Key Trends in Globalisation

Unfortunately US neo-cons have not reversed a confrontationist course towards China

The goal of the Obama administration’s ‘pivot to Asia’ was encircling and containing China. This was officially denied but was evident from the facts and, therefore, naturally was transparently clear to China’s leadership,consequently considerably increasing tensions in the Pacific region.

A new element in the ‘pivot’ was the clear US administration calculation that China was now sufficiently strong that the US alone could not by itself feel sure of winning a contest with China in the Pacific. Therefore the US administration attempted to construct an ‘anti-China alliance’

 

US policy steps in line with the ‘pivot’ only made sense in that framework - stationing US military forces in Australia; announcing the Diaoyu Islands were included in the military alliance with Japan; stating 60% of US military forces would be in the Pacific; encouraging Philippine challenges to China, seeking agreements with Vietnam clearly de facto aimed against China.

China undoubtedly attempted to persuade the US against a course of confrontation. In June 2013, shortly after becoming president, Xi Jinping went to California, for a summit with President Obama, to try to establish US-China relations based on what China terms mutual respect for 'core interests'/a ‘new type of relation’ between powers. Regretfully the US did not change its policies. If there was a personal coolness at the Xi-Obama press conference after the APEC summit, as some commentators have suggested, this was possibly due to the fact that Xi’s personal attempt to head off a US-China confrontation had been rebuffed.

Slightly over a year later, around the APEC and G20 summits in November 2014, it is evident that China’s growing strength has won a decisive victory against the US confrontationist policy. But, regretfully, as will be seen, US neo-con forces have not concluded this fight is strategically damaging but merely that the terrain of confrontation with China must be shifted.

Analysing the key developments in the region, Abe’s calculation was that ‘Abenomics’ - yen devaluation to increase exports combined with monetary expansion - would restart Japan’s economic growth while nationalist rhetoric would create political support.

Instead ‘Abenomics’ has failed failed. Japan has re-entered recession.It is clear that Abe's calculations were wrong. Internationally the US economy is not growing fast enough to create a surging market for Japan’s exports and Abe’s confrontation with China damaged exports to the world’s largest goods trading nation. Domestically yen devaluation created inflation without wage growth, cutting Japanese living standards. Abe’s popularity therefore shrank, with him now dashing to a new election before his support errodes further.

To China’s south, India’s new Prime Minister Modi is eager to ensure enhanced US military guarantees for India, but refused to join a strategic ‘anti-China alliance’. Talks during President Xi’s visit to India were constructive and Modi rejected US calls not to join the China supported Asian Infrastructure Investment Bank, with India becoming a founding member.

To China’s north, Russia’s already good ties with China became even closer following US and EU sanctions over Ukraine.

Vietnam recently moved to smooth relations with China, and the Philippines is too weak compared to China to constitute a significant threat.

In the last year therefore, on almost every front in Asia, China used economic strength, skilful diplomacy, and a policy corresponding to Asian countries interests, to win foreign policy victories.

But unfortunately regretfully, instead of concluding that a confrontationist policy should be abandoned, US neo-cons have concluded that they must regroup to launch a renewed confrontations after the APEC and G20 summits.

This was made clear, for example, in an article in the Wall Street Journal sourly analysing the failures of the confrontationist ‘pivot to Asia’. Under the title’ China’s Gift-Bearing Evokes Ancient Ritual’ this analysed, rather ironically for a US which had long used its foreign aid budget and economic strength as a primary foreign policy tool, that:

‘Traditionally, the East Asian order was held together by gift-bearing ritual and ceremony.

‘Spectacular processions from Southeast Asia, Korea and other neighbors turned up at the Chinese court to show their deference by offering “tribute.” Emissaries kowtowed, secretaries stooped, sedan-chair carriers and umbrella holders sweated in the heat.

‘In return, the emperor showered his visitors with presents more lavish than those he received to demonstrate his power and benevolence. Once the political hierarchy had been established, the delegations were allowed to set up stalls in the capital and start trading. Business was a reward for correct behavior.

‘What the U.S. now fears is that recent Chinese pledges of bounty for neighbors is part of an elaborate ruse to push America out of East Asia.’

The reason for the sourness of the tone was the conclusion that:

‘If this plays out as a modern game of checkbook diplomacy, China wins hands down.’

More precisely the Wall Street Journal concluded, surveying recent US foreign policy setbacks: ‘ Xi Jinping ’s pockets are jangling with cash; Barack Obama’s are almost empty. That translates into big political influence for China in East Asia.’

The conclusion that should be drawn by the Obama administration from recent events is that the interests of the US, China, and global stability are best served by accepting the formula proposed by Xi of working out an agreement which safeguards both the US and China’s core interests. In the US Kissinger has put forward a somewhat parallel concept. Instead the renewed course of confrontation proposed by the US neo-cons is likely to lead to further confrontations in the Pacific, which are harmful to global stability - but but also to further US foreign policy defeats of the type that followed the Xi-Obama summit.

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This is an edited and expanded vesion of an article which originally appeared in Chinese in International Finance News.

 

Why China's population is much more optimistic than that of the US

The US Pew Research Center, one of most important global opinion polling organisations, recently concluded ‘pessimism is pervasive’ in G7 countries. IMF Managing Director Christine Lagarde, in a memorable phrase, characterised the situation as ‘the new mediocre’. Indicating how currently depressed spirits are, a New York Times article immediately seized on this phrase to describe not only the economy but everything in the US from fashion, to books to TV shows. Regarding the economy former US Treasury Secretary Laurence Summers characterised the US and G7 economic situation as ‘secular stagnation’ – a prolonged period of very low growth.

Feeding the depressed state is the reality that even when some economic recovery has taken place it has not turned into improvement in ordinary people’s living conditions. Median US wages are lower than seven years ago, while the UK has suffered the most severe fall in personal incomes in the country’s recorded history.

Such economic trends inevitably created an increasingly bitter political atmosphere. A recent US poll found 65% believed future generations would live worse than the present one, while other surveys showed respect for US political institutions at record lows - only 13% of Americans believed the US government could be trusted to do the right things most of the time. A further poll found only 33% of the US population believed the country was going in the right direction, compared to 62% who believed it was going in the wrong one. Europe is witnessing a rise of racist right wing parties, such as the Front National in France, and separatist and independentist movements – most recently in Catalonia.

The same global polling organisations find China remains the exception among major economies. The latest Pew Research Center survey found 87% of people in China were ‘satisfied with the way things are going in our country’ - compared to the US 33%. At the factual level, the latest economic data shows that in the year to the third quarter of 2014 China’s economy grew by 7.3% compared to 2.3% for the US – China’s economy was growing more than three times as fast as the US.

