Monday, May 01, 2006

More on the nature of the Chinese economy from Doug Fuller, Ph.D. from MIT and currently a post-doc at Stanford University. This commentary is very thoughtful, and I also wonder how efficiently capital is being used these days. I think efficiency of capital usage has improved a bit, from roughly 2.5% monetary growth for 1%GDP growth to something like 2% monetary growth for 1% GDP growth.

I agree that intra-firm meddling may occur (I think
Vic may question this with his statement about the
state not sweating the small stuff), but I question
how well any of the national champions are managed.
At best, we have Bao Steel and Huawei as black boxes
of which we know virtually nothing about their real
returns on investment over time.

If we are contrasting finance to equity-based
capitalism, China certainly is not the latter so if
these are the only two choices... Nevertheless, I am
less concerned about the taxonomy of China's
capitalism than what the state of China's institutions
says about its future development. My reading of Vic's
work is that financial control by the central state
has not led to a more efficient allocation of capital.
True, the increase in noncorporate lending (lending to
consumers has been a more efficient allocation of
capital vis-a-vis China's past poor practice except
for the now major problem of China's real estate
bubble) may improve efficiency at the margins and goes
back to Matt's point about the state allowing markets
on the wide margins of the economy. Hard data showing
an improving ICOR or some other significant
measurement would change my mind about the continued
severe misallocation of capital, but I have not seen
such data. What I have seen is data showing China's
ICOR underperforming the not-so-inefficient financial
sectors of Japan and Korea in their developing,
investment-heavy heydays and data showing China badly
underperforming current developing countries in
efficient allocation of capital.

Dividing Naughton from the others, Naughton's stance is
that China's capital allocation is becoming more
efficient because the state has 1) abandoned most
industrial policymaking (which he problematically
equates only with chaebol-building) and 2) the number
of formal SOEs are smaller. Others take a more
constructivist approach by pointing out several
"market capitalisms" that exist in China.
The state uses "market as selection" i.e. allows firms
to fail with those firms not important to the center

China may have finance-based Leninist Capitalism, but
what concerns me is China neither has efficient
markets nor efficient hierarchies. In short, in
finance, China suffers either 1) simultaneously from
market and government failures or 2) one could say the
government failure crowds out the very possibility of
a market mechanism, failed or otherwise. I am less
concerned about the debate over how far product
markets operate in China--I think we all acknowledge
that they are pretty extensive-- but Naughton's
announcement that the solution to China's severe
capital misallocation has arrived appears entirely
inaccurate. He seems to be re-stating "growing out of
the plan" by assuming a smaller share of SOEs in the
economy equates to better financial management.

My read on Nolan's 2001 work is that he believes China
has sacrificed dynamic efficiency gains to be gained
through industrial policies on the altar of static
efficiency gains that have been gained through
economic openness by not pursuing an ambitious
industrial policymaking program. He underestimates
the Chinese state's past and perhaps present ambition
and overestimates its capabilities. Nolan also has
that 2004 book that seems much more optimistic about
China's economic reforms (I have not read it) in
contrast to his pessimism about China's dealing with
globalization in his 2001 book.

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