Tag Archives: INSEAD

The One Question That Matters About China’s Model Of State Capitalism

Monday’s publication will push the World Bank’s report, China in 2030, to center stage in the emerging, if ultimately pointless debate about whether China’s state-directed capitalism is better than the U.S.’s free-market capitalism. The later has undeniably damaged its case with the self-inflicted injuries that caused the 2008 global financial crisis. The revival of the 1930’s blend of banker and gangster, bankster, is timely and apt, in that regard, just as are the Occupy protests that have sprung up around the free-market world. But, in their rush to throw out some fetid bathwater, capitalism’s critics risk tossing out the baby, too. Nor is the Chinese model a proven substitute. For all that it has seen China though the post-2008 crisis period with higher growth rates than the Western Economies, the long-term costs have yet to fall due.

The World Bank report reportedly argues that the dirigiste model that has seen China through a remarkable three decades of economic development has run its course. We don’t yet know the details of the Bank’s arguments, but this Bystander has long argued the necessity of structural change if China is to move up the development ladder. The heart of the real test for China’s state capitalism is not whether it is better than banksterism. It is, can it vault the country from the ranks of poor countries to rich. To do so, it will need to clear the middle-income trap or the economic Great Wall–choose your metaphor–something no developing country has done without institutional change. This Bystander thought it timely to republish China’s $10,000-12,000 Question, first published in January last year, examining whether China can defy history:

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

1 Comment

Filed under Economy

Tang Dynasty Redux

This Bystander’s eye was caught by an assertion that modern-day China aspires to be a latter-day incarnation of the Tang dynasty. It was made by a serious figure. David Daokui Li is a worldly and respected academic economist, well-known in the U.S. and now a professor at Tsinghua University. He is high enough in policy-making circles to be one of an elite group of academic economists advising the central bank on monetary policy. In an article published by Insead, a European business school, and titled How China Is Managing Western Hostility, Li writes:

Our aim is the revival of our great civilisation. We are not looking for retribution against the West and we are certainly not interested in dominating the world. Instead, we would like to see the revival of a peaceful, confident, open-minded civilisation similar to that of the Tang Dynasty.

The Tang dynasty lasted from the seventh to the 10th centuries and is seen as a high water mark of Chinese civilization, especially in its first 200 years and particularly in the arts. It was a period of stability and innovation. It created a powerful, centralized bureaucratic elite, introduced Buddism and woodblock printing. Its capital, modern day Xian, was probably world’s largest and richest city at the time. Yet the political and economic parallels are interesting. It was an empire of protectorates and tributary states that extended southwards into Indochina and westward along the Silk Road into Central Asia in rivalry with the Tibetan empire. It was a maritime power whose giant ocean-going junks traded across the Indian Ocean to Africa and the Middle East. Its trade and commerce thrived even as a declining central government, eclipsed by the rising power of regional military governors, withdrew from managing the economy.

Past is prologue, but only up to a point. And we would not want to overegg this particular pudding, particularly with a selective reading of history. But the issue of how the West sees China’s emergence as a world and economic power and China’s response is an important one. Li lays out a clear and succinct exposition of how to understand China’s motives and objectives. For example:

China’s emergence gives us an alternative model for social and economic institutions, different from that of the U.S and other Western countries. A model where more weight is given to social welfare, well-being, and stability, rather than to pure individual liberties.

Whether you find that threatening or not, the piece is well worth the read.

Leave a comment

Filed under Politics & Society

One Crop Failure From Catastrophe

A peasant is happily showing her harvested wheat in Ganyu County, east China's Jiangsu Province, Oct. 17, 2011.

China’s farmers have been buying land abroad, from Africa to South America, and they should be buying more, according to the prominent Chinese economist David Daokui Li, to forestall a potentially catastrophic grain shortage that faces the country.

Li suggests that it would only take one bad crop to throw the world into food shortage. “We can imagine that with the frequency and severity of natural disasters in China as well as in other parts of the world, the overall global grain output will be decreased, which will pose a potentially grave threat to grain security, leading to worldwide food shortages and resulting in global inflation in food prices,” he says.

Li comments came in an interview published by Insead, the French management school that has a partnership with Tsinghua University, where Li is Director of the Center for China in the World Economy. He is also a member of the Monetary Policy Committee of the People’s Bank of China.

Buying more farm land overseas, Li says, “will not only work towards China’s self-interest, but will also contribute to helping to solve the wider global grain supply problem.”

China’s leadership has been repeatedly expressing its concern about the future of the country’s grain supplies. Regardless of record harvests being reported year after year for seven years despite a string of natural disasters, there is no hiding  the challenges facing China’s growers of wheat, rice and corn. A richer and growing population, urbanization and natural and man-made water shortages have  left supply struggling to keep up with rising demand.

The vulnerability of the country’s harvest, particularly the wheat harvest, increasingly concentrated on the drought-prone North China Plain, is only too clear to see. China is reaching the the edge of its capacity to keep its grain harvests increasing. Agri-technology is still boosting fruit and vegetable yields, but grain may have reached its limits after decades of seed and fertilizer improvement. In addition, grain farming remains inefficiently small scale and labour intensive, as is suggested by the photo above of a farmer from Ganyu County in Jiangsu. Acreage and younger farmers alike are also being lost to towns, exacerbating the longer-running effects of erosion, desertification and other environmental damage.