The correlation between these economic developments and public moods is highly rational. Pew’s research showed almost two thirds of economic optimism or pessimism found in opinion polls in a country is accounted for by how fast its economy is growing.

Taking first the bottom of the economic ladder, the reason for much greater optimism in China than in the West is therefore easily explained. One of the most striking World Bank statistics is that there has been no fall in the number of people living in internationally defined poverty in capitalist countries in the last 30 years. The whole decline in the number of those living in poverty is accounted for by countries describing themselves as socialist – above all China.

Taking middle income bands, while median US wages fell in the last seven years, China’s real urban incomes frequently rose annually by not far short of double digit amounts. Much greater satisfaction by average and low income China’s citizens with the country’s direction, compared to the situation in Western countries, is therefore unsurprising.

But a striking feature is that China’s economic improvement is dramatic not only at the middle and bottom of the income ladder but at the top. This was spectacularly highlighted when Alibaba’s IPO raised $25 billion, the largest for any company in history, instantly turning Ma Yun into China’s richest person.

This was only the tip of the iceberg. By 2012 China had 10.9 million private companies, employing 113 million people, plus 40.6 individual enterprises, employing 86.3 million people. No equivalently rapid expansion of private enterprises took place anywhere else in the world. How, therefore, has China, an avowedly socialist state, produced not only the world’s biggest improvement in living standards for ordinary, and the poorest, people but the world’s fastest development of private companies? This combination helps explain the much higher levels of optimism in China compared to US pessimism.

The reasons for both the objective economic dynamic, and its reflection in popular moods, is the way the fundamental economic structure created by China’s economic reforms has successfully aligned all the major forces in its economy. This, as will be analysed, is strikingly unlike the situation in the West, where the economic structure is currently riven by contradictions, with consequent economic misfunctioning, producing the deeply pessimistic economic moods already noted. As the contrast has major lessons for world economy and politics it is worth analysing in detail.

The G7’s proclaimed media self-image is that they are ‘market economies,’ in which large numbers of companies compete on equal terms to produce fair efficient economic outcomes. Small and medium enterprises are particularly held up as the economic exemplar of this.

But this is image of economies dominated by relatively small scale competitive markets ispure myth. In reality a dominant feature of modern production is that it takes place on ever larger scales. The invention of the railway, in the first half of the 19^th century, created for the first time a large industry in which the investment required was so great it produced an inherently monopolistic character – the cost of railway construction being so huge duplicate competitive lines being impractical. Since then pure monopolies spread into further fields of production - the electricity grid in all countries is so expensive it is impossible to create competing systems, the metro system of modern cities is impossibly costly to duplicate etc. In short, in a modern economy a number of economic sectors, are necessarily monopolistic in character and cannot be made competitive.

Even when pure monopoly does not exist, globalisation illustrates that many branches of modern industry require production of dimensions for profitability that they cannot be carried out a purely national scale. There are only two major civil aircraft manufacturers in the world, Microsoft has overwhelming dominance in computer operating systems, outside China Google dominates search engines, less than 10 companies dominate world automobile production etc. In its most developed form this has created the phenomenon of companies recognised as ‘too big to fail’ – i.e. firms operating on such large scales that no alternative can take over their functions without unacceptably destabilising the economy. This reality is explicit in sectors such as banking but, as the state bailout of the US auto companies after 2008 graphically showed, it extends to a far wider range of industries.

Some industries, of course, still remain characterised by competition between large numbers of companies. In addition to obvious small scale ones such as restaurants, hair dressers etc, in an industry such as tourism, one of the world’s largest, no company holds even a 1% market share. But overall large companies which dominate the economy. To illustrate this with a striking statistics, the turnover of the world’s 2,000 largest publicly listed companies, the Forbes 2,000, is equivalent to more than 50% of world GDP.

In short, the concept that a modern economy consists of huge numbers of small scale competing enterprises is an ideological myth. Equally, the West treating a totally uneven and differentiated economic structure as though it were a single ‘market’ has, as will be seen, dangerously negative destabilising tendencies. It is the consequences of this which creates the pessimistic mood in Western economies.

A key example is the banking and financial system, which has been at the core of economic crisis in the G7 economies. The fact the largest private banks are ‘too big to fail’ necessarily incentivises them to extreme risk taking, and even criminal, activity. In a purely competitive economy company risk taking is constrained by the threat of bankruptcy – the latter automatically halting risky, indeed all, activity. But once a private financial institution receives a state guarantee it is ‘too big to fail’, and therefore it will survive whatever its risk taking, pure pursuit of the highest potential return, and consequently the riskiest financial projects, becomes wholly rational - as the private institution will receive the profit if such projects are successful but the state will absorb the losses if they fail. The continuous series of massive private banking scandals – LIBOR, JP Morgan’s ‘Whale’, foreign exchange manipulation etc. – are therefore an inevitable development, as was the huge asset misallocation seen in developments such as the US sub-prime mortgage crisis prior to 2008.

Such ability to undertake ultra-high risk and ultra-high profit activities necessarily also means an increasing part of profit is taken by such private institutions – contributing to the huge increase in the percentage of total US profits taken by the financial sector. Simultaneously, the absorbing of increasingly high proportions of profits by such institutions permits the financing of extraordinarily high pay rates for their top executives, helping ensure that the gains of increased economic output are almost exclusively taken by the best off sections of society – the now notorious problem of the 1% and the 99%.

Such gigantic inequality of outcomes is therefore an inevitable consequence of the real economic structures which exist in the G7 economies, ands necessarily produces not only economic disfunctioning but pervasive popular pessimism of the type already described.

While the purely private operation of privately owned competitive companies may therefore be sufficient, for example, to maintain order and efficiency among small scale producers it is dangerously destabilising for banks or very large scale industry. Consequently, an undifferentiated economic policy cannot be successfully applied across economic sectors which have totally different economic structures - talk of ‘the market’, as though it were the same for local family shops and for large scale banks, is entirely misleading.

Far from being a single ‘market,’ a modern economy has at least three major types of market – pure monopoly, competition between small numbers of very large companies (oligopoly), and competition between very large numbers of small producers (perfect competition). By maintaining the myth that there is only one single type of market the G7 economies conceal economic reality, with the dangerous consequences already noted.

China’s economic structure, ‘socialism with Chinese characteristics’, sharply differs from such Western myths. The very word ‘socialism’ derives from ‘socialised’, i.e. large scale, production. In China the purest form of large scale production, monopolies, remain firmly in state ownership. But, simultaneously, since 1978 China has rejected a distortion, which originated in the post-1929 USSR, that small scale, i.e. non-socialised, production should be in state hands. The largest sector of small scale production, agriculture, is not collectivised, and purely competitive industries are left to the private sector. In competitive sectors dominated by large scale production (oligopoly) both state and private producers have advantages so the best way to test the relative strengths of these is to let them compete.

