critic of the realities of the Leap, and it was he who in early 1959, during a first phase of retrenchment, pointed to similarities with Stalinism on the issue of concern here, that of squeezing the peasants: We should make a comparison between Stalin's policies and our own. Stalin had too much enthusiasm. With the peasants, he drained the pond to catch the fish. Right now, we have the same illness.'”
It’s ironic that Mao would make such a protest just before he would go on to push his country into the most insane rush to industrialization of all time—making the same Stalinist mistakes on an even grander scale. As he song peasant praises, he simultaneously wrung them dry for the sake of rapid industrialization.
A dialectic relationship is perhaps hard to distinguish from schizophrenia, particularly when it characterizes an individual’s personality. The constant negotiation, back and forth, teeter tottering between oppositional ideas. So it was with Mao and the peasants, and his views on industrialization. Mao’s claim to distinctness among the Marxist camp was his unique reliance on and championing of the peasants. Yet he created a system and pushed his lieutenants to exploit the peasants nearly as ruthlessly as the Soviet Union did. He similarly talked a good game about agrarian reform and helping peasants maximize their yields, while entirely failing to do so in practice. Instead, he forced them into mass starvation by goading cadres to force peasants into half-baked industrialization schemes like backyard iron-smelting, and shoddy irrigation and public works projects. Rather than simply encouraging them to feed themselves and produce the agricultural surplus that is necessary for—and indeed would prove crucial for China’s—economic development, their labor was expropriated and ultimately wasted more aggressively than any capitalist system has ever achieved.
Mao was also known to be genuinely more motivated than his guru, Josef Stalin, about egalitarianism. Stalin, perhaps due to Russia’s relative proximity to an already developed Europe and the exigencies of a looming war, unrepentantly prioritized national development over and above egalitarian concerns. As Bianco puts it in his book comparing Stalin and Mao:
“Mao was more faithful to the October ideals. Faithful and inconsistent, for he wanted everything at once: a great powerful and egalitarian nation...Unlike Stalin, Mao did not subordinate one end (social equality) to another (development), instead he tended to emphasize the former to the detriment of the latter. More often as not, wanting to believe that everything was possible, he gave up nothing and got nowhere” (Bianco, Stalin & Mao, pp 324).
Here again, then, a dialectical relationship juxtaposes the peasants and rural well-being with concerns over industrialization. Sadly, contrary to the Hegelian and Marxian dialectic wherein antithesis and thesis combine to promote a productive synthesis, such a dialectical relationship under Mao’s PRC produced nothing but failure. Not only did the PRC fail to develop—the poorest segments by the time of Mao’s death were actually worse off than they were in 1933—but inequality between rural and urban expanded, although given the overall impoverishment one won’t be surprised to learn the inequality was relatively constrained, with a 3:1 rural-urban income ratio. As Bianco explains again, while post-Mao PRC has evolved into one of the most unequal countries in the world, one might
“be tempted to blame this on Mao’s successors, so-called Thermidorians who betrayed Maoism and the revolution. In fact between 1978 and 1985, those successors began by reducing the most glaring inequality of all: the chasm between city and country dwellers, but then proceeded to increase it further. Contemporary inequality, in part inherited, is growing within a framework, and thanks to a system, erected by Mao. During his lifetime there had been relative equality within each of the two universes (the privileged urban one and the miserable rural one), which scarcely concealed the poverty in both cases. In all, Mao lost on both counts” (Bianco, Stalin & Mao, pp 36).
What happened under Mao in the PRC is something that only a term like ‘internal colonization’ seems apt to describe. As Bianco explained, and as Dikötter showed in his gripping book on Mao’s Great Leap Forward, the contemporary roots of the PRC’s massive urban-rural inequality stretch back to this era. During his post-civil war land reform, Mao helped deliver the peasants a more equal distribution of land—albeit in a bloody campaign that killed roughly 2 million ‘landlords’ (via arbitrary quotas that often resulted in random murders), operated as a mechanism of social control that was effectively a pact sealed in blood between the peasants and the party.
But then Mao took all the land away and nationalized it during the fastest collectivization ever seen.