Stocks and imports have covered the gap with growing demand, forestalling, so far, the sort of shortages that Li fears. China imports more than 4 million tonnes of corn (mainly for animal feed) and more than 1 million tonnes of both wheat and barley a year. But being subject to world commodity markets pushes up prices, and no country likes to feel it can’t be self-sufficient in food, especially when it has an increasing number of mouths to feed.

The UN’s Food and Agriculture Organization estimates China to have 137 million hectares of arable land. China itself reckons 120 million hectares to be the minimum needed to maintain food security. All agree that the hectarage is moving in the direction of the smaller number, with the shrinkage of the area under grain shrinking causing most concern. Better water management, a national priority under the current five year plan, can reclaim some land for farming, but beyond that, as Li suggests, there is only one place to get any more.

1 Comment

Filed under Agriculture

From Fast Imitation To Frugal Innovation

China, like India for that matter, has set off down a development path to convert its companies from imitators to innovators. President Hu Jintao reaffirmed that at an exhibition in Beijing showcasing the country’s scientific and technological achievements during the just concluded five-year plan, urging scientists to enhance China’s capacity for innovation so as to seize the initiative in global competition.

China has made a purposeful start, but it will be a long journey. The country ranks 21st out of 40 countries on its own global innovation list. Against the oft-used benchmark of patents granted, China generates 2,000 a year, one fortieth as many as the U.S., and half of China’s comes from local affiliates of multinationals. Yet that belies advances China is starting to make in fundamental science and technology. Measured by how much the country spends on research and development as a percentage of its gross domestic product, a measure known as GERD, China now ranks third in the world after the U.S. and Japan, having raised its GERD from 0.57% in 1995 to 1.54% in 2008. That translates into annual R&D spending approaching half a trillion yuan ($75 billion), though China’s critics will jibe that much of that should be called R&C spending, for research and copying.

Beijing’s long-term target is for a 2.5% GERD by 2020. The new five-year plan calls for a large increase in R&D spending. There are straws in the wind that suggest that that will manifest itself as an up to 10 trillion yuan ($1.5 trillion) boost for selected advanced industries over the next five years, both directly through soft loans and government procurement and via incentives for foreign companies to set up more R&D facilities in China. The number being floated may be pie in the sky (it is after all two and a half times the size of the 2008 stimulus package) and it is far from clear how much would go for R&D as opposed to infrastructure development, but it is clear that improving the technological capabilities of China’s manufacturers is a policy priority. The anointed industries are biotech, post-fossil-fuels energy, energy conservation and environmental protection, clean-energy vehicles, new materials, and next-generation information technology and high-end equipment manufacturing. The plan calls for these industries to account for 15% of China’s GDP at the end of the next five-year plan, up from 5% going into it.

It is easy to forget that China’s exports have been moving up the value chain away from low-tech products since the 1990s. Firms like Huawei and Lenovo have prospered by absorbing foreign technology and business expertise, and adapting them to produce products for the Chinese market before taking the same strategy into global markets. Not all foreign suppliers of technology and expertise have been happy with the first part of that strategy. They have had to agree to hand over technology to win access to domestic markets and then found that Chinese enterprises are preferring — or being encourage to prefer — to buy locally developed products, patriotic support of the pursuit of “indigenous innovation’.

What also needs not to be lost sight of is that this is a different stripe of innovation, not so much yet leading-edge technological innovation as process innovation; the use of China’s labor quality, supply chain integrity and infrastructure to reduce cost. As S.D. Shibulal, chief operating officer of Infosys Technologies, notes in an INSEAD article on innovation in emerging markets, Chinese companies “are redesigning products to reduce costs; they are redesigning entire business processes to do things better and faster than their rivals.” He dubs this “frugal innovation”.

This lets Chinese companies pickoff niches where they can refine their products and market entry. Haier, the white-goods manufacturer, was a harbinger of  this approach with wine-cooler refrigerators, turning what was a high-end consumer good into a much cheaper middle-market one, and grabbing 60% of the market in the process, according to Peter Williamson, a former INSEAD professor who has written a book on the topic. Consumers were prepared to accept a small drop in quality in return for a large cut in price.

“The real challenge for foreign firms is not so much the top end of the market in many given industries, but the medium sector, which we call the ‘good enough’ sector,” says Anil K. Gupta, a current INSEAD professor. The lesson is that Western multinationals are going to have to learn to compete in the middle market as well as the top-end one, as this is where “future battles for world market share will be fought.”

Meanwhile the challenge for Chinese firms will be to develop their own brands and innovate their own products, then move from manufacturing them at home to designing them there and manufacturing in lower cost countries.

Update: The Economist Intelligence Unit estimates that China’s R&D spending of 500 billion yuan in 2009 will rise to 1.2 trillion yuan by 2015 and to 2.1 trillion yuan by 2020, which is $320 billion at today’s exchange rates. Much of the support will come via fiscal inducements, it says.

7 Comments

Filed under Economy, Industry

China’s $10,000-12,000 Question

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and, as Dan Harris from China Law Blog points out, the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

13 Comments

Filed under Economy, Politics & Society