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Posted at 11:41 AM ET, 01/28/2011

What is the "China Model?"

By Kevin Lu

At Hotel Seehof last night, I joined Joe Stiglitz, Paul Collier and several others in a discussion panel on the emergence of new economic development models in the 21st century. The panel was moderated by Joshua Ramo, who as usual did a great job, and also included my good friend Marco Magnani, who was unfortunately tasked to present a European economic perspective. The food was tasteless, but the discussion memorable.

I focused my presentation on a question that I felt has not been adequately explored at Davos this year, in spite of the fact that people have evoked the concept left and right. What exactly is the "China Model"? Five distinguishing features in my view.

First of all, the Chinese government has a unusually large policy tool kit, as a result of the legacy centrally planned system that has been in place since the 1950s, giving the authority an ability to provide economic interventions in a highly coordinated manner far beyond the regular monetary and fiscal policies one would find in a typical market economy. You frequently see different public or quasi-public sector players, including central and local economic planners, the central bank, regulators and SOEs act together to achieve policy goals. For instance, when the authority believed that the equity market might be overheating, the Chinese securities regulators at one point simply fast-tracked approval of a number of new mutual funds, with an explicit goal of injecting new capital into the market and changing the basic supply demand dynamics. The dramatic credit expansion after the financial crisis, by not only state owned banks but also major private sector banks, is another well known example.

Second, the role of state in the corporate sector goes far beyond complete or partial state ownership and control of many major corporations, which we usually associate with state capitalism. The Chinese system features accountability of the corporate sector to the government in a very broad sense. For SOEs, this peculiar accountability system creates a situation where there are very few externalities, and corporate chieftains are used to internalizing these considerations in their decision-making process. China has the world's largest banks these days in terms of asset size, and the heads of these banks, including ICBC for example, receive total compensation in the order of $200,000. The success of these bank CEOs is far more likely to be rewarded by a promotion in the Chinese bureaucratic system, or a coveted appointment to the local or national legislatures by the government than an outsized bonus by corporate boards. Nearly every Chinese SOE manager carries a rank that represents his/her status in the bureaucratic system. You will find a "Deputy-Director-level CEO" hoping desperately to be promoted to "Director-level CEO," and that decision is probably with the local Party secretary. Hence the accountability toward the government.

Third, the Chinese government has a deep wallet and the fiscal ability to throw money at problems, whether it is cleaning up the balance sheet of state owned banks, or subsidizing renewable energy or other economic priorities. This is the result of three decades of rapid economic growth and wealth accumulation, but more importantly the result of wealth distribution. The Chinese government not only collects taxes, as any other typical government would do, it also benefits from profits from SOEs and it owns all the land. One rarely hears complaints of fiscal problems at the municipal level, as auctioning off one more piece of land to developers always seems to be an option for mayors.

Fourth, the Chinese economic policy-making has a long time-horizon, beyond short-term electoral considerations. While the explosive expansion of the Internet and gradual ease of media control have created a much stronger culture to also listen to public opinions, the fundamental ability to substantially control information flows provides a potential protection to decisions that are unpopular in the short term if they can be justified in the long run. This system allows strategic considerations to play a prominent role in decision-making and long-term cash flows to be internalized upfront.

Finally, the Chinese economic policy-making processes are grounded in a political system that is both heavily top-down but also open to local experimentation. Many controlled social, economic and political experiments have occurred and are still occurring. Successful ones get adopted and replicated. Unsuccessful ones simply disappear. Controlled transparency plays a role to minimize potential disruptions from failures.

It would be very hard to argue that this Chinese brand of state capitalism has not served the country well economically for the past three decades, with hundreds of millions of people lifted out of poverty. The challenge today is whether it would continue to work in a much more interconnected world, e.g. when Chinese policy has far reaching implications to remote corners of the world or when Chinese companies are trying to expand overseas. Effective coordination between Chinese banks and companies could be seen as creating an uneven playing field by foreign competitors. Long-term strategic decision-making and less reliance on short-term cash flows could spell mercantilism abroad. In other words, would the "China Model" work in a globalized world of the 21th century where the borders between countries are being radically redefined from many angles, including trade, capital, immigration, information, technology, security, and most importantly, mindset?

Kevin Lu is the World Bank Group's Multilateral Investment Guarantee Group's (MIGA) Director for the Asia-Pacific Region. In this capacity, Lu serves as the senior representative of MIGA in the region, manages relationships with key regional clients and partners, oversees regional business development activities, and runs MIGA’s regional presence in Hong Kong, Singapore, Beijing and Tokyo. Lu is a member of MIGA’s senior management team.

Return to the Insiders' Guide to Davos 2011 page

By Kevin Lu  | January 28, 2011; 11:41 AM ET
Categories:  Kevin Lu  
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