This structure is why China, a socialist country, also has the world’s most rapidly growing private sector. China has unremittingly affirmed dominance of its state sector. As recently as November 2013, the 3rd Plenum of the Central Committee of the 18th Congress of the Chinese Communist Party, the last top level decision making meeting on China’s economic policy, unequivocally stated: ‘We must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector.’ Furthermore, this is not merely apaper statement - China has by far the largest state sector of any major economy.

But the difference, given the economic structures outlined above, is that whereas in the West the state and private sectors of the economy are seen as counterposed, in China, for structural economic reasons given, they are complimentary.

Western economic experts already concede the results of China’s economic structure isthe greatest economic growth seen in world history. As Nicholas Lardy, one of the most well-known US writers on China’s economy, recently summarized: ‘China’s growth since economic reform began in the late 1970s is unprecedented in global economic history. No other country has grown as rapidly for as long.’ Laurence Summers put it more precisely: ‘China… “already holds the distinction of being the only instance, quite possibly in the history of mankind, but certainly in the data” to sustain super-rapid growth for more than 33 years.’ China simultaneously saw the most rapid rise in living standards of any major economy

The attempt is made in the West to claim that this is nothing to do with China’s specific economic structure and is due only to private companies. But this thesis does not make sense. The great majority of countries in which private companies are dominant - Africa, Latin America, and much of Asia – remained trapped in poverty. As already seen, no major country with an economy based on private ownership has ever achieved China’s rate of economic growth over such a prolonged period.

But, alongside the overall rise in living standards, it is clear why the economic structure outlined explains why China has also produced the world’s most dynamic private sector. While the state should not own the companies in sectors dominated by small scale competition, and it does not in China, this does not mean that such companies do not require the state – not in owning the companies in the sector, but in creating the conditions in which they can best operate. Posed in terms of economic theory a truly (‘perfectly’) competitive market requires strict preconditions – perfect knowledge of market conditions, simultaneous price adjustments, minimal or zero transport costs etc. But these require real material underpinnings. Much of what is popularly referred to as ‘infrastructure’ is in fact the material structures required for efficiently functioning competitive markets – roads, railways, information technology standards and structures, power supply, wholesale markets etc. Many of these, due to their high costs, are monopolistic in character and therefore best supplied by the state. Consequently, even in sectors where the state should not own the operating companies, the state is required to create the conditions for most effective market functioning.

The same applies in sectors where the huge expenditures required are not in production but in research. To take a graphic example, it is a myth that the foundations of the information technology revolution, the cutting edge of US industrial innovation today, were developed by the private sector. They were developed by the US state. As Martin Wolf, chief economics commentator of the Financial Times, put it reviewing the Mariana Mazzucato’s classic study The Entrepreneurial State:

‘innovation depends on bold entrepreneurship. But the entity that takes the boldest risk and achieves the biggest breakthroughs is not the private sector; it is the… state…

‘The US National Science Foundation funded the algorithm that drove Google’s search engine. Early funding for Apple came from the US government’s Small Business Investment Company. Moreover, “All the technologies which make the iPhone “smart” are also state-funded ... the internet, wireless networks, the global positioning system, microelectronics, touch screen displays and the latest voice-activated SIRI personal assistant.” Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation.’

In China, also, the state monopoly on large scale banks is fundamental in keeping down the cost of capital for productive companies. In the West, the high risk strategies which are rational for ‘too big to fail’ private banks mean their assets are most logically deployed in areas offering the highest returns and which therefore typically have the highest risk – derivatives and futures trading, foreign exchange operations, commodities speculation, interest rate arbitrage etc. Such high risk activities can be undertaken on a large scale because fatal losses will be borne by tax payers. To attract savings for such highly profitable, but high risk activities, high interest rates on deposits can be offered. The rates of return on such high risk activities are typically far higher than those achieved by productive companies. Due to such pressure the interest rates for the supply of capital to productive companies is sharply raised. China in contrast, by control of interest rates and restrictions on high profit but high risk financial operations, ensures a lower cost of capital tor productive companies.

By providing both a comparatively cheaper supply of capital plus superior infrastructure, i.e. the material conditions for markets, China’s state dominated economic structures creates particularly favourable conditions for the development of private business. It is therefore by seeing the state and private sectors of the economy as complimentary, not counter posed, that China has produced economic growth never achieved by Western economies. It is this which, in turn, explains the high levels of optimism in China regarding its development compared to the pervading pessimism which currently all studies find gripping the West.

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This article was originally published in Chinese on Sina Finance's Opinion Leaders column.

What the G20 needs to learn from China

Summary

Since 1978 China has seen the most rapid economic growth of any country in world history, and the most rapid growth of living standards of any major economy.

Following the beginning of the international financial crisis China has far outperformed any other major economy – in the six year from 2^nd quarter 2007 to 2^nd quarter 2014 China’s economy grew by 78% and the US by 8%.

In a single generation China has gone from a ‘low income economy’ to the verge of achieving ‘high income’ status by World Bank criteria. China achieving ‘high income’ status will double the number of people living in such economies globally.

This extremely rapid development is sometimes explained in terms of unique ‘Chinese characteristics’, but economic research over the last 30 years shows that the reasons for China’s economic growth are rooted in universal economic processes.

Therefore, while the combination of global forces producing economic growth is unique in China, and produces unique ‘Chinese characteristics’, the forces propelling China’s growth operate throughout the world economy. Other countries can therefore learn from China’s economic success.

The importance of China’s economic success is evident for developing economies – if most other developing economies could achieve the scale of China’s economic success global problems of poverty and its consequences would be solved.

China’s economic success also has decisive lessons for developed economies – China’s policy response to the international financial crisis was far more effective than that of other major economies.

This paper examines the chief strategic lessons to be drawn from China’s success for the G20 economies.

The historical scale of China’s economic success

Since 1978 China has undergone economic growth on a scale unprecedented in world history. To summarise a few key parameters:

• Table 1 shows the percentage of global population in the world’s largest economies at the time they commenced rapid and sustained growth.[1] No other economy remotely approaches the 22% of the world’s population in China in 1978 at the commencement of its sustained rapid economic development. China’s was seven times the relative percentage of the world population of the US or Japan and almost three times that of the USSR at the time of economic ‘lift-off.’
• China’s growth in absolute terms in a single year far exceeds any other country in history. Measured at internationally comparable prices, i.e. parity purchasing powers (PPPs), adjusted for inflation, the greatest absolute increase in GDP in a single year ever recorded outside China was by the US in 1999 when it added $567 billion in output. The highest increase in production every achieved in a single year by Japan, frequently thought of as a post-war ‘miracle economy’, was $212 billion. But in 2010 China added $1,126 billion in output.[2] China’s GDP increase in a single year was more than twice that ever achieved by the US and five times that of Japan.

