Galbraith on China’s Model of Economic Growth

I have been reading James Galbraith’s book The Predator State. Good reading, one of the most thorough defences of post-Keynesian economics I’ve come across in awhile. I thought his description of the Chinese economy, and how it functions, was extraordinarily novel. He’s writing this in 2008 and there’s certainly been a lot of changes since then, some of which he notes are on the horizon.

I’ve never seen anyone focus on the role of banks quite like he does. I know Harry Sanderson has explored the Chinese banking system in China’s Superbank, but I’ve not read it and do not know how much the arguments align. It’s also worth noting that Deborah Brautigam says that China’s EXIM Bank is what everyone needs to understand to ‘get’ China in Africa right now. Anyways, now on to what I hope is a ‘fair use’-level of copying and pasting from a book:


Now a new star rose in the East: the People’s Republic of China. China’s emergence as a world trading power, as a place where real living standards have, on average, risen fourfold in twenty-five years, and as the holder of the second largest bilateral trade surplus with the United States, bears an especially cool-eyed examination. How is it that an ostensibly communist country, practicing the strictest form of capital control in the modern world, could emerge as the most rapidly rising trading partner of the United States, in the era thought most profoundly to symbolize the triumph of free trade? The answer usually offered to American readers is “low wages.” And indeed wages in the Chinese manufacturing sector, when measured in dollars, are very low. But the vision of a country of concentration camps and slave labor is belied by any visit to the exporting regions of China, which are bustling, prosperous, and largely free of the human degradation associated with the severe poverty still found in rural China or 1452

Then there is the mute testimony of the security arrangements surrounding the zones themselves, in places like Zhuhai and Shenzen. Checkpoints exist, but they face outward: there is control on entry but none on the exits. Allowing for the fact that much of the labor is that of young women on jobs of extremely short tenure, relative wages in Chinese export-oriented manufacturing are not very low by Chinese standards, and real wages in the exporting regions—wages measured in terms of the consumption goods they provide for—are not low at all by the larger standards of working populations in the developing world. The reason is that the food, clothing, transportation, and much of the housing available to workers in China is extremely cheap. Where wages are a tenth or less of American values, the prices of necessities are at least that much lower than in the United States.

Working people in Chinese cities are largely fit, literate, and well fed; the difference in living standards consists largely in amenities—living space, cars, boats, plasma televisions, distilled spirits—that the ordinary Chinese household does not consume at all. How do the Chinese achieve this? Not by planning, and not by avoiding the competitive pressures of the free market in consumer goods. Quite to the contrary: China enjoys the largest number of small producers and the most diverse and competitive consumer marketplace on the planet. Correspondingly, many of these firms perform as the competitive model predicts: they earn profits rarely, losses often. How then do firms survive? Why does China prosper? How can it continue to grow at reported rates near 10 percent, through the Japanese depression, the Asian crisis, the Russian crisis, the Internet bust? The answer is, once again, not to be found in the trading arrangements so much as in the structure of financial control. For in this area, China benefits from its underdevelopment.

A key and unique feature of the Chinese scene is the relative absence of a developed market for capital assets. Such markets—for stocks and corporate control—do exist; indeed the Shanghai stock market went on an epic run in the mid-2000s.* But the capital markets have limited scope, limited liquidity, and limited power. Most firms are not publicly valued and not easily traded; in this important sense, “property rights” in the firm are limited. Diverse ownership form and relatively small scale are especially characteristic of the vast array of consumer goods producers that now dominate manufacturing in southern China. Though formerly owned by villages and townships in many cases, they have been recently privatized—sold off to managers or workers’ collectives—not because they are profitable but because they are not. Selling them off removes their direct claim on the local budget. 1475

In these circumstances, capital markets do not exercise discipline over the medium-term financial performance of manufacturing firms. Firms can run losses, and their shares do not collapse, they are not subject to hostile takeover, and their managements are not replaced. When they run profits (with difficulty, but it does happen) their managers are not enriched per se; there is graft and there is speculation, but there is relatively little possibility, for most executives, of selling out and retiring on the proceeds. To make money in this situation requires preserving the enterprise as a going concern. And that means passing whatever financial scrutiny would otherwise cause the firm to lose credit and to be shut down. In China, this scrutiny is extremely weak.

In China, financial supervision is nominally the province of the banks (as it would be for small businesses in the West), but banks in China do not perform this function well. Being state owned, historically policy oriented, and anyway nominally insolvent owing to a large inventory of nonperforming loans, banks tend to support firms through long periods of low profitability or actual losses. The loans often go bad, but so what? Nonperforming loans of the state-owned banking sector are essentially contingent debt of the state itself, which will not (and cannot) permit the banking sector to fail. The consequence is, as noted, a proliferation of manufacturing firms and extreme competition in the production of basic consumer goods: clothing, small durable goods, electronics, household items, and food. This competition results in a condition of chronic glut in consumer markets. This is evident in the fact that sidewalks across China are covered with stalls. Price competition is phenomenal, as any casual visitor can find out: with minimal effort, prices will fall to a tenth or less of the original offer.

