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No secrets to China's success

The Guardian (UK) - August 18, 2009

John Ross – A major international debate has broken out on the success of China's economic stimulus package. Taking non-Chinese writers, I am on one side with Jim O'Neill, chief economist of Goldman Sachs, Professor Danny Quah of the London School of Economics, Mark Weisbrot and others who hold, naturally with differences on "why" and on scale, that China's package is being successful.

On the other side are the Guardian's Larry Elliot, Morgan Stanley's Stephen Roach, Michael Pettis of Peking University, Martin Wolf of the Financial Times and others who consider, again with significant differences on why and scale, that China's economic strategy is wrong, its stimulus package is misconceived, or both, and therefore it will end badly.

The practical importance of this issue is evident. The scales of economic processes involved, as Danny Quah put it, are visible "from outer space". This year China will probably account for the whole of net world economic growth. China's GDP growth is projected to be 8.0% or above. Its economy grew by 7.9% year-on-year in the second quarter and was accelerating. Urban investment increased by 34%, retail sales by 15%.

China's performance is stellar in conditions where this year most major economies will shrink. Compared to such results, talk of possible "green shoots" in other economies relates to minor improvements.

China has good reasons for not seeking to promote its economic model to other countries, or dissuade others from following it. It states its system is "with Chinese characteristics", emphasising its specifically Chinese character. The Chinese authorities rightly constantly explain that their primary duty is to lead a country with more than 1.3 billion people to economic development. But that China does not seek to promote its economic model does not mean that others cannot learn from it.

China's economic success is explicable by normal economics. The specific combination of these policies is, of course, unique and indeed has "Chinese characteristics". But the elements of that economic model are universal in character.

It is therefore worth setting out succinctly why China has had such success in confronting the economic crisis and why its policies are right not only practically but from the viewpoint of economic theory. The mistakes of critics of China's stimulus package can be set out against that framework.

China has a series of interconnected and mutually reinforcing policies.

The first is the economy's high proportion of exports – crucial to its "opening" process. Every economist since Adam Smith has known that the division of labour is a decisive lever in raising the level of productivity, and division of labour in a modern economy is necessarily international. A high level of exports and imports is the way of participating in such a division of labour – as well as benefiting from advantages such as economies of scale.

Economic theory therefore confirms what economic practice already demonstrated. That the alternative to China's open approach, that of inward-looking "import substitution" policies lead to inefficiency in capital use and low productivity.

Critics of China's "export-led growth" confuse two ideas. The first is a high level of exports in GDP, rightly integral to China's growth model, the second is a high trade surplus – not integral to China's model, which appeared only after 2005, and is now disappearing rapidly.

Second is China's high level of investment. Modern econometric research shows conclusively that, following division of labour, the largest element in economic growth is the growth of fixed investment. This applies not only to a developing economy such as China but also to developed economies. Dale Jorgenson, the world's leading expert on productivity growth, notes that "investment in tangible assets is the most important source of economic growth in the G7 nations. The contribution of capital inputs exceeds that of total factor productivity for all countries for all periods."

Criticisms of China's high level of investment would be valid only if China used that investment inefficiently, and contrary to claims made without evidence, all studies on productivity show that China uses that investment with an efficiency rate from respectable to high (pdf).

Third, a decisive point showing China has a "socialist market economy" and not "market capitalism", is its method of macro-economic regulation.

Keynes noted in the final chapter of his General Theory, in a point highly relevant to a situation where mass unemployment is again soaring, that "a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment".

That "somewhat comprehensive socialisation of investment" is impossible in a private sector-dominated economy. The decisive advantage China has in the present crisis is that it does not have to rely only on indirect means (reduction of interest rates, budget deficits etc) to attempt to reverse the plunging investment that is the driving force of this as with every major recession. China can use its large state-owned company sector to increase investment and instruct its state-owned banks to lend. That is why its economy is growing, while Alistair Darling is still pleading ineffectually for UK banks to increase their lending and while UK investment in housing and transport is plunging by 30% and more.

Other points could be added but these three fundamentals are by themselves sufficient to ensure economic success.

For the last 30 years China has enjoyed the world's most rapid economic growth not by accident but because its policies conformed to the basic laws of economic development. Its economic stimulus package is so successful for the same reasons.

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