Legacies from this era linger on. The PRC’s 600 million+ rural residents do not own the title to their lands, and have no rights to sell it, making it expressly difficult to accrue wealth. As Rhodium Group noted in early 2021:
Land reform never got off the ground. While the 2013 Third Plenum promised to allow rural residents to sell their land through markets, authorities have only piloted this reform in 33 counties, accounting for just 0.1% of China’s total rural nonagricultural land.
Further, during this period, Mao implemented internal passports called hukou, designed to lock-in populations for control and planning purposes and which still exist today as a massive barrier to mobility.
Part 2: A Living (and Growing?) Legacy
When Other’s Finally Stood Up, Rural China Sits Back Down
The rise of the rural laborer in the PRC begins with his reclaiming of family farming. That rise in yield freed him from the depravations of hunger and furnished him with sufficient surplus to begin building what would really ignite the PRC’s early post-Mao growth: township and village enterprises. These crude start up firms were able to eat off the plate of the extremely inefficient state owned firms, and set the stage for the PRC’s growth miracle.
And yet, despite this peasant fueled growth miracle, throughout reform and opening the central government’s policies never changed to secure the peasants’ ability to prosper. Hukou was kept in place, land rights were never established, and education and social policies—one of the strong points under Mao, even if still lagging in rural areas—were severely underinvested and left to languish. Still today, if you live in a city in the PRC today without the proper hukou, you cannot receive social benefits such as healthcare nor can your children attend public schools in the area, which has led to a large phenomena of ‘left-behind’ children in the countryside.
Instead, just as the central government under Mao worsened the rural populace’s plight by forcing local lieutenants into ‘target inflation’ races and incentivizing unrealistic schemes for advancing industrialization, the PRC’s post-Mao central government has actively undermined its rural populace. In addition to the problems described above (lack of land rights and hukou), the center has actively encouraged local governments to quite literally steal rural farmers’ land. As many scholars have argued, the primary culprit for this likely lies in ““the changing fiscal incentives [i.e. the 1994 & 1995 centralizing tax revenue changes that] might have caused local governments to shift their efforts from fostering industrial growth to “urbanizing” China, for instance, by developing the real estate and construction sector.” This also touches on some of the other perverse political economic incentives at play, discussed in this paper and in a previous post.
At bottom, though, is a human tragedy.
It’s a little known fact that the Chinese countryside is a hotbed for self-immolations. Not only are rural inhabitants denied the ability to use their land to accrue wealth—either as collateral for loans or via leasing, but even worse they are actively forced to surrender their only source of cash flow, often brutally by local government hired criminal groups. As a result, rural denizens have been documented to kill themselves via self-immolation by the dozens annually. And that’s just the tip of the iceberg. There are undoubtedly more, and many others who die in less shocking fashion but of whom we simply cannot know. The reason we cannot know is the same, obvious, reason many of the darker sides of the PRC cannot be fully ascertained.
Ultimately, just as the rural populace was beginning to stand up and get rich, they were effectively forced to sit back down. Joe Studwell sums up this whole tragedy eloquently in his book How Asia Works:
“There will likely be a clamp-down on household farm land conversions to commercial agriculture but, unless China’s local government funding problem is resolved, the fiscal pressure to squeeze farmers (and their money-remitting offspring) will remain. The Chinese farmer is a long-suffering beast who, down the ages, has been repeatedly mistreated by his urban masters. In recent times, it was his support which ensured the communist revolution. Left to his own devices he produced a brief output boom, still remembered by older Chinese as a golden era, between the end of the Second World War and the start of collectivisation in 1956. Following various Maoist misadventures, in the 1980s he brought China back from the brink, ramping up agricultural output during an era that also saw the country's most competitive businesses created in rural areas. Huge companies like off road vehicle maker Great Wall Motor...leading car parts maker Wanxiang, top beverage firm Wahaha, and Broad Air Conditioning...sprang out of the countryside in the 1980s. And then, at the stage when landowning farmers in Japan, Taiwan and Korea were getting used to four-wheel drive cars and holidays at the seaside, local government started to take away the Chinese farmers fields to satisfy its fiscal deficit and the greed of village cadres. Central government, which did not finance local government adequately, looked on and said it was all a terrible shame. Now, once again, the Chinese farmer is constrained to fulfill his traditional role and, as the Chinese idiom has it, eat his bitterness.”