China’s rapid growth has transformed its place in the world economy. Indeed, the scale of this transition is frequently underestimated, due to use of a misleading method of categorising and ranking countries without taking account of their population. This illogically gives the same weight to Monaco, a country with a population of under 40,000 and a higher per capita GDP than China, and India with a population of 1.2 billion, or Indonesia with a population of nearly 240 million, and lower per capita GDPs than China. This has the effect of confusing, not clarifying, China’s real position in the world economy. Serious calculations of China’s position in the world economy must take population into account.

Making calculations in terms of world population, when China’s ‘reform and opening up’ began in 1978 less than 1% of the world’s population lived in countries with a per capita GDP lower than China’s - 74% lived in countries with a higher GDP per capita measured in current dollars. By 2012 the situation was transformed - 29% of the world’s population lived in countries with a higher GDP per capita than China and 51% lived in countries with a lower GDP per capita – Figure 1. China had therefore moved into the top half of the world’s population in terms of economic development, with less than a third of the world’s population living in more economically developed economies. No comparable improvement in the position of such a large proportion of the world’s population has ever previously taken place in human history.

Figure 1

 

China’s successful response to the international financial crisis

In addition to this long term growth, China has come through the international financial crisis far more strongly than any other major economy. Between the 2^nd quarter of 2007 and the 2^nd quarter of 2014 China’s economy grew by 78% compared to 8% for the US – and the US was the best performing of the major developed economies. Therefore not only was China’s long term growth performance higher than that of other economies but its short term anti-crisis macroeconomic policies were also superior to those of any other major economy.

Figure 2 

Economic laws and specific national situation

This unprecedented scale of China’s economic success evidently leads to the question of how applicable are lessons from China to other countries? This, in turn, immediately encounters the preliminary issue of whether China’s economic development was wholly specific, in which case few if any lessons can be drawn by other countries, or whether it was based on economic forces operating globally – in which case other countries can learn lessons from China.

This issue was well addressed on the opening page of a study by Deng Rong of her father Deng Xiaoping. She notes:

After the People’s Republic was established, we had more than seven years of successful socialist reform and construction. But then, the domestic and international situation, plus the combined influence of our victories, inflated self-confidence, and overheated brains, engendered inside the Party a kind of joyous arrogance. An exaggerated estimation of our accomplishments, plus an eagerness to speed up the progress… further stirred unrealistic thinking and opened a broad avenue for impetuous surges in violation of the laws of economics.[3]

This analysis poses a fundamental question. On the one hand China has insisted on the entirely specific character of its own development – emphasised by its self-characterisation as socialism ‘with Chinese characteristics’, references to a political system ‘with Chinese characteristics’, a legal system ‘with Chinese characteristics’, industrialization ‘with Chinese characteristics’, urbanization ‘with Chinese characteristics’ and the concept of the specific ‘China dream’. [4] As Deng Xiaoping emphasised: ‘To accomplish modernization of a Chinese type, we must proceed from China’s special characteristics.’[5] Similarly Justin Yifu Lin emphasises, discussing practical applications of economic policy:

we can never be too careful when it comes to the application of a foreign theory, because with different preconditions, no matter how trivial they seem, the result can be very different.[6]

This emphasis on specificity is correct. In fact, to pose the issue in the most general terms, not merely is each country different, but each country is itself different at each point in time – specificity is not only geographic but chronological. Not only is Germany not China, but China in 1949 is not China in 2014. In the famous and correct dictum of Heraclitus, nobody ‘ever steps in the same river twice’.

Nevertheless, simultaneously with this insistence on the entirely specific character of China’s development, Deng Rong’s passage speaks of ‘laws of economics,’ and ‘laws’ by their nature are universal. Deng Xiaoping stated this clearly by speaking not only of China’s specific character, its ‘Chinese characteristics’, but also that: ‘We have tried to act in accordance with objective economic laws.’[7] Is there, therefore, a contradiction between the simultaneous assertion of the entirely specific character of China and of ‘universal’ economic processes?

A unique combination of universal elements

In reality there is no contradiction between the idea of China’s uniqueness and of universal/global elements. Any practical economic analysis is not of an abstract idea but of a material reality. The fundamental structural elements of every economy (consumption, investment, savings, primary industry, manufacturing industry, service sector, trade, money etc.) are universal. But the specific way in which these universal elements combine and are interrelated in any economy is entirely unique both in place and time.

It follows from this no country can copy another. If one country applies the same policy as another, in what is inescapably its own and therefore a different situation, it is necessarily making a mistake – not only the other country’s situation but its own is specific. But, equally, a country can learn from others, as China did, by analysing the elements of which other economies are composed, and analysing how these elements combine differently in its own specific situation.

Deng Xiaoping, and the other architects of China’s economic reform, were therefore accurate in stating simultaneously that China’s policies were wholly specific and that they were acting in accordance with ‘universal’ economic forces. It therefore follows that other countries can learn lessons from China’s economic development – not in terms of mechanically copying policies, as the specific form of these is determined by the unique situation of China, but in terms of analysing the universal/global elements of which China’s economic policy is composed, and understanding how these combine in the unique conditions of another country.

Universal elements

In order to understand the relation between the universal elements in economic growth and their specific combination in China, and derive lessons for other countries, it is consequently necessary:

i. to study these universal elements;

ii. To analyse the specific combination of these elements in China.

It is this fact that, while China’s economic policy is entirely specific both in time and place, nevertheless it is composed of elements which are universal and global in character, which allows lessons to be drawn by other countries from China’s experience. However to analyse these ‘universal’, that is global, elements accurately it is necessary to grasp advances in understanding of the causes of economic growth, and its measurement, in the last decades.

Modern advances in Western econometrics

In the last three decades major advances in measurement of the causes of economic growth have taken place, leading to clearer understanding of economic growth in general and also the causes of China’s economic growth. These advances, which are now formally recognised by the UN, US, and OECD may be briefly summarised.

The formalisation of the study and measurement of the causes of economic growth, technically known as growth accounting, was carried out in the 1950s by Robert Solow.[8] Solow himself primarily considered two inputs, capital and labour, but a strength of his framework was that other inputs can and have been added.[9] In his ground-breaking papers Solow, however, made two errors which were corrected later by others and which are directly relevant to analysis of economic growth in general, of China and Asia’s economic success, and therefore of conclusions that may be drawn from it.

