Part 10 (1/2)

”I see Yes”

”That was the tallest one standing ten years ago”

”My God,” I said

The a In just a decade, the builders of Shanghai had put up a fair imitation of Manhat-tan What New Yorkers would have made of it, I don't know It made us Londoners feel like country bumpkins

Yet it could all have been so different For most of the twenti-eth century, China was poorer than Cameroon In 1949, when the People's Republic of China ca-est country was torn by civil war and ruled by a communist dicta-torshi+p In the late 1950s, millions of people died in a faovernment In the 1960s, the university system was destroyed by the Cultural Revolution, when millions of educated citizens were forcibly relocated to work in the countryside After all this, how did China becoreat-est econo revolutions A visit to Shanghai is enough to provoke the question Clues to the answer can be found all over China I picked up several of thezhou

The train itself was the first clue: it was more coland China's road and rail network appeared to be in superb condition Sec-ond, the Chinese seemed to have an excellent education system- I was soundly but politely thrashed at chess by a PhD in econo man who had never been outside China but who spoke h the train was packed, there were few children and no large families China's ”one child family” policy has created a society where women have time to work and where the bulk of people are neither old nor young but in s have provided the investment money for the roads, the trains, and more At the minimum China clearly had the human resources, infrastructure, and financial capital required by traditional h these resources would be well used; we already know that without the right incentives they will be wasted

Under Mao, that waste was legendary China's initial develop-ed: massive investment in heavy in-dustry such as steel, plus application of special agricultural techniques to make sure that China's vast population was fed The policy focus was understandable China's northern prov-inces are rich in high-quality coal, which logically could pro-vide the basis of an econo had been the basis of the industrial revolution in the leading econodoriculture had to be a priority for any Chinese governh fer-tile land to feed the country's hundreds of zhou I was looking out over Henan, China'sdesert

This two-pronged push was called the ”Great Leap Forward” It seereatest economic failure the world has ever seen Mao conducted economic policy based on the hidden premise that if people tried hard, the iers were ordered to build steel furnaces in their backyards but had no iron ore to put into theood iron and steel- tools, even doorknobs-in order to meet the quotas demanded by the state Even Mao's personal doctor worried about the wisdom of a policy to ”destroy knives to produce knives” The steel that eed from the furnaces was unusable

If industrial policy was a farce, agricultural policy was a trag-edy The Great Leap Forward had already pulled many workers off the land to labor at the furnaces or in public works like da birds, and the population of insect pests exploded as a result Mao person-ally redesigned China's agricultural techniques, specifying closer planting and deeper sowing to increase yields Rice planted so closely together could not grow, but party officials, anxious to please Mao, staged shows of agricultural and industrial success When Mao traveled by train to admire the fruits of his policy, local officials built furnaces in strips along the railroad and brought rice from miles away to replant, at the officially specified density, in adjacent fields Even this charade could not be maintained without the use of electric fans, which were used to circulate air and prevent the rice fro

Crop yields fell, of course, but even this would not have been disastrous without the state's insistence that the policy ork-ing When the defense minister raised the issue of the fa, he was punished and ordered to write a ”self-criticisures who denied that there was a surplus were tortured While crops were failing, China doubled its exports of grain from 1958 to 1961 as a symbol of its success In Henan province, across which ere traveling in corain stores contained enough food to provide for the people but reovernrain surplus Mean-while, people starved to death outside in the snow Some were left unburied, others were eaten by desperate family members; neither fate was uncoe frohly the entire population of England, or of California and Texas coed that 30 h they blamed bad weather