Don’t China Model Me
The comparison between the other North-east Asian states is salient. Far from pioneering a ‘Chinese model’, I’d argue the PRC rather switched from a Stalinist developmental model imported almost whole-sale under Mao, to a Meiji Japanese development model imported almost whole-sale under Deng. People can and will quibble about differences, but key facts are plain as day: the most important elements of the Japanese development model—i.e. land redistribution & state-led investments in improving yield, export-oriented manufacturing industrial policy, and a concerted effort to force up savings and funnel those savings through a state-led financial apparatus relying on financial repression to fund both (though the banks in Japan were not fully government owned and controlled). Sadly, unlike Taiwan, South Korea, and Japan, the PRC’s dialectical development would prove, yet again, to militate against a real peasant uprising (this time in material well-being).
The Rural Urban Divide
Scott Rozelle’s recent book Invisible China packs a life-time of first-hand experience in the Chinese countryside into a plaintive call for action regarding rural-urban inequality in the PRC.
In short, the central government is not making the investments necessary to uplift the rural community who have, in contemporary Chinese history, been soaked again and again for the purposes of industrial development. As a result, education inequality between rural and urban has metastasized, as have issues related to health inequality and income inequality. The dialectical development of industry in the PRC has always seemed to come at the expense of the rural population.
Why? It’s largely about stability, control, and great power status. A dispersed rural populace is easy to control and hide, whereas a centralized urban populace requires much greater care and consideration. This is one of the reasons Mao was fond of sending people back to the countryside in the millions. And it’s one reason why the CPC still has hukou restriction in place stopping rural citizens from moving to cities. Further, institutionalizing the right of rural citizens to the title of their land would give them a degree of autonomy that would fundamentally erode the power of the state, and would forestall local and central government ability to requisition their land on the cheap. Rural wealth and well-being would necessarily come at the expense of the CPC’s voluntarist inclinations.
And so the rural-urban divide has only grown exponentially more drastic since Mao—when it was a relatively benign 3-fold difference in income inequality, which owed mostly to the lackluster urban economy. The CPC tries to resolve this dialectic via its preferred route: state-led voluntaristic development projects like ‘develop the west’ which sees state-owned companies financed by state-owned banks plow billions into expensive yet questionable physical infrastructure in poor provinces. Such projects have the added benefit of juicing GDP by creating economic activity, though like many such investments in the PRC, generously tack onto the debt load. What these development projects can’t do, however, is actually develop the rural areas and backward provinces. Only a structural reapportionment of wealth that gives rural individuals their land titles, greater resources, and more social security can do that. But, again, such things come at the expense of, or do not align with, the CPC’s voluntarist intentions nor the numerous powerful vested interests in land-development revenue sources.
In fact, a structural re-distribution of wealth might up-end the CPC’s investment-led and urban-biased developmental schema. This is a debate that is still on-going today. Like Japan before it, the CPC has proved unwilling or simply unable to move beyond the growth strategy that got it to where it is today. The institutional inclinations that enabled its growth miracle—the high savings funneled into investment-led growth—have likely needed to be seriously re-thought for years. As Studwell writes with characteristic succinctness:
“The main problem for China is that its structural rate of growth is beginning to slow as it gets richer and reduced population growth is cutting the supply of new labour to the workforce. This means the government will be less able to rely on growth going forwards to shrink its debts relative to the size of the economy. In turn, with annual growth dropping from 10 percent to perhaps 7 percent in the next few years, and a somewhat more open financial system, financial crisis risk increases. Another way of putting this is to say that China’s investment-led industrial learning process needs to be less wasteful in the future. The country cannot run away from debt as quickly. The best days of industrial policy-led development are therefore already gone.” (Pg 263)
This passage was written in 2013. Interestingly, it echoes precisely what Michal Pettis wrote in his 2013 book ‘Avoiding the Fall’, which is that the easy and obvious investment projects that the Japanese developmental model is perfectly suited for were likely mostly saturated by 2013. Instead, as both authors argue, institutional reforms are severely needed—and have been for sometime. As Rozelle would likely agree, these reforms need to take place in a way that allows the rural population to catch up and flourish.