• First, Solow did not include ‘intermediate products’, the unfinished inputs of one industry into another, in his analysis. This was crucial quantitatively because factual study shows intermediate products grow even more rapidly than capital, labour, and productivity during economic development. This rise of ‘intermediate products’ is an index of the growing division of labour domestically and internationally.
• Second, Solow’s calculations made the error of not taking into account improvements in the quality of investment and labour. This led to the erroneous conclusion that the majority of economic growth came from productivity increases – an error repeated in some discussions of China.[10] This latter mistake was subsequently corrected, and accurate methods of calculating growth were formally adopted by the US, UN and OECD.[11]

Such corrections are important for economies in general and are of particular relevance for China – many continuing errors in interpreting China’s economic growth turn out to not to be due to problems in China but to people using inaccurate measuring rods![12]

Accurately measuring with the most advanced Western econometric methods, it is easy to show that China’s economic growth follows an entirely comprehensible pattern – confirming Deng Xiaoping’s assertion that China simultaneously follows an entirely specific path of development, its ‘Chinese characteristics,’ and the ‘universal laws’ of economics.

These issues allow a clear understanding of the ‘universal’ elements of China’s growth, and therefore the lessons that may be drawn by other economies.

Division of labour

The first key issue is the notable ‘openness’ of China’s economy – the results of its conscious process of post-1978 ‘opening up’. This, however, in turn is based on the determinants of economic growth in general and therefore applies to all economies.

The significance of Solow’s error in leaving out intermediate products was immediately highlighted by empirical studies confirming that the growth of intermediate products, i.e, increasing division of labour, is the most rapidly expanding factor in economic development. For example, regarding the US, the most developed economy, Jorgenson, Gollop and Fraumeni found:

the contribution of intermediate input is by far the most significant source of growth in output. The contribution of intermediate input alone exceeds the rate of productivity growth for thirty six of the forty five industries for which we have a measure of intermediate input.[13]

Considering findings for the US economy in more detail Jorgenson noted:

Comparing the contribution of intermediate input with other sources of growth demonstrates that this input is by far the most significant source of growth. The contribution of intermediate input exceeds productivity growth and the contributions of capital and labour inputs.[14]

To illustrate this, Table 2 shows Solow’s original growth accounting categories – capital, labour, TFP - together with a column for growth of intermediate inputs. As may be seen, over the period 1977-2000, the median rate of growth of intermediate inputs in the US economy was 115% of the rate of growth of US GDP - far higher than any other input.

The same result as for the US was found for other economies - specifically including China. Regarding rapidly growing Asian economies:

• For South Korea, Hak K. Pyo, Keun-Hee Rhee and Bongchan Ha found regarding material intermediate inputs: ‘The relative magnitude of contribution to output growth is in the order of: material, capital, labour, TFP then energy.’[15]
• For Taiwan Province of China, analysing 26 sectors in 1981-99, Chi-Yuan Liang found regarding intermediate material inputs: ‘Material input is the biggest contributor to output growth in all sectors during 1981-99, except… seven’.[16]
• For mainland China, Ren and Sun found that in the period 1981-2000, subdivided into 1984-88, 1988-94 and 1994-2000: ‘Intermediate input growth is the primary source of output growth in most industries.’[17]

Division of labour at an international level - China’s ‘Opening Up’

This question of understanding the importance of division of labour makes clear, from a global/universal economic perspective, the significance of China’s ‘opening up’ policy. Division of labour is not purely domestic. The key trends in globalisation - rising share of trade in GDP, rising ratio of foreign direct investment to GDP, plus studies of particular industries - are all powerful evidence of increasing international division of labour.

These realities therefore have immediate consequences for China’s ‘opening up’ strategy. In particular, the fact division of labour is the most powerful quantitative factor in economic growth immediately determines which development strategies will and which will not work.

The consequences of division of labour being the most powerful factor in economic growth drives globalization and dooms ‘import substitution’ strategies – the latter being the dominant form of attempts to build up a self-contained national economy.

Success of ‘opening up’

A wide range of empirical studies supports the theoretical conclusion that more outwardly oriented economies achieve significantly higher rates of real growth of GDP. It is China’s rejection of ‘import substitution’ strategies that is the first feature of its economic policy.

The success of China’s ‘opening up’ policy is so evident, and has been stressed by numerous authors, that it is unnecessary to give excessive detail here.[18] It is however highly significant that China is much more open to international trade than the US. As Japan is the world’s third largest economy, it is also illustrative to include it comparisons.

As shown in Figure 3, in 2012 China’s exports were 27% of GDP compared to only 15% for Japan and 14% for the US. Consequently China’s export sector is almost twice as large a proportion of its economy as is that of the US. That China is a much more open economy in trade than the US or Japan gives a competitive advantage over the US and Japan in promoting more rapid growth.

China’s openness to foreign trade is also much higher than a number of other large developing economies.

Figure 3

 

Investment

After division of labour, modern economic research shows capital investment is the second most important source of economic growth. This is of particular relevance to studying China, and economic growth in general, and therefore lessons of this from China are relevant for all economies.

The finding that investment is the second most important force in economic growth, considerably exceeding the contribution of productivity, was seen not only in China but in all rapidly growing Asian economies - Asia being the only part of the world in which countries have gone from poverty to ‘first world’ living standards in a single lifetime. Analysing what created this ‘Asian miracle’ is therefore evidently of great importance not only for China’s but for economic policy of all countries.

The result of applying up to date economic methods to study Asia’s rise to prosperity is clear - and directly underpins drawing lessons from China’s economic success. After division of labour, both domestic and international, reflected in their ‘open’ character, the overwhelming cause of Asian economies rise to prosperity was their huge accumulation of investment. As Vu Minh Khuong finds in his magisterial The Dynamics of Economic Growth, by far the most comprehensive study of Asia’s economic growth: ‘Capital accumulation was… the primary driver of Developing Asia’s lead over other parts of the world in terms of economic growth.’[19]

There were no exceptions in this pattern of successful Asian development: ‘The pattern of rapid growth driven by intensive capital investment… is consistent over time and robust to different types of economies in terms of size, location… and level of development.’ [20]

Very high capital investment accounted for 54% of the growth lead of developing Asian economies over the Western industrialized economies and for 62% of developing Asia’s lead over other developing economies. High capital investment was almost twice as important as productivity increases in explaining Asia’s growth lead over advanced economies.