In the ”world of truth” described in chapter 3, such disasters cannot happen Mistakes, certainly, will beBut the mistakes stay small; in market economies we call them ”experiments” If ven-ture capitalists back them, they do not expect many to succeed When they succeed, theyin-novation to the whole economy When they fail-which is o bankrupt, but nobody will die Only command econoant scale and suppress informed criticism (Mao was not alone The Soviet president, Nikita Khrushchev,a visit to the United States, when he ordered Soviet fields to be replanted with the corn he had seen growing in Iowa The failure was a catastrophe) It is worth re- that ic as the worst failures of governainst his own people, Mao died After a short interregnu and his allies in Decee in China's econoricultural output, always the headache of the Chinese plan-ners, had grown by 40 percent Why? Because those planners had brought the ”world of truth” into China As we discovered in Cameroon, incentives matter Before 1978, China had some of thetook power, Chinese agriculture had been lo-cally organized into collectives of twenty or thirty families People were rewarded with ”work points,” which were awarded based on the output of the collective as a whole There was little op-portunity for personal ienuity As a result there was little of either

The governions that produced a surplus, but did so at a severely depressed price, discouraging ricultural land Many rural workers were underericultural output andit China's output of grain, per person, was as low in 1978 as it had been in thehad little tira that ”socialiset the incen-tives right He started by raising the price paid by the state for crops by nearly a quarter The price paid for surplus crops rose bythe incentive for fertile areas to produce more crops

At the sa land to individual households Instead of claovernment allowed the innovation to see whether it would work, just as a market econo land from collectives had every incentive to work hard and think of ss because they were rewarded directly for their successes Crop yields immediately increased The experiment spread: just 1 percent of collectives had used the ”household responsibility system” in 1979; by 1983 98 percent had switched to the system

These reforms were linked with a nurain was allowed to rise, further increasing the incentive to produce as needed Restric-tions on trade between regions were eased, so that each region could enjoy its coe Production quotas were soon abandoned altogether

The results were draricultural output expanded by 10 percent a year in the first half of the 1980s More impressively still, more than half of the increase was attributable, not to work-ing harder or usingmethods Much of that productivity increase was directly attributable to the abandon the refore real inco the power of reat leap forward

All these statistics are best understood by thinking back to chap-ter 3 and the world of truth Partly by accident, partly by benign neglect, and partly by design, Deng introduced the world of truth to Chinese agriculture Those who had good ideas, good luck, and orked hard, prospered Bad ideas were quickly aban-doned Good ones spread rapidly Farrew more cash crops and devoted less effort to crops that were difficult to grow; all of this was the unsurprising result of introducing a price syste the so-called capitalist road

Such a journey cannot be coricultural refor to continue Attention needed to be turned to the rest of the econo for the future Zhengzhou is not a stunning city like Shanghai It is ugly and crowded and, despite being a major railroad intersection, sozhou area without seeing a single foreign face In its oay, though, Zhengzhou is as ihai A city the size of Lon-don far frouidebook as ”a sprawling paradigzhou at least demonstrates that China's economic revolution has spread beyond the coastal provinces Forty-story high-rises loom solidly over the enore department stores and hotels, and brutal concrete overpasses Advertising is everywhere

To construct such buildings, rails, and roads requires an enormous investment Economists have a label for the roads and factories, hos, which result from investment: they call such constructions ”capital,” and all sustained development needs capital Capital can con, who hope to recoup profits, or it can co the proceeds, or by a prograests that if you want to be richer tomor-row than you are today, you should invest oods and services to be enjoyed immediately You could invest it in an education, in a house, or in a bank ac-count Either way, if you consume less today and invest the ood ones (Building blast furnaces in the back garden will not do Neither will building a library with a leaky roof) An unmysterious chunk of the development of countries is based on the sa to-day h in the fast-growing economies of the Pacific Rim How-ever, that is not the whole story, as we learned in chapter 8 A market economy cannot simply decide to save and investin Cameroon: they have feays to recoup investments in basic infrastructure like roads, and little confidence that they will be allowed to do so if they build factories or shops The few exceptions, such as the cell-phone sector, which can be funded by pay-as-you-go cards, have been the stunning successes you n investment but cannot even retain the confidence of their own citizens, who are eager to invest s rates are low, and the percentage of those savings invested inside Ca a secure environovern-overnment had no problem with access to capi-tal While a market economy cannot simply decide to save and invest more, a socialist econoraovernment or by state-owned corporations In both casestaken out of the pockets of individuals and invested on their behalf There was plenty of capital available, too: about a third of national incohly twice as et fairly good returns out of this capital In the early 1950s, when the main task was to rebuild essential infrastructure and industry, every 100 yuan invested added 40 yuan to China's annual output, an i The tasks facing the Chinese gov-ernh: in particular, what had been broken during the war and the revolution needed to be fixed All that was needed was for the governive the orders