And yet, the sort of institutional reform that would see resources reallocated, are heavily guarded against by vested state interests, including local governments, large property developers (whose relationship with the CPC is incredibly cozy), and key parts of the center itself. Barry Naughton, in a 2017 piece titled ‘Is China Socialist?’ summarizes the situation:
“A number of the policy shortcomings described in the previous section are consistent with an interest group interpretation of the policy process: the failure to redistribute income from urban to rural households; preference for expensive physical capital investments over modest social expenditures; difficulties in shifting from an investment-driven to a consumption-driven economy; sluggishness in addressing issues of environmental deterioration; and others. One possibility is that the very revival in the fortunes of the government described earlier led the Chinese system to evolve a network of entrenched interest groups. Redistributive policies cannot be carried through without fundamental reforms of the fiscal, financial, and decision making systems, which interest groups have so far been able to stall and deflect. In this view, the system ends up reflecting the interests of insiders: for example, of managers of state-owned enterprises. In a broader sense, the interests are those of a larger group of Communist Party officials, politicians and technocrats, and even the urban population—at least those with urban residence permits—as a whole.”
The CPC’s desire for regime stability is predicated on making its urban populations, those most capable of engaging in collective action, happy. That exigency, which rose to particular prominence post-Mao, dove-tails with the CPC’s revitalized commitment to its state-led, urban biased, investment-led model.
An under emphasized but, I think, leading reason why the CPC persists in a developmental scheme that worsens urban-rural inequality is great power status competition. The CPC is more concerned with reaching the pinnacle of technological breakthroughs, which it believes will bring power and prestige, than with redistributing and allocating resources so as to empower and benefit rural citizens. The CPC appears sanguine about pushing 300 million coastal urbanites to the stratosphere while letting rural residents languish.
The New Industrial Policy
The newest reflection of the PRC’s unyielding dialectic of development is to be found in Xi Jinping’s preferred political economic paradigm: innovation-oriented industrial strategy! Rather than engage more seriously with non-urban biased, pro-growth reforms—which might require serious political changes, such as allocating local government & state resources to the rural populous directly—and rather than accept the copious arguments—from veteran economists who don’t all see eye to eye but do on this, such as Michael Pettis, Barry Naughton, Nicholas Lardy, Joe Studwell, Yasheng Huang, Yukon Huang—that more state-led, urban-biased developmentalism is not the answer, the CPC persists.
Barry Naughton’s primer on the PRC’s industrial policy offers a sympathetic reading toward Beijing’s objectives. From a historical perspective, the PRC had not practiced industrial policy prior to the 2008 great financial crisis (GFC), at least according to Naughton’s definition. For Naughton, industrial policy is specifically about changing the sectoral composition of an economy. The general industrial subsidies that Beijing had in place from the 90s onward, such as cheap credit (thanks to financial repression), free or very cheap electricity, land, and other inputs, and a severely undervalued exchange rate (until 2013 or so) were too sweeping to be considered industrial policy proper. Since the massive credit and investment boom unleashed in response to the GFC, however, and in particular since the late 2010s, the CPC has been engaged in industrial policy proper.
Naughton recently spoke to Jude Blanchette about the ‘New Industrial Policy’ on the latter’s Pekingology podcast. Therein, they tried to project themselves into the minds of CPC leaders to understand their thinking behind this. Why more state-led investment in an already debt saturated political economic ecosystem? What’s more, they also tried to understand how this ‘New Industrial Policy’ might, in fact, actually end up working out.
A useful heuristic for thinking about this that Naughton coined is the term ‘grand steerage.’ It is, in essence, a somewhat natural evolution of the CPC’s statist macroeconomic control mechanisms.