China’s pattern of very high capital accumulation was therefore the most advanced case of the ‘Asian miracle’ –a clear illustration of the fact that while the specific combination of elements was entirely unique in China, creating its ‘Chinese characteristics’, the economic driving forces of China’s growth were universal/global in character, and therefore other countries can learn from them. In particular, as Vu notes: ‘The pattern showing the stronger expansion of fixed investment relative to GDP was even more notable for China, which was the most rapidly growing economy in the region during 1990-2010.’ [21]

Again giving exact numbers: ‘the share of the [developing Asian] region in the world’s GDP increased by 14.9 percentage points during 1990-2010, while its share in the world’s fixed investment rose by 29.1 percentage points… China’s share in the world’s GDP increased by 10.1 percentage points, while its share in the world’s fixed investment raised by 24.7 percentage points.’[22]

Capital accumulation as the global driving force of growth

It is crucial to understand that the fact investment was this driving force of Asia’s rise to prosperity was not unusual. Modern econometrics shows clearly that investment is the main factor, after division of labour/intermediate products, in economic growth in all parts of the world economy:

the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide… This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity (TFP) for all countries for all periods examined. [23]

The specific feature of China’s rapid economic growth, and the East Asian economies rise to prosperity, was therefore not that it was ‘investment led’ but simply the exceptional quantitative degree to which China mobilised investment. Dale Jorgenson, the world’s leading authority on measurement of the causes of economic growth, whose work led to the changes in the methods of official calculation of economic productivity and growth in the US, OECD and UN, writes in his introduction to Vu’s study:

The emergence of Asia… is the great economic achievement of our time. This has created a new model for economic growth built on globalization and the patient accumulation of human and non-human capital. [24]

The study of Asia also confirms previous findings that as a country moves towards being an advanced economy，the role played by investment in its growth increases. This is shown in the chart below. Taking countries in ascending order of economic development, the percentage of growth due to investment is 50% in non-Asian developing economies, 55% in Asian developing economies and 57% in advanced economies. Growth in advanced economies is therefore more ‘investment led’ than in developing economies, and development to advanced economy status leads to growth becoming more investment intensive.

Figure 4

 

The quantitative determinants of economic growth

These global facts have clear implications for China and for economic growth in general – and therefore for lessons other economies can learn from China. Productivity is too small a part of economic growth, accounting for only 11% of growth in advanced economies, to be the main driver of development compared to capital investment which accounts for 57% of growth. Any policy relying primarily on boosting productivity therefore cannot be successful for basic quantitative reasons

Attention must naturally be given to maintaining the highest possible rate of productivity growth, via a high marginal rate of return on capital, but the largest part of growth will necessarily have to come from investment. As Vu notes: ‘The secret of successful Asian economies, therefore, lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods.’[25]

Successful and failed strategies for growth

These modern advances in the study of measurement and causes of economic growth, as well as the practical examples of China’s and Asia’s economic growth, settle the issue of the difference between two possible growth strategies, and also explain why the Western economies are relatively stagnant compared to China and the dynamic Asian economies.

(i) The first strategy, the one confirmed by the facts, is that the primary force in economic growth is accumulation of capital and labour (factor accumulation) and that productivity (Total Factor Productivity - TFP), while significant is less quantitatively important than factor accumulation. This growth strategy was pursued in the developing Asian economies and above all in China. It has been a spectacular success, creating the fastest increases in living standards ever seen in human history, lifting hundreds of millions out of poverty, now creating `first world' living standards in a series of what were originally `third world' countries (south Korea, Singapore etc.), and bringing China from a poor country to the brink of ‘high income’ countries by World Bank criteria.

(ii) The alternative strategy says that factor accumulation, of capital and labour, is not nearly as important for growth as TFP. This is the policy that has been applied in the advanced economies, and has accompanied their economic slowdown. As Jorgenson notes: `The growth strategy of many advanced economies emphasizes innovation, which has been quite satisfactory for the past decade, but neglects investment in human and non-capital, which continues to fall.'[26]

The two different analyses have different practical policy conclusions:

(i) if the most important driver of economic growth is factor accumulation then the most important policies are those promoting high rates of factor growth. These include high savings rates (to finance capital investment), policies to widen participation in the labour force (as this increases labour supply), promotion of education (as this increases labour inputs via increasing labour quality) etc. A reasonable rate of growth of TFP is important, but quantitatively not as important as policies which facilitate factor accumulation. As Vu summarizes the results: `the secret of the Asian growth model lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods.'[27]

Modern econometrics shows clearly also that investment is the main factor in economic growth in all parts of the world economy: `the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide. For example, Jorgenson and Siroh..., Oliner and Sichel... found that capital input is the most important source of growth in most economies. This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... even for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity for all countries for all periods examined. This finding is supported by the results... that, on average, capital input accounted for approximately 57 per cent of GDP growth in the industrialized group.'[28]

(ii) Alternatively, if the main locomotive of growth is believed to be TFP growth, then initiatives promoting factor accumulation (high saving rates, widening participation of the population in the work force etc.) are not so important as policies assumed to increase productivity.

The facts confirm that the downplaying of factor accumulation (capital investment and labor development) in the advanced economies has been unsuccessful as a growth strategy. This is inevitable as TFP by itself is too small a part of the economy to create rapid economic growth.

It is therefore inevitable that as Jorgenson notes, the successful growth strategy of Asia, and China in particular, is counterposed to, and has proved itself superior, to those strategies based on TFP growth (innovation, entrepreneurship) in Europe and the US. As Jorgenson notes: `Economic commentators, especially those outside Asia, have been reluctant to recognize the new paradigm for economic growth that originated in Asia, since this would acknowledge the failure of Western ideas that still greatly predominate in the literature on economic growth and development.'

Conclusion

1. China’s economic development has a unique and specific character – its ‘Chinese characteristics’. This unique character is, however, a specific combination of economic forces which are global in character. Those who created China’s economic policy, notably Deng Xiaoping, were therefore correct in their claim to be simultaneously following uniquely Chinese policies and to be operating according to ‘universal laws’ of economics. It follows that other economies cannot mechanically copy China but can draw clear lessons from its economic success.

2. The ‘opening up’ policy of China is rooted in the fact that domestic and international division of labour, reflected in the growth of intermediate products, is the most powerful force of economic development. Only an ‘open’ policy, that is participation in international division of labour, and not import substitution, can be the basis of rapid economic growth in any economy.

3. China’s pattern of growth driven by very high investment levels but corresponds to the general forces propelling economic growth. Capital investment is, after division of labour, the second most powerful force of economic growth. This applies in both developed and developing economies. For basic quantitative reasons, therefore, strategies based on TFP growth (e.g. promoting ‘entrepreneurship’) cannot be successful in generating economic growth – this explains the relative stagnation of the Western economies. This reality also shows the correctness of concepts, such as those of Justin Yifu Lin, that the key goal of development policy should be to alter ‘factor endowments’ so that economies for their development gradually make the transition from labour intensive to capital intensive production.