The trouble ca aside the chaos of the Great Leap Forward and the Cultural Revolution, the Chinese state found itself increasingly unable to get value out of its in-vestments By the ti only 18 yuan to China's annual output This was less than half as efficient as two decades before Given that the govern such a large chunk of the nation's income, this reduction in the efficiency of investht conclude that it was inevitable that after the obvious investht be true for a cutting-edge economy like japan or the United States, but in 1976 China was still desperately poor Few people had cars, telephones, electricity, or running water In such a poor country, the right invest such basics of modern life There was plenty of effective investment to beas it was obvious what to order people to row, this didn't y advanced and long-demanded investments were made, the communist economies slipped farther and farther away froe quickly In South Korea, 80 to 90 percent of workers, land, and capital orking or being used for different pur-poses in the 1970s than they had been in 1960-in 1960, agricul-tural output was 45 percent of the econo output less than 10 percent By the early 1970s, the ricultural sector More i and retraining, fir down Korea's export indus-tries used to make toys and underwear, but now they make memory chips and cars If, in 1975, a planner for the South Ko-rean government had tried to run the economy based on out-dated information from 1960, the result would have been a catastrophe Fortunately, nobody did Such folly was left to the North Koreans Command economies from North Korea to the Soviet Union to China siht choices

Unlike Cameroon, where individuals and companies have little incentive to invest, Maoist China had no problem with incentives- after all, the leaders had the power of life and death over their followers But incentives alone are not enough Chapter 3 showed that the world of truth created by ood out-coen-erates inforoods and services through the price system The socialist sys-teest in-centives iinable, but not the infor to demand from world markets, like the South Koreans did, the Chinese responded to demands from Mao: plant crops more closely, kill birds, et any value out of the vast suan a gradual shi+ft to a ricultural refor reforms of the whole econo came to power, returns on investment had quadrupled: for every 100 yuan invested, China's annual output grew by 72 yuan: each investment paid for itself after just 500 days Nor was this because the govern only the very best projects Quite the reverse: investher than in the 1970s It's srew spectacularly But hoere the high returns to invest out of the plan Like the Soviet bloc economies, China's industrial sector was controlled by planners The plan specified, for instance, that a particular steel mill would produce a defined quantity of steel, that that steel would then be used for certain specified purposes, and that a standard quantity of coal (08 tons of coal were said to be required for each ton of steel) would be delivered to the steel mill in order to make production possible, and so on The calcu-lations required were tre that junior bureaucrats were supplying honest information about costs and quality (Everybody had an incentive to claie were insufficient and of poor quality, and to claim that nevertheless their output was vast and excellent Without a world of truth, the real story was i aside Mao's fatal uto-pian whims, such a system could work tolerably well for a time because each year the planners had the previous year's plan to guide theed, the process of adjusting output requirely difficult: this is why the returns to capital in China were so much lower in 1976 than in the 1950s A market system would have done much better, but it was no simple mat-ter to create one Markets do not ithoutinstitutions: in a market economy, people need banks for commercial loans, contract law to resolve disputes, and confi-dence that their profits will not be confiscated Such institutions cannot be set up overnight Meanwhile, ed in unproductive activities and ht simply starve unless the adjustment process was phased in or they received some kind of compensation The problems were most acute for the industrial sector of the economy because it was overnovern decided siht, the likely outcohts, the collapse of the finan-cial sector (because overnment-run banks had made loans that could never be repaid), and widespread uneht have worked out for the best quite quickly, but it is likely that they would not (In the former Soviet Union in the 1990s, such ”shock therapy” re-sulted in economic collapse) What is more, such extreme refore nuht have been politically ied twice under Mao's chairmanshi+p yet re-turned to lead the country, well understood the value of political credibility