In particular, though, this ‘new industrial policy’ ‘grand steerage’ represents a bet—a very big bet, in fact—that the world is currently riding the crest of a 4th industrial revolution technological wave. The total fundraising scope for the CPC’s Industrial Guidance Funds (IGFs), designed to invest in a broad scope of cutting edge technology, is over $1.6 trillion. These IGFs are far more than Made in China 2025, which in actuality was merely one of the stand alone industrial strategy plans.
As Naughton describes:
Even if we confine our attention to the Industrial Guidance Funds, it is almost certain that China's Innovation-Driven Development Strategy (IDDS) represents the greatest single commitment of government resources to an industrial policy objective in history. Moreover, many other instruments are in play, and it is likely that the resource effort suggested by their implementation has also increased since the inception of the IDDS. This IDDS seems to be a remarkable and unprecedented government effort.
Beijing’s belief—hope—is that if it can position itself properly, it can unleash revolutionary technological advances that will spread across the PRC’s economy and fundamentally shift its development into a new gear, all without having to change the growth model.
It’s not a crazy idea. Keep the savings rate high, funnel investment into productive sectors disciplined by export-oriented competition, and reap the rewards. The problem is, however, the Japanese investment-led growth model works well when a country is far from the technological frontier—when you simply need to incentivize uptake of known best practices. Whether this model works well at the frontier of technological advancement is a much, much more dubious prospect. The CPC, however, is now betting the house on it.
Xi’s new industrial policy may also be a way of making good on his dictate that ‘houses are for living, not for speculation.’ Xi and the PBSC may be thinking that they can use the power of the state to seed a shift of the economy away from the real estate focus that has come to dominate it in recent years. Again, from the CPC’s perspective, this state-led developmentalist solution would obviate the need for fairly serious political changes—i.e. reallocation of resources. As a recent paper from the People’s Bank of China clearly demonstrates, many thinkers in the CPC are quite comfortable continuing on with the investment-led growth model:
“First of all, we should be highly vigilant and prevent the savings rate from declining too rapidly. We must be clear that our country not only bears the burden of development, but the burden of caring for the elderly. Understand this: without [capital] accumulation, there is no growth. Secondly, we must recognize that consumption is never a source of growth. We must understand that it is easy go from frugality from extravagance, but difficult to go from extravagance to frugality. The high consumption rate of developed economies has historical reasons; once you switch, there’s no going back, so we should not take them as an example to learn from. Thirdly, we should pay attention to investment. We must expand domestic investment in the central and western regions; although China’s marginal return on capital continues to decline, the potential for replacing workers with robots in the these regions is still promising. We must expand outward, and especially invest in Asia, Africa and Latin America, because these regions provide the only remaining large demographic dividend.”
Justin Yifu Lin, a famed economist who last year advised Xi Jinping, has similarly affirmed this view, telling Bloomberg News in an interview that “calls for consumption-led growth ‘are not supported by empirical evidence or economic theory.’ He argues that high investment in new infrastructure and equipment enables workers to be more productive and raises their income, in turn increasing consumption.”
Accumulation vs Innovation
Beyond affirming the analyses presented so far, it is interesting to note the tension between the neo-classical view of growth expressed above—i.e. capital accumulation causes growth—and the innovation oriented growth strategy championed by Xi Jinping. Indeed, Xi Jinping himself expounded a different view in 2014, saying:
“The old path seems to be a dead end. Where is the new road? It lies in scientific and technological innovation, and in the accelerated transition from factor-driven and investment-driven growth to innovation-driven growth.” (June 9, 2014)
As the rising school of innovation economics increasingly challenges what Joe Studwell has called the “intellectual tyranny of neo-classical ‘efficiency’ economics,” it seems like 2014 Xi Jinping might have been onto something.
