Wednesday, 16 November 2011

“Growing Like China” - Less State-Led Development than Transition

A perennial issue among development economists is whether and how China’s growth experience can be emulated by other poor countries. China’s success is referred to by many shades of ideology, from pure market to statist. My reading on the subject makes me question to what extent China is unique or what elements of its growth story can serve as a model to others. To be sure, Justin Lin – the Chinese Chief Economist of the World Bank - has studied the very issue since long.
 I have come, admittedly quite late, across a great paper in the American Economic Review (Feb 2011) that models and calibrates China’s outstanding and stable growth performance which started in 1992, when Deng Xiaoping opted for an acceleration of reforms: “Growing Like China”, by Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti. The paper presents a growth model consistent with China’s output growth, sustained returns on capital, reallocation within the manufacturing sector, and its large trade surplus.
The model is populated by two kind of firms – private and state-owned. Private firms use more productive technologies, but due to financial imperfections they must finance investments through internal savings. State-owned firms have low productivity but survive because of better access to credit markets. High-productivity firms outgrow low-productivity firms if entrepreneurs have sufficiently high savings. The downsizing of financially integrated firms forces domestic savings to be invested abroad, generating a foreign surplus. A calibrated version of the theory accounts quantitatively for China’s economic transition. Workers have shifted in increasing numbers from state-owned enterprises to private firms. In the chart, the solid blue line represents the results from the model over a long time period; the dashed red line shows a very similar rising trend in actual data from 1998 to 2007 in the share of total employment in private firms.

So China is, since 1992, first and foremost about the transition to an economy with a shrinking share of state-owned enterprises and a strong rise in the share of private domestic firms in total employment (and in GDP); in 2007, that share hovered around more than 60 percent while it is now approaching 80 percent.

While these trends must be puzzling to advocates of ‘state-led development’, neoclassic economists will find it impossible to explain within their (closed-economy) neoclassical growth models that return to capital stayed constant in China over the growth period, despite heavy capital accumulation. And the high return to capital is difficult to reconcile with the observation that it did not lead to net capital inflows but went along rising foreign exchange reserves due to big foreign surpluses. No, these surpluses are NOT explained by an artificially undervalued renminbi – another reflex response typical of mainstream economists – but  are due to disparities among China’s firms in their relative productivity and access to credit.

Source: Growing Like China, AER Feb 2011

As state-led firms with privileged access to (development bank) finance are crowded out of the market by the more productive private firms, a larger proportion of domestic savings is invested in foreign bonds/assets (or in real estate in reality!) by the state-led firms as long as the private firms do not get easy access to that bank finance. The recent monetary tightening has effectively increased that disparity between privileged state firms and private firms; the latter need to pay skyrocketing curb market rates on informal credit markets (a repeat of Korea and Chinese Taipei earlier on).

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