So Deng and like-y In 1985 the size of the ”plan” was frozen: the production levels specified by the governrew Instead, state-owned firms were allowed to do as they wished with any extra production Efficient coal manufacturers would find that efficient steel manufacturers wanted to buy extra coal to make extra steel, which would be sold on to efficient construction firot nowhere

This strategy turned out to work very well for several reasons First, it was easy to understand, and the commitment to freeze the size of the plan was a credible one Such a credible commitment was important: if the planners had constantly tried to expand and update the plan in the light of the inforeuseful infores they made would quickly be absorbed into next year's plan, would have stuck to safe choices

Second, because the plan was kept fixed, a certain stability was guaranteed Workers who had jobs could keep therowth resulted, there was the possibility that they could get better Many people grabbed that possibility, preferring long hours and poor conditions in a textile factory, even if they had to travel thousands of miles fro a living- or failing to do so-on the inal, arid farmland

Third, the in Reinal benefits are what really ine the decision of a factoryto decide whether to pro-duce one extra ton of steel, froinal cost (the cost of producing one extra ton) and the price he is offered is a market price (which reflects the benefits to soht decision: produce if the price is higher than the inal cost The output of the factory will be efficient

Decisions about what happens to the rest of the steel are not important for whether the quantity of output is efficient Nine tons out of ten could be produced and allocated in accordance with the plan, but it is the decision about the tenth ton that matters for efficiency

What this meant was that efficient firms expanded to meet extra demand: an eleventh ton and a twelfth followed the tenth That de sections of the economy, which really needed supply, rather than froot to keep profits and reinvest them-and had an incentive to make sure that the investments were profitable

Inefficient firovernradually stopped doing so in the 1990s), they could still keep producing forever; but since the Chinese econo in 2003 as it had been when the plan was frozen in 1985, the relative importance of those firrew out of the plan

Entry and scarcity power We know that a market system limits the scarcity power of firms; most firms face competition, and sectors of the economy that are not very competitive tend to attract new competition over ti scar-city power, pushes powerfully toward efficient production, new ideas, and consue entry and lierously unpredictable strat-egy of rapid liberalization They hoped to improve the perfor-mance of the state sector, introduce new public sector coradually foster a private sector, and slowly open up to international competition If one source of competition didn't work out, there was always another The overne enterprises” Despite the nae in-dustrial n corow, too

As late as 1992, only 14 percent of industrial output was being produced by privately owned or foreign firms, while the state sector was responsible for nearly half of output The output of local-governe enterprises made up most of the remainder The Chinese economic miracle was not really about privatization What mattered was not ned the com-panies, but that the companies were forced to co down scarcity power and bringing in the information and incentives of the world of truth

The effects are even measurable Reh profits were often a signal of scarcity power If new entry and stronger co the scarcity power of state-owned firms, ould expect their profit rates to fall

That is indeed what happened Chinese firh rates of profit: many sectors had profit rates of over 50 percent (for a fairly competitive economy, you would expect not more than 20 percent and often much less) Profits also varied a lot fro of the plan: the oil refining sector had a profit rate of al sector just 7 percent In all cases, the government confiscated the profit and reinvested it

As the econoan to bite, profits started to fall; they also started to converge, as the most profitable sectors faced the fiercest con fire profit rates fell by over a third; in the juiciest sectors they fell by at least a half The effect of all this was to reduce waste, give Chinese customers better return for their money, and make China a potential player on world markets Scarcity power disappeared

China and the world There have been times in China's history when it has been an insular place This is not one of thezhou we had no difficulty finding coke, McDonald's, pool roohai it was almost impossible to escape from familiar brand names

Anyone who visited China in the early 1990s could tell you that this is all very new But it's more than an anecdotal impres-sion: the statistics tell the salobal trading scene The United States and Germany exported almost ten tiest exporter in the world, and even the United States and Germany export less than twice as much This is no accident The drae has been one of the last acts of China's economic reform