For the PRC, however, neither state-led developmentalism nor innovation economics is the what the doctor ordered. At its current developmental position, after so many years of distorting factor prices, there is ample room for efficiency led, re-allocative growth. But that requires confronting entrenched interests and making hard political choices. So, instead, Beijing appears intent on trying to somehow synthesize a lumbering state-led investment growth model with an innovation-led growth model, while going in the opposite direction with regard to re-allocative growth. To quote Xi again:
“Whether we can stiffen our back in the international arena and cross the ‘middle-income trap’ depends to a large extent on the improvement of science and technology innovation capability”
Conclusion
The first big problem with Beijing’s investment-innovation synthesis is that it is all predicated on a huge bet: that massive investments in the 4th industrial revolution will unleash miraculous productivity gains.
The second big problem, as outlined at the beginning, is the corruption and rent-seeking that already is and will inevitably continue to accompany massive government-led industrial policy. Further, as William Baumol once argued, entrepreneurial energies will be increasingly directed toward winning state largesse rather than competing in the market. This is an inevitable tension with Beijing’s intention to marry a Party-state-directed, investment-led growth model with an innovation-oriented model. One side is going to give, and, in my view, the consequences for innovation are predictable.
The third problem is this new industrial strategy seems to be actively oriented against a rebalancing of the PRC’s economy away from investment-led growth and toward consumption-led growth. Rather than fundamentally change the growth model, the strategy seems to be to steer the massive amount of savings, largely via the state controlled financial system, into the cutting edge technology industry. But unlike the infrastructure and real estate industries that have thus far absorbed such investment, a tech sector closing in on the knowledge frontier is simply not able to productively and effectively absorb the deluge. With aggregate debt levels already at 300% of GDP, racking up more dubious debts seems unwise.
The fourth problem is this strategy is unlikely to foster rural development or bring up lagging provinces. Despite the PBOC’s hopes, more state-led infrastructure projects aimed at ‘developing the West’ aren’t likely to materially change the situation for rural inhabitants. What would do that? Giving them the resources to improve their own lives and secure wealth for themselves, particularly via establishing land rights. Not to mention ending hukou, what some have even called apartheid, so they can move more freely and receive access to schools and healthcare wherever they live. Such an advance would dovetail with the center deciding to step up and nationalize health care (something you might expect an allegedly socialist country would do) rather than passing the buck to local governments who are already strapped and incentivized to steal land to cover existing outlays. As Brad Setster put it in a recent Foreign Affairs piece, rather than more state-directed investments, the best way to make a difference is to centralize and increase social spending:
“[The CPC] may claim to be communist and to embrace the ideological legacy of Karl Marx, but the government offers relatively little support to many workers. It maintains one of the world’s most regressive tax systems while also offering relatively modest social benefits. Thanks in part to these realities, China now is one of the most unequal societies in the world...China’s limited spending on health care has almost certainly contributed to its exceptionally high savings rate [and] public spending on health is one of the most effective ways of reducing savings rates and raising household consumption...China does need to continue liberalizing its state-dominated economy, and it needs to allow the private market more room to operate in a number of sectors. Yet when it comes to taxing and spending, China needs a bigger, not a smaller, state—one that collects more income taxes and uses the resulting revenues to provide a stronger system of public health and social insurance.”
The fifth and final problem expands upon this fourth problem and brings us back to the PRC’s ‘dialectical development’. Not only will more industrial policy be unlikely to improve rural lives—especially when compared with obvious but politically hard to swallow alternatives—it will actively expand the rural-urban divide. Writing nearly two decades ago, researchers Dennis Yao and Cai Fang singled out industrial policy as uniquely contributing to urban-rural inequality:
“We find that the sharp sectoral divide in the planning episode [i.e. Mao era] was a result of industrial development strategy, but since the reforms the politically powerful urban population has pressured the government for fast income growth using various transfer programs. The central government has continued urban bias in order to preserve regime stability and political legitimacy. Our analysis indicates that, while the urban coalition may pressure the state for favors, political activities are not a necessary condition for the existence of urban bias. The pursuit of industrial development strategy alone can result in a rural-urban divide.”
The PRC has been turning every problem into a nail to be hit with a state-led investment hammer, and some problems simply require solutions that such a hammer is not only unfit to resolve, but actively exacerbates. Rural-urban inequality and the future growth of the PRC are plausibly two such things.