Business Magazine

Capitalism with Entrepreneurial Characteristics

Posted on the 16 March 2011 by Center For International Private Enterprise @CIPEglobal
Capitalism with entrepreneurial characteristics

(Photo: Reuters/Joe Tan/Files)

China is often held up as a model of state-directed, market-driven growth, symbolized in the slogan “Capitalism with Chinese Characteristics.” Yet, in a recent cover story by The Economist, the authors found that perhaps a more accurate model may be symbolized by a small warehouse in Zhejiang, a coastal province situated on the shores of the Taiwan Straits.

Inside the cold, dimly lit factory, workers assembled components for electrical tools that are sent to manufacturers across a “horizontal network of trade and capital.” Outside the factory sit the fruit of their labor: Jaguars, BMWs, and Porsches. China’s private sector accounts for some 70 percent of its GDP, 93 percent of all of its companies, and 92 percent of its workers. Yet, something in the warehouse wasn’t quite right.

For one thing, the factory’s owner wouldn’t let The Economist use his name, for fear of the consequences. Why? It’s because for all of this entrepreneur’s success he still operates squarely in what’s known as the “informal sector,” or the part of the economy that sits outside of formal regulations and taxation. No one quite knows the percentage of businesses in China that operate in this shadow economy, but as The Economist sees it, these entities are the true engine of China’s growth and point to the profound need for reform in China if broad-based development is to continue.

China’s booming economy, growing influence, and rapidly expanding military undoubtedly makes the country a formidable force in the world today. Significantly, this success seems to have come outside the Western narrative of rights and governance. As such, many see in China’s rise a new model for development in the 21st century, and one that’s particularly attractive to other developing countries.

What is China doing right? By almost any standard, China has developed at a terrific rate. On average, its GDP has grown by 11 percent each year for the past 30 years. Measured at purchasing power parity, this translates to an almost tenfold increase in GDP per head over the same period. China’s hard currency reserves are the largest in the world, mainly in dollars fed by an immense trade imbalance with America. Poverty fell by over 50 percent since 1981, and infant mortality by 40 percent since 1990. Telephone access in this same period rose more than 94-fold. Yet, it is not the rate of development alone that is impressive. Japan grew at similar rates up until the 1970s. So did South Korea until the Asian financial crisis of 1997. Neither country though came from the desperate level of poverty found in China when reforms began in 1978 or boasted the incredible size of China’s population and territory.

With all of this success, is there a Chinese model to follow? Certainly, China’s approach has been highly pragmatic and linked to its own unique interests and capabilities. Many have tried to define this approach in general, applicable terms, the most famous attempt being the so-called “Beijing Consensus.” As described by Joshua Ramos, the Beijing Consensus is “practical and ideological at the same time”, centering on a “ruthless willingness to innovate,” a strong sense of national defense and strategic interests, and a steady accumulation of the ability to project power asymmetrically. If there’s a model, it can be found in mixed ownership, state champions, heavy state intervention, and decentralization of innovation to local townships and villages.

What is more striking is not what constitutes the Chinese economy, but what doesn’t. Market economies normally display a large degree of private ownership, secure property rights, liberal financial markets, and relatively open political institutions. These attributes are not fully part of China’s economy as of yet.

There is a critical piece of history that I have passed over, though, and in its telling one finds an often overlooked aspect of China’s development. In 1978, China had just emerged from a devastating famine that killed nearly 45 million people, most immediately a result of a disastrous agricultural policy. The average Chinese was living on less than a dollar a day and could barely get by. In the popular telling of the story, this is when Deng Xiaoping called for the “reform and opening up” of China. The reforms began in the rural areas with townships and village enterprises spearheading a decentralization of control, the development of local markets, public-private ownership of property, and increased access to finance.

That opening up has now developed into what The Economist calls China’s “bamboo economy.” While it is true that many of China’s largest companies are state-owned, “alongside the mighty state engine myriad smaller ones are whirring – and probably more efficiently.” A recent study found that investing in completely private Chinese firms yielded a nearly 10 percent greater return on equity than investing in state-backed entities.

It would seem that running unencumbered by the red tape of bureaucracy would be a good thing. In abstract, entrepreneurs are freed from “direct state management” and the thicket of licenses, titles, and taxes that often stifle economic growth. Factories and firms can emerge quickly to meet a perceived demand, and local politicians steer clear of them because they need the high rates of growth that this entrepreneurism brings.

Yet, in this environment, entrepreneurs are also subject to the whims of bureaucrats and find it hard to access the capital needed to grow their businesses to maturity. There “is ample scope for abuse” by public officials, hence the fear by the factory owner in Zhejiang at being publicly referenced. Corruption is only a step away; officials demand a piece of the action and informal entrepreneurs are ready to supply it if only for the sake of staying in business. In fact, as The Economist’s correspondent went in to the factory, he saw one local official leaving a meeting that isn’t supposed to have happened with a firm that isn’t allowed to exist.

There is a rule of law deficit in China, one that no amount of fiscal surplus can paper over for long. The Economist is right to call attention to the growing challenge of informality in China, as well as the dynamic nature of private sector entrepreneurialism that lies at the heart of China’s growth.

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