*   *   *

This paper was presented to the G20 Summit Think Tanks meeting organised by Chongyang Institute for Financial Studies, Renmin University of China in Beijing on 3 September 2014.

Notes

[1] This is of course rapid growth by the standards of the relevant period.

[2] Calculated from (The Conference Board, 2014) Calculated in EKS PPPs

[3] (Deng R. , 2002, p. 1)

[4] The different categories with ‘Chinese characteristics’ are from (Wen J. , 2011). The term ‘China Dream’ is of course from Xi Jinping.

[5] (Deng X. , 30 March 1979)

[6] (Lin, 2012, p. 66) Emphasis deleted from the original.

[7] (Deng X. , 30 March 1979, p. 173) Equally Deng Xiaping spoke of the ‘universal truth of Marxism-Leninism’ (Deng X. , 2 June 1978). This insistence that China acted simultaneously in accord with its specific conditions and universal laws was continuously asserted by Deng Xiaoping in numerous different contexts. For example:

‘Our principle is that we should integrate Marxism with Chinese practice and blaze a path of our own. That is what we call building socialism with Chinese characteristics.’ (Deng X. , 21 August 1985)

‘The Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China.’ (Deng X. , 31 May 1980)

‘the Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China, we should not demand that other developing countries, let alone the developed capitalist countries, adopt our model in making revolution. Of course, one cannot demand that they all adopt the Russian model, either.

‘We were victorious in the Chinese revolution precisely because we applied the universal principles of Marxism-Leninism to our own realities.’ (Deng X. , 28 August 1985)

‘Comrade Mao Zedong successfully integrated the universal principles of Marxism-Leninism with the realities in China’ (Deng X. , 13 October 1987)

[8] (Solow, 1957)

[9] For an extended analysis of some of these major changes see (Jorgenson D. W., 2009)

[10] See for example (Zheng, Bigsten, & Hu, 2009)

[11] For a conceptual explanation of the changes see (Jorgenson D. W., 2009). For detailed technical studies see (OECD, 2001) and (OECD, 2009).

[12] See for example (Zheng, Bigsten, & Hu, 2009). The whole framework of this is a false assumption that the majority of world economic growth is due to productivity increases.

[13] (Jorgenson, Gollop, & Fraumeni, 1987, p. 200)

[14] (Jorgenson D. W., 1995, p. 5)

[15] (Pyo, Rhee, & Ha, 2007)

[16] (Liang C.-Y. , 2007)

[17] (Ren & Sun, 2007)

[18] See for example Lardy (Lardy, 1993) and Cao et al (Cao, Ho, Jorgenson, Ren, Sun, & Yue, 2009).

[19] (Vu, 2013, p. 198)

[20] (Vu, 2013, p. 198)

[21] (Vu, 2013, p. 196)

[22] (Vu, 2013, p. 195)

[23] (Vu, 2013, p. 198)

[24] (Vu, 2013, p. vii)

[25] (Vu, 2013, p. 242)

[26] (Vu, 2013, p. viii)

[27] (Vu, 2013, p. 242)

[28] (Vu, 2013, p. 198)

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Deng, X. (13 October 1987). We Are Undertaking an Entirely New Endeavour. In Selected Works of Deng Xiaoping Vol. 3 1982-1992 (1994 ed., pp. 249-252). Beijing: Foreign Language Publishers.

Deng, X. (21 August 1985). Two Kinds of Comments About China's Reform. In Selected Works of Deng Xiaoping Vol. 3 1982-1992 (1994 ed., pp. 138-9). Foreign Languages Press.

Deng, X. (28 August 1985). Reform is the only way for China to develop its productive forces. In X. Deng, Selected Works of Deng Xiaoping 1982-1992 (1994 ed., pp. 140-143). Beijing: Foreign Languages Press.

Deng, X. (30 March 1979). Uphold the Four Cardinal Principles. In 2001 (Ed.), Selected Works of Deng Xiaoping 1975-1982 (pp. 166-191). Honolulu: University Press of the Pacific.

Deng, X. (31 May 1980). An important principlefor handling relations between fraternal parties. In X. Deng, Selected Works of Deng Xiaoping 1975-1982 (1984 ed., pp. 300-301). Honolulu: University Press of the Pacific.

Jorgenson, D. W. (2009). 'Introduction'. In D. W. Jorgenson (Ed.), The Economics of Productivity (pp. ix-xxviii). Cheltenham, UK: Edward Elgar.

Jorgenson, D. W., Gollop, F. M., & Fraumeni, B. M. (1987). Productivity and US Economic Growth. New York: toExcel.

Lardy, N. R. (1993). Foreign Trade and Economic Reform in China 1978-1990. Cambridge, UK: Cambridge University Press.

Liang, C.-Y. (2007). ‘Industry-Wide Total Factor Productivity and Output Growth in Taiwan, 1981-1999’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 146-184). Cheltenham: Edward Elgar.

Lin, J. Y. (2012b). Demystifying the Chinese Economy. Cambridge UK: Cambridge University Press.

Maddison, A. (2010). Statistics on World Population, GDP and Per Capita GDP, 1-2008 AD . Retrieved January 23, 2011, from Angus Maddison (1926-2010): http://www.ggdc.net/MADDISON/oriindex.htm

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OECD. (2009). Measuring Capital, OECD Manual 2009. Paris: OECD.

Pyo, H. K., Rhee, K.-H., & Ha, B. (2007). ‘Growth Accounting and Productivity Analysis by 33 Industrial Sectors in Korea (1984-2002)'. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 113-145). Northampton: Edward Elgar.

Ren, R., & Sun, L. l. (2007). ‘Total Factor Productivity Growth in Chinese industries, 1981-2000’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia, Economic Growth and Competitiveness (pp. 76-112). Northampton: Edward Elgar.

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Vu, K. M. (2013). The Dynamics of Economic Growth - Policy Insights from Comparative Analyses in Asia. Cheltenham, UK and Northampton, M.A., US: Edward Elgar.

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Zheng, J., Bigsten, A., & Hu, A. (2009). 'Can China's Growth Be Sustained? A Productivity Perspective'. World Development, 37(4), 874-888.

Why private companies grow fast in socialist China

A striking feature of China's economic development is the breadth of social layers benefitting from it. At the bottom of the economic ladder, China has lifted over 600 million people from internationally defined poverty - accounting for the entire global fall in the number of those living in poverty. Taking middle incomes, while median U.S. wages have fallen in the last seven years, China's real urban incomes rose annually by not far short of double digit figures. At the top income level Alibaba's IPO, raising US$25 billion, the largest for any company in history, turned Ma Yun into China's richest person.

