An Economic Argument To Tackle China’s Vested Interests

Economists at the International Monetary Fund have added their voices to those calling for China to lessen state control over its economy as the necessary path to reform. A new IMF Working Paper edited by Ashvin Ahuja, De-monopolization Toward Long-Term Prosperity in China, argues that the inefficiency of China’s monopolistic domestic services industries and agriculture in particular means the average Chinese worker has earned roughly nine times less over the past decade and been 10 times less productive than their American counterpart (measured on purchasing power parity). Weakening the state protection of vested interest groups and industry insiders, the paper says, could increase long-term per capita income by a factor of 10. With growth trending slower for structural reasons, every possible boost to the incomes of Chinese households becomes more valuable.

It is not an unusual finding that the main obstacles to productivity growth and economic progress in poor countries are policies that limit market competition. China provides a bifurcated example. Its merchandise manufacturing and heavy industries are more open to competition and more efficient than non-manufacturing firms. Systematic resource misallocation is less, governance and work practices better and technology, skills and innovation superior. “The success of China’s manufacturing sector confirms a clear link between pressure from global competition and powerful incentives and ability to adopt better technology and improve work practice,” the paper says.

It is how an economy improves the use of its factors of production, not the raw accumulation of them, e.g., through fixed asset investment growth, that is crucial to making long-term gains. Productivity improvement requires a shifting away from monopolistic rights to free enterprise policies, and that, the paper says, is what should inform the policy discussions on corporate and financial reform in China.

Despite the greater competition in manufacturing, where productivity is already high and close to U.S. levels, the paper outlines how great a task lies ahead for the reformers:

China’s economy is still dominated by state and state-partner monopolies, which are shielded from meaningful competition in the domestic market, for instance, by state support, regulations, licensing and technology sharing rules. These firms tend to be large, capital-intensive  and well-connected, concentrated in ‘strategic’ and ‘pillar’ sectors, and benefit from subsidies as well as preferential access to finance, land and other resources. They are not confined to electricity generation and distribution, natural gas, and water, but outside the industrial sector, such as banking, telecommunications and the media.

Another problem, and one that explains why the pace of reform has become so glacial now it is hitting the hardest rocks of vested interest, is that state protection makes the cost of entry by other firms, domestic or foreign, prohibitively high. That, in turn, makes monopoly rights immensely valuable, and ones that holders will not readily exchange for the uncertain benefits of greater efficiency that could be generated in a competitive market. There is just no perceived benefit for a vested interest in adopting better work practices or operating even inferior technology more efficiently. So the status quo stands, and maintaining high barriers to entry, i.e. state protection, becomes a business goal.

It doesn’t take much to list the industries where this holds true:  agriculture, financial services, construction, transport, education, health, telecoms and utilities. Yet, as China’s manufacturers have shown, there can be another way.

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One response to “An Economic Argument To Tackle China’s Vested Interests

  1. Pingback: China Readings for March 15th | Sinocism

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