There is little possibility that such prices cover the fixed costs of those who produce the goods on offer. Is there any way for the Chinese manufacturing firm to turn a profit? Yes: the alternative to selling on the domestic market is to export. And export prices, even those paid at wholesale, must be multiples of those obtained at home. But the export market, however vast, is not unlimited, and it demands standards of quality that are not easily obtained by neophyte producers and would not ordinarily be demanded by Chinese consumers. Only a small fraction of Chinese firms can actually meet the standards. Those standards must be learned and acquired by practice. Luckily, one does not need to visit the pole in order to find the direction; an ordinary compass will show you the way.

For the typical Chinese light-industrial manufacturing firm, the optimal strategy for earning a profit eventually is to aim, at least in some ultimate sense, for exports. It is to produce and produce, gaining practice, improving quality, and demonstrating reliability—in the hope of eventually selling part of production on the export market—perhaps first to some low-income venue such as India, later to middle-income countries such as Turkey or Mexico, and ultimately to the United States and Europe. For this, labor must be treated as a fixed cost. That is, production must continue regardless of demand. The strategy will be defeated, from the beginning, if firms must interrupt production and dismiss workers simply because the output they are producing cannot be sold immediately at the Wal-Mart price.

So what to do with the output that cannot be exported? The answer is already stated. That output is dumped on the domestic market at whatever price it may command. The imperative to the small shopkeeper inside China is not to earn a profit; it is to unload product, because more will be coming in from the factory soon. And the result is falling prices (deflation) for Chinese consumers. Relative to a fixed money wage, this implies a rising real wage in terms of staples. The result—well-fed, well-clothed citizens and a near-absence of visible human depravity in the cities—is visually evident to any observer. The role of the banks in this system is vastly different from that of banks in the West. They must cover the losses incurred in the short and medium run in order to permit firms to enjoy the possibility of eventually earning the profits potentially available in the export sector. The portfolio of nonperforming loans in this area, far from being an albatross around the neck of the system, is instead its primary motor force. (We do not speak here of nonperforming loans to state-owned enterprises in the heavy industrial sector, but there one finds another twist to the story: those loans support welfare and legacy payments for firms that, in at least some cases, would be marginally profitable if the welfare benefits were instead paid directly by the state.)

Capital control and regulation protect the banks, and the economy, from too much external competition. The result resolves the puzzle of Chinese wages. They are extraordinarily low when measured in dollar terms, which reflects the fact that the labor of young women in light manufacturing has an extremely low shadow price and also a low status in China. But when measured in real terms and by standards elsewhere in the Third World, wages in China are not low at all. They are also very high by historical Chinese standards, so that every adult citizen in the South and along the urbanized coast has a memory of strong improvement in most material respects. This also accounts for the tolerance most urban Chinese display toward the regime; unrest is much more pronounced in the countryside, where conditions are not as good.

Thus, as China emerges from communism, we have the paradox of shopping, already touched on. China reproduces, more closely than capitalist countries do, both the theoretical dynamics and the public welfare implications of the perfectly competitive market. It does so precisely because it lacks the essential feature of advanced capitalism, a fully developed market for capital assets. Such markets are under development—if China truly lives up to commitments made under its World Trade Organization (WTO) agreements to liberalize its financial sector—and one may confidently predict that if it becomes fully developed, the Chinese model will go into crisis, and progress will stop—as it did in Latin America, Eastern Europe, and elsewhere in Asia. But for the moment, the Chinese appear to have that impulse to self-destruction under control.

For now, a system of low-cost producers under an evolutionary offshoot of communism has morphed into the matched trading partner for the United States, a country that serves as the leading consumer market and the supplier of liquidity to the world system. Though many do not like it, the system is symbiotic. It serves the immediate interests of large parts of both populations: one experiences high consumption standards with declining manufacturing effort; the other experiences rising living standards from a low base. One may doubt the sustainability of this arrangement (perhaps it will not last), but its efficacy is beyond serious dispute. And this much is certain: the Sino-American marriage of convenience is not the product of comparative advantage, and it did not emerge from free trade. The real free traders, in the actual world economy, are those outside this symbiotic system, and for them, the record has not been nearly so good. But of course, since those countries are not as successful, they do not trade as much, and they cannot be cited as direct threats to American jobs. And so their importance to a fair appreciation of trade policy’s consequences tends to be overlooked.

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