The soaring Alibaba [By Zhai Haijun/China.org.cn]

But Alibaba is the tip of an iceberg. By 2012, China had 10.9 million private companies, employing 113 million people, plus 40.6 million individual enterprises, employing 86.3 million people. No equivalently rapid expansion of private enterprises has taken place in any other country. How, therefore, has socialist China produced not only the world's biggest improvement in living standards for ordinary, and the poorest, people but also the world's fastest development of private companies?

The reason is that China's economic structure successfully aligns all major economic forces. This is strikingly unlike the current situation in the G7 - which was characterised by IMF Managing Director Christine Lagarde economically as "the new mediocre" and Pew International Research polling found the prevailing mood as "pessimism is pervasive." As the contrast, the continued rapid development by China's private companies demonstrates the advantages of China's economic structure, which has major lessons globally.

Taking first the West, the G7 proclaim themselves "market economies," in which large numbers of private companies compete equally to produce fair and efficient economic outcomes. Small and medium private enterprises are held up as their economic exemplar.

But this image of economies dominated by relatively small scale production, with perfectly competitive markets, is a myth. A dominant feature of modern economies is increasingly large scale production. In a number of sectors the investments required are so large they produce pure monopolies - railways, the electricity grid, metro systems in modern cities etc.

Even when a pure monopoly does not exist, globalization illustrates the way that many branches of modern industry require production on an extremely large scale to be competitive - therefore it cannot be carried out purely nationally. The world only has two major civil aircraft manufacturers, less than 10 companies dominate world automobile production etc.

In its most developed form this creates companies recognized as "too big to fail" - firms operating on such large scales that no alternative can take over their functions without dangerously destabilizing the entire economy. This is explicit in sectors such as banking but, as the state bailout of the U.S. auto companies after 2008 illustrated, it extends to far wider ranges of industries.

Some economic sectors, naturally, remain characterized by competition between large numbers of companies - in tourism, one of the world's largest industries, no company holds even a 1 percent market share. But overall, large companies dominate. The turnover of the world's 2,000 largest publicly listed companies is equivalent to more than 50 percent of world GDP.

The ideology put forward in the West that a modern economy consists of huge numbers of small scale competing enterprises is therefore myth. Equally, the West treating a totally differentiated economic structure as though it were a single "market" has dangerously negative consequences - which actually inhibits development by private companies.

A key example is the financial system, which has been the core of economic crisis in G7 economies. The largest private banks being "too big to fail" necessarily incentivizes extreme risk taking, even criminal, activity. In a pure competitive economy, company risk taking is constrained by the threat of bankruptcy, but once a private financial institution receives a state guarantee as "too big to fail," pursuit of the highest potential return, and consequently the riskiest financial projects, becomes rational - the private institution receives the profit if such projects are successful but the state absorbs the losses if they fail. The continuous series of private banking scandals such as LIBOR, JP Morgan's "Whale" trading, and foreign exchange manipulation, are therefore inevitable, as was the huge asset misallocation seen in developments such as the U.S. sub-prime mortgage crisis prior to 2008.

Far from being a single "market," a modern economy has at least three major types of market - pure monopoly, competition between small numbers of very large companies (oligopoly), and competition between very large numbers of small producers (perfect competition). An undifferentiated economic policy therefore cannot be successfully applied across economic sectors which have totally different economic structures.

China's economic structure - "socialism with Chinese characteristics," sharply differs. The very word "socialism" derives from "socialized," i.e. large scale production. In China the purest form of large scale production, monopolies, are state owned. But, simultaneously, since 1978 China has rejected a distorted idea, originating in the USSR, that small scale, i.e. non-socialized, production should be in state hands. China's agriculture is not collectivized, and purely competitive industries are left to private companies. In competitive sectors dominated by large scale production both state and private producers have advantages, so the best way to test their relative strengths is to let them compete - as China does.

This structure explains why China, a socialist country, has the world's most rapidly growing private sector. China affirms the dominance of its state sector, but whereas in the West state and private companies are seen as counterposed, in China, for the structural reasons given, they are seen as complementary.

The economic structure of China has produced the greatest economic growth in world history. As Nicholas Lardy, one of the chief U.S. writers on China's economy, recently summarized: "China's growth since economic reform began in the late 1970s is unprecedented in global economic history. No other country has grown as rapidly for as long."

China's economic structure reinforces the world's most dynamic private sector. While the state should not own companies in sectors dominated by small scale competition, and in China it does not, this does not mean such companies do not require the state. Economic theory shows an efficient competitive market requires preconditions - perfect knowledge of market conditions, simultaneous price adjustments, and minimal or zero transport costs. But these require real material underpinnings to be realized, and a lot of "infrastructure" is actually structures required for efficiently functioning competitive markets such as transport, information technology standards and structures, and wholesale markets. Frequently, due to their high costs, these are monopolistic and consequently best supplied by the state. Therefore, even in sectors where the state should not own the operating companies, the state is required to create the conditions for effective market functioning.

The same applies where research requires huge expenditures. To take a graphic example, it is a myth that the foundations of the information technology revolution, the cutting edge of U.S. industrial innovation, were developed privately. They were created by the U.S. state. As Martin Wolf, chief economics commentator of the Financial Times, wrote in a review of Mariana Mazzucato's "The Entrepreneurial State:"

"All the technologies which make the iPhone 'smart' are… state-funded ... the Internet, wireless networks, the global positioning system, microelectronics, touch screen displays and the latest voice-activated Siri personal assistant. Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation."

Regarding financing of private companies, in China, the state monopoly of large scale banks reduces the cost of capital for productive companies. In the West, high risk strategies, rational for "too big to fail" private banks, mean their assets are deployed in areas offering the highest returns and which therefore typically have the highest risk - derivatives trading, interest rate arbitrage etc. These can be undertaken on a large scale because fatal losses will be borne by tax payers. This has the effect of concentrating profits into the private financial sector. To attract savings for extremely profitable high risk activities, high deposit interest rates can be offered. Due to such pressure interest rates for supply of capital to productive companies is sharply raised. China in contrast, by controlling interest rates and restrictions on high profit but high risk financial operations, ensures a lower cost of capital for productive companies.

By providing both a cheaper supply of capital, plus a superior infrastructure, China's economy creates particularly favourable conditions for the development of productive private business. By seeing state and private sectors as complimentary, China produced economic growth never achieved by Western economies. It is also why socialist China has the world's most dynamic private sector.

*   *   *

This article originally appeared on China.org.cn.

China and the APEC summit

Video of my TV interview with CNC (Xinhua News Agency TV) on China's rise and its impact on APEC can be watched here.