China’s ‘Big Government’ tradition and its future
As ‘Big Government’ makes a comeback in many advanced economies, the power of the state has also been on the rise in China, especially since Xi Jinping became president and head of the Chinese Communist Party (CCP) 10 years ago. Despite the seeming similarity, however, China has a rather unique tradition of big government that goes well beyond the concept of government intervention in economic affairs common in western countries.
To start, China has a deep tradition of centralised government power that can be traced back to the Qin (or Ch’in) dynasty (established in 221 BC), the first dynasty of imperial China. Since then, China has, for most of the time, remained a unified country with highly centralised political power, in contrast to the European experience where centralised national states only emerged relatively recently (after the French revolution) and to the federal system represented by the US. In both America and Europe, the central government’s power is relatively limited, and, especially in the US, the idea of a strong central state has always been viewed with suspicion.
This is not the case in China, where the people seem to be much more accepting of a powerful central state, as long as the latter delivers a good standard of living. The existence of this kind of implicit social contract between the state and its people is evident in the current political arrangement in China, where people enjoy few political rights but in return the government continues to deliver economic growth. This acceptance of strong state control was especially striking during the pandemic when the Chinese government successfully kept the coronavirus under control through strict containment measures in the first two years (until the highly transmissible Omicron variant became dominant). An important reason why China was able to contain covid-19 for such a long time was most people’s willingness to surrender much of their personal freedom in exchange for ‘protection’ by the state. This is in sharp contrast to the experiences in many western countries.
“Personal freedoms were expanded significantly as the government abandoned most controls over people’s personal choices.”
Taking its cue from the Soviet Union, ‘Big Government’ was at the centre of the economic and social system that the CCP adopted when it came to power in 1949. Under such a system, the state decided the allocation of virtually all resources, determining what should be produced and by whom. Products were sold at government-set prices and, in many cases, in pre-determined quantities through quotas. All factors of production were also under the strict control of the state, which set interest rates and wages. To maintain such a level of control, the government deprived people of personal choice in a number of domains, such as education, employment and migration. Under such a system, personal freedoms taken for granted in the West were reduced to a bare minimum and markets played no role in deciding domestic resource allocation. Unsurprisingly, such a system was characterised by low efficiency and lack of innovation. While serving other political and social objectives, the flaws of central planning proved a significant obstacle to economic growth.
Recognising the huge economic cost of such a system, China’s post-Mao leadership (particularly Deng Xiaoping, China’s de facto leader from 1978 to the early 1990s) decided upon reform. Starting in the early 1980s, these reforms changed the Chinese economic system almost completely from a strict command economy into a market economy. For example, private businesses in an increasing number of sectors were allowed to compete against state-own enterprises (SOEs), with the latter undergoing restructuring, which, in many cases, led to outright privatisation. Encouraged by official policies, foreign capital took advantage of China’s inexpensive labour and turned the country into an export powerhouse. China’s accession to the World Trade Organization (WTO) in late 2001 greatly accelerated this process. The government also gradually let go of controls over factors of production, with wage rates determined by market demand and supply and interest rates gradually liberalised.
Although the reforms made little change to China’s political system, they greatly reduced state control of the economy and enabled markets to play a greater role in resource allocation. Personal freedoms were expanded significantly as the government abandoned most controls over people’s personal choices. In this sense, the Chinese government moved from an extreme form of ‘Big Government’ to a smaller one, accompanied by a general liberalisation of the economy and of society at large.
“The most immediate impact of increased state intervention in China can already be seen in the huge loss of momentum in some sectors since late 2020.”
However, this started to change when Xi Jinping became general secretary of the CCP in 2012, and especially since his second term began in 2017. Xi seems to have a different vision for the Chinese economy from his predecessors. For example, while the focus previously was mainly on enhancing SOEs’ efficiency through reform (ultimately leading to privatisation of many of them in the 1990s), Xi believes that SOEs not only need to be more efficient but should also play a central role in the Chinese economy (possibly to maintain the political dominance of the Communist Party). Also, Xi believes that further economic development in China requires more top-down planning instead of reliance on bottom-up experiments. This obviously goes against the previous trend to decentralise policy making and Deng’s famous motto of “crossing the river by feeling the stones”. In addition, Xi believes that the state should act to correct problems perceived as being caused by free markets, particularly the so-called “disorderly expansion of capital”. This idea has led to a wave of anti-monopoly regulations and has forced deleveraging of highly indebted property developers since late 2020.
While some economic theories justify government involvement to correct so-called ‘market failures’ such as monopolistic behaviour and negative externalities (e.g., pollution and climate change), much of the recent increase in state intervention in China likely reflects Xi Jinping’s own thoughts. Regardless of the true intentions behind this shift, it could have a profound impact on China’s future trajectory if it continues, as we expect.
The most immediate impact of increased state intervention in China can already be seen in the huge loss of momentum in some sectors since late 2020. Real estate, internet, fintech and after-school tutoring have been the most directly impacted. Almost the entire for-profit tutoring sector was wiped out in 2021 because of newly introduced regulations, for example. The massive regulatory changes and their economic impact have led us to lower our projections for China’s economic growth for the next five years.
Beyond the near-term economic cost, there could be long-term consequences as well. The effect of a more intrusive state on entrepreneurship will be particularly important to watch. Stronger state intervention generally dampens entrepreneurship and forces businesses to spend time and energy on dealing with the government and predicting its next move. These activities tend to be counterproductive. While it is still too early to conclude that growing state intervention is going to cause long-term damage to the Chinese economy, this is definitely something that will be worth watching closely.
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