Former Dean of The George Washington University School of Business, Former Professor of Management and International Business, The George Washington University, Washington DC
Breaking the Wall of Efficient Innovation. What Can Be Learned from China's Planned Capitalism
Good afternoon. I want to thank you all for having me here. It is wonderful to get to talk amongst so many interesting people about these issues. We are going to go from the micro-level up to the macro-level economic level. But, one of the things that joins what was just discussed and what I am doing is really trying to think through what issues drive innovation. About a week ago or two weeks ago, I guess I was at a forum in which Carlos Slim, the world’s richest business man, or I guess I the richest man of the world right now, was talking about issues that he wanted to discuss that have to do with innovation and how the world can solve its problems. Of course he relied fundamentally on the privatisation model. His notion was that: if you want to understand innovation, you have to think about privatisation and let get governments out of the way.
For somebody who has been studying the economic reforms in China over the last two decades, I never really believed that. But, that issue was heightened for me in the recent economic crisis. I want to talk about two walls today. One is: first, a mental wall; one that we particularly have in the United States, which is an obsession with the idea that markets can solve all of our social problems, and that they will fundamentally solve those problems better than governments do. The real mental problem here is not- I wouldn’t argue that markets can’t solve them better- it is that we, as people, don’t have the political will to actually live in a market world. The problem is: when you have a situation in which you give people the incentives, or you deregulate and allow them to take massive risks but you are not willing to let markets discipline that risky behaviour, the whole system falls apart. So, if we don’t live in a world in which we have the political will to engage, to allow markets to truly disciplinebehaviour, which meant in the case of the most recent crisis: we should have let all of the banks fail. Then we simply don’t have any business talking about the beauty and the elegance of a free market system.
That kind of takes us to another question. What I really want to talk about today though, is what I have learned from China over the last couple of decades. This is an economic story that we know well. A backwater, third world, developing nation, on the brink of bankruptcy in 1979, emerges to become the second largest economy in the world and truly and an economic powerhouse. The interesting thing about that economic power right now though is that it is often thought of as just being the factory for the world. There is nothing really going on in terms of true innovation there. We just know that they got there, because of deep cheap labour.
But what we are really talking about is this: this scientific, this futuristic, science- fictionesque landscape that has just emerged out of nothing to become this grand economic system. Now, this economic system penetrates right down to the market levels. There are many images with which we might tackle China or what we might understand what is going on there. You could think about it as red China and the rise of a guerrilla warrior who led China to freedom. You could think about China’s coming together with the West. But, the real moment that I like to begin talking about is when Deng Xiaoping won his position in the party. He got on a plane, came over to the United States, donned a cowboy hat, met with Jimmy Carter, went to a John Denver concert, and then visited three cities that really marked what was going to happen over the course of the next set of twenty years.
First he went to Seattle. He wanted to see what a high-tech economy like Boeing- not high-tech in a classical sense, but a very technologically adept economy. He also wanted to see what a consumer-based system looked like with Coca-Cola, and he wanted to see what NASA was up to. The real moment though that the world fundamentally changed, and China made the transition, or crossed the threshold from being a big economy with a deep cheap labour pool to truly being a dramatic innovative economy; it happened in this moment, which was September 18th, 2001. Not many people remember that moment, because we had other things on our mind at that time. But, this was the moment of China’s accession to the WTO.
Of course, who could forget in 2008, the greatest coming out party the world had ever seen.
Now, what I want to do though, I also want to acknowledge or think about why China sort of gets so little credit for what is actually going on. There is a whole phenomenon, or (? 42:54) industry that I like to think of as the doom and gloom industry of China. Every year there is a new person on the horizon to talk about why this whole system is going to fall apart: the pollution is terrible- an endemic, the trade and balances are horrible, and of course, the political system we all know very well from the images that we have seen.
Now what I really want to talk about today in the remainder of my time is how innovative an economy like this can be. Is China just a deep cheap labour pool, and is it winning in the economic system because of that cheap labour? Or is there actual innovation that is going on here, and what can we learn about it? The interesting thing here is that China, at least with respect to the United States especially- Europe is doing better than the United States- but China is completely dominating the space of renewable energy. How that actually happens, I think, is a key to what the lessons can be learned here. It is even so extreme right now that the united steel workers are filing a claim in the world trade organisation against China’s unfair practices for state’s subsidies. Which I think is kind of humorous, because state subsidies aren’t necessarily an unfair practice; they are just good business.
What do we do in places like the United States when we want to see renewable energy come? We usually use symbolic acts and a bully pulpit, and then we wait for venture capital to come in from the side lines. So, we get a lot of good press.
Now what does China do? China doesn’t wait for venture capital to come in from the sidelines, because venture capital has a fundamental problem for long-term industries. Venture capitalists typically want to see exit strategies within about seven years. When you have energy like renewable energy, and an industry like renewable energy, you are not going to have exit strategies coming in seven years, and so you have to have a motor that really invests aggressively in that system. You cannot allow
the market mechanism to drive this process forward. You have to have states get involved.
So, China, while we were wondering whether or not we should get into this industry and setting up some symbolic acts and some States subsidies through tax credits, China was aggressing whole hog in this energy. One of the most famous companies in this area is Yingli Green Energy Holding Company. It is a subsidiary of an organisation called the State-Owned Assets Supervision and Administration Commission in China, which is in many ways still a fundamental body of the state, but is one of the most dynamic capitalist investors- one of the most dynamic asset companies in the world.
