Sun, May 06, 2007 - Page 8 News List

China's evolving economic system

By Assar Lindbeck

It is generally agreed that China's impressive economic achievements during the last three decades are largely the result of the radical reform of its economic system. While private ownership of firms hardly existed when these reforms started, private firms today account for about 60 percent of total production.

Ownership, however, is only one dimension of an economic system.

China's economic system has changed just as drastically in other ways as well. Decision-making regarding consumption and production has largely been decentralized to individual households and firms, respectively; economic incentives, markets, competition and internationalization have to a considerable extent replaced command, administrative processes, monopoly and autarky.

Generally speaking, China's reform period has been a stark contemporary illustration of the historical lesson that unleashing individual initiative tends to boost economic development.

How, then, should the Chinese economy be characterized today? Some observers describe the economic system as "state capitalism"; others (including China's rulers) call it "market socialism."

Both labels mislead. One reason is the domination of private firms on the production side. Another is the fact that "socialism" usually does not rely upon strong economic incentives and competition, which are the dominant economic factors in today's China.

In fact, China is a type of mixed economy, with a number of specific features, some of which favor GDP growth, while others have not dragged down the economy to any considerable extent so far. But this situation is likely to change. So further reforms will be decisive in determining the future performance of the economy.

Although internationalization of the economy has served China well, it is unlikely that the current 35 percent share of GDP claimed by exports and the heavy reliance on foreign technology are sustainable in the long run. Tension between widespread private ownership of firms and pervasive public ownership of assets is another specific feature of the economic system that looks similarly creaky.

For example, by disfavoring lending to private firms, state-owned banks distort the allocation of resources.

Agriculture provides another example of tension between private entrepreneurship and public-sector ownership of assets. In particular, public ownership of land harms the investment incentives for family farms and reduces their chance of consolidating land holdings in order to exploit economies of scale.

Reducing this tension over ownership of firms and assets is imperative, because the entry and expansion of small private companies will be increasingly important when China's domestic markets and domestic innovation need to play a greater role.

Thus, for China to gain maximum advantage from private entrepreneurship, it is important to continue shifting the share of financial assets and land holdings out of the public sector.

This would also help address the endemic corruption that is also a specific feature of the Chinese economic system.

Corruption is difficult to reduce drastically so long as politicians and bureaucrats have much "to sell" to firms and individuals -- including rationed loans from public-sector banks and regulatory permits of various types. In rural areas, corruption emanates from frequent expropriation of land-lease contracts held by farmers working on collectively owned land, which local officials then turn over to non-agriculture land developers.

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