The second factor is that China's financial system allocates its vast savings pool inefficiently. It allotted subsidized credit and cheap equity capital to China's most inefficient firms -- the SOEs -- while systematically denying financial resources to China's dynamic private firms. The result is that both SOEs and private firms fail to become competitive.
To illustrate the consequences of China's system for financial allocation, imagine a personal computer of an early 1990s vintage equipped with a Windows 2000 operating system. Now imagine another computer, the most high-powered on the market, but one equipped with a DOS operating system from the 1980s. This is an inefficient combination of hardware and software and the likely result is poor performance from both computers.
This brings us back to the earlier point about why so many Chinese goods are flooding stores around the world but not Chinese companies. Because Chinese firms are uncompetitive, foreign firms find it profitable to invest and produce in China. Foreign firms use capital and labor efficiently and they respond to market opportunities quickly. SOEs, however, do not bother with efficiency and are not market savvy. Private firms do not have sufficient resources to capitalize on their superior software capabilities.
This inefficiency also has an impact on overall performance. Indians save about half of what Chinese save and India gets one tenth of the foreign direct investment that China gets every year. Yet India's GDP growth in recent years is about 80 percent of China's. India is doing something right. It is using its capital more efficiently because its government does not discriminate against private firms and its financial re-sources fund efficient firms. It is time for China to learn from India.
Huang Yasheng is an associate professor at Harvard Business School.
Copyright: Project Syndicate
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