Quite ironic, I am writing how china grew rich at a time when china is in deep trouble.
Anyways, let’s dive straight into the plough.
Let’s go back to 1949, when after winning a civil war against US supported Kuomintang, Mao Zedong’s Soviet backed communist party adopted a communist system.
The ‘Great Leap Forward’
China's initial development efforts were two-pronged: massive investment in heavy industries such as steel, plus application of special agricultural techniques to make sure China's vast population was fed. Understandable, right? After all, China's northern provinces are rich in high-quality coal, which logically could provide the basis of an economic revolution. Coal, steel and heavy manufacturing had been the basis of the industrial revolution in the leading economies: the UK, the USA and Germany. Meanwhile, agriculture HAD to be a priority for any Chinese government because there was barely enough fertile land to feed the countries hundreds of millions of people. This two pronged push was called the ‘Great Leap Forward’. It seemed to make sense, but it was kind of the greatest economic failure the world has ever seen. Mao conducted economic policy on the hidden premise that if people tried hard, the impossible would happen. Villagers were ordered to build steel furnaces in their backyard but had no iron ore to put into them. Some villagers melted down good iron and steel – tools, even doorknobs – in order to meet the court as demanded by the state. Even Mao’s personal doctor worried about the wisdom of a policy to ‘destroy knives to produce knives’. The steel that emerged from the furnaces was unusable.
If industrial policy was a farce, agricultural policy was a tragedy. The Great Leap Forward pulled away a multitude of workers off the land to labour at the furnaces. Mao ordered the people to kill grain-eating birds, and the population of insect pests exploded as a result. He further redesigned china’s agricultural techniques, and specified closer planting and deeper sowing of seeds. This didn’t make sense as rice planted so closely could not grow but party officials, anxious to please Mao, staged shows of agricultural and industrial success. Crops yield fell, of course, but even this wouldn’t have been disastrous without the state’s insistence that the policy was working.
In short, it was a catastrophe.
CHINA ON THE SO-CALLED CAPITALIST ROAD
In 1976, Mao died, (After so many crimes against his own people) replaced by Deng Xiaoping in December 1978. 5 years later, the scenario changed incredibly. Agricultural output grew by a staggering 40%.
HOW? Because those planners had brought the ‘world of truth’ to china. INCENTIVES MATTER (to get a more clear picture about the ‘world of truth’ you can go back and read the ‘Perfect Markets’ blog)
Back then, farmers had to grow crops collectively in groups of 20-30 families. ‘Work points’ were awarded according to the output of the commune as a whole. No incentive for personal improvement. Also the government purchased the surplus at a depressingly low rate, discouraging farmers to make the most of their land. Still barely any incentive. Deng had little time. He announced ‘socialism does not mean poverty’ and raised the price paid by the state to improve agriculture. Few communes sub-contracted land to individual households. Now the farmers were rewarded directly for their successes and crop yields immediately increased.
The experiment spread and the results were dramatic: agricultural output expanded by 10% a year in the first half of the 1980s. Much of the productivity increase was directly attributable to the abandonment of the collective system. In the 5 years following the reforms, the average real income of farmers doubled. It was not Mao but Deng, by using the power of markets and prices, who had achieved the great leap forward. Good ideas spread quickly. Bad ideas were quickly abandoned.
FUTURE INVESTMENT
Development requires buildings, railways and roads which require an enormous investment. Back in 1976, China was still desperately poor even after setting aside the chaos of the great leap forward and the cultural revolution; every 100 yuan invested was adding only 18 yuan to china’s annual output. China’s socialist government didn’t actually have any problem with access to capital; almost all savings came from state-owned corporations. It just didn’t know how to make proper use of it. Deng’s regime quadrupled the returns on investment within 15 years.
How?
Instead of giving complete control of the industrial sector to the planners who would change output requirements yearly, Deng in 1985 freezed the size of the plan and state-owned firms were allowed to do as they wished with any extra production. Efficient coal manufacturers would find efficient steel manufacturers who would find efficient construction firms. Inefficient firms got nowhere. This plan worked quite well. Stability was guaranteed. Workers who had jobs would keep them. Things were guaranteed not to get worse—but it growth resulted, there was the possibility that they could get better. The market operated exactly where it needed to—at the margin. Managers got to keep profits and reinvest them—and had an incentive to make sure that the investments were profitable.
SCARCITY POWER
The Chinese economic miracle wasn’t really about privatisation. What mattered was not who owned the companies, but that the companies were forced to compete in a relatively free market, driving down scarcity power and bringing the information and incentives to the world of truth. As competition increases, profits begin to fall which was exactly what happened in China as the economic reforms began to bite. Scarcity power disappeared.
WHY DID CHINA NEED THE WORLD?
A country of over a billion people seems pretty much self-sufficient, doesn’t it? But China’s economy was still tiny in 1978—smaller than Belgium’s— and the reformers realised engaging with the world could help. First, China could tap into world markets for labour-intensive goods such as toys, shoes and clothes. Second, the foreign currency earned from these exports could be spent on raw materials and on new technology to develop the economy. Lastly, foreign investors brought in the modern production and business techniques, which was crucial for a country who’s been communist for decades. China didn’t need foreigners to supply capital, it was their expertise that really counted. American and Japanese firms made investments in transport and electronics (because China had a substantial and a rapidly growing domestic market) and china is now the largest producer of majority of important consumer electronics. Social ties with Hong Kong and Taiwan helped compensate for problems in china’s legal system in the early years of reform.
This is how China became one of the fastest growing countries in history.
Countries that are rich or rapidly growing have embraced the basic lessons of economics: fight scarcity power and corruption, correct externalities, try to maximise information, get the incentives right, engage with other countries and embrace markets.
In the end, economics is about people and economic growth is about a better life for individuals—more choice, less fear, less toil and hardship.
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