I thought there was a particularly interesting moment, and I had to put this on here, because I think that is Germany, right, in the most recent World Cup. But, the interesting thing to me is really what those signs behind say about the different economies. In the United States we have McDonalds to sell to the world. China is busy using Yingli Solar. We are losing that game.
Very quickly, I want to talk about a couple of different ways to think about how these economic reforms have come forward. I am going to focus on three key things that are fundamental here. I think unpacking the economic reforms actually allows us to understand something that we have missed, or is often missed, in terms of thinking about how China’s reforms have gone forward: gradualism, decentralisation, and openness to foreign investment.
First gradualism. China is the one planned economy that whole-heartedly rejected the notion that you could have a rapid transition to private property. A lot of the world looked at this and just thought: well, China is just being (? 46:28) here, because they are a set of authoritarian oligarchs who just want to hold onto power, which may be true. Except this approach to reform has actually been incredibly innovative, because the process of building institutions is completely the opposite in China than in places like the United States. In the United States we agree on an economic model, impose it from above, and say, “This is what it is going to be.” In China, on the other hand, these institutions grow from the grassroots up.
To give you an example, in 1994 there was a lot of hand wringing, because China hadn’t passed a labour law. Everyone was wondering: where it is, and why is it taking so long. What most people didn’t know is that China was experimenting with labour contracts since 1983, in order to build up the knowledge of how this institutional structure or this institutional system should be. So, by the time they pass a labour law, it is actually one that really makes sense for how the economy works.
The second piece of the puzzle that is really important for understanding China’s economic reforms is decentralisation. This is the key. This is the model of how economic development happens in China. China did not privatise, but it localised. So, we’ve created an entire decentralised system of entrepreneurial, local officials, who were very aggressively competing with each other to drive forward a capitalist process.
One thing that is a side note here, and it is important to know about China: the most important thing going on to China is not happening in Shanghai, Beijing, and Guangzhou. That is the typical place where everybody is looking, but that is old news. The real news is the second-tier city phenomenon: places like (? 48:00 names Chengdu, Dalian) These places are so interesting in terms of what is going on, and it is all because they have entrepreneurial local governments and are very nimble and fast.
I will tell you a quick story about how this goes. If you have seen the transformation of (? 48:14 name) and Shanghai, for those of you who have been there, you should go 100 miles inland and see the transformation of Suzhou industrial park. This is one of the most amazing economic stories you will ever see. Suzhou was having problems competing with Shanghai, because Shanghai was actually really shutting it out in terms of development. So they got together with the Singaporean government, built an industrial park that brought in nine billion dollars from Singapore, and very quickly became the number one destination of foreign direct investment in all of China. It is a truly remarkable and miraculous system. It is truly because of the entrepreneurial nature of the local investment.
I also mentioned a few minutes ago the State-Owned Assets Supervision and Administration Commission. This is a state body, of course. This is not a private system. A lot of people who are co-investing like Warren Buffet think, well, this must be some form of privatisation, because we know, because of the economic ideology about this, that markets are better and privatisation is better. If PetroChina is becoming the most efficient company in the world, which it is by almost every statistic, in terms of efficiency, then it must be a privatised system. It is not. This is a state system, but is a dynamic capitalist investor.
So, here is really where we get to the interesting point of China. How is it today that the largest communist society in the world is the most dynamic capitalist economy in the world? That really is the interesting question of our time. Now, there is also a key part of this that is about attracting foreign direct investment. This is the Holy Grail for what these local officials want. They attract players; they do interesting deals with them. Those that are less corrupt are actually winning this game, so we often hear about the corruption that is endemic in China. The reality is that places like Suzhou and Chengdu are winning the fight for foreign direct investment, precisely because they are so nimble, so good, and so uncorrupted.
Key example of the case of Chengdu: Intel used to have its entire operation operating out of Shanghai until about three years ago when they decided we need to move west. Chongqing thought it was going to win that dynamic. It had labelled itself a provincial level municipality in a way of getting that kind of business. But, it was Chengdu that got it, because of this nimble, driven, entrepreneurial local state that actually drove that process.
Similarly, of course, bigger organisations like Wal-Mart are all over China, and they are really driving, of course, an amazing set of investment opportunities, and really, in many ways, creating a very dynamic capitalist sector that is really about an allegiance between the local states and the foreign investors.
Now I just want to wrap up very quickly here before I get the hook. In the capitalist west, I think we should drop the silly allegiance around the beauty of the free market. We don’t have the political will to live by it, and it fails in terms of innovation. I think
we have a tremendous amount to learn from China. I will just give you four key points on that. China is not just a place of radical institutional change, because of the material changes that have gone there: It is a place that is actually remaking how we think about the evolution of market. It is a place where radical institutional change is happening through experimentation. It has been successful largely because of government intervention. I use that word intervention ironically, because actually it has been primarily because of the government’s will to actually drive this process forward. It is not a story of cheap labour. It is actually a story of true state-led innovation. There is one ironic kicker here: China may, in the end, actually be more transparent even, say, than the United States. I would say this is less so the case with Europe. But, we think we always have them beat on the transparency front, because, of course, capitalists’ institutions are much more transparent than state-led ones. The corporate lobby that is distorting markets fundamentally in the country that I come from, which is also ironically, I think, a broken democracy. I think is ultimately probably not nearly as transparent as what is actually going on in China. So that is all I have for you today. Thank you.