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Renowned Economist Yang Xiaokai On China’s Economy: An Interview By NTDTV

[Editor’s Note: Nobel Laureate of Economic Science James Buchanan stated about Yang Xiaokai that his analysis of specialization was perhaps the most important economic research in the world. Yang was deemed the most promising Chinese candidate for the Nobel Prize in Economic Science.

Yang Xiaokai died last year, but not before granting an interview to New Tang Dynasty Television (NTDTV).

Yang Xiaokai was born in China in 1948 to high-ranking officials of the Communist Party. His father, Yang Dipu, was at one time Secretary-General of the Hunan Provincial Party Committee and his mother, Chen Su, served as deputy head of the provincial trade union organization. At the age of just 19, he wrote a political tract entitled, “Whither China?” which, as well as advocating radical change in economic policy, openly denounced the powerful Communist Party elite. His book became famous but it landed him in prison for the next ten years of his life.

Once free, Yang studied at Hunan University and accepted a position at Wuhan University. He was awarded a Ford Foundation Fellowship and obtained his PhD in economics from Princeton University. He then took a postdoctoral position at Yale University before accepting the first of his appointments as a lecturer in economics at Monash University in Australia. He was elected as a Fellow of the Academy of Social Sciences of Australia in 1993. He was a Visiting Fellow at Harvard University (1998-1999), Yale University (1987-1988), and at many other universities. His research papers appeared in American Economic Review, the Journal of Political Economy, the Journal of Development Economics, the Journal of Organization and Economic Behavior, the Journal of Urban Economics, the Journal of Economics and in countless other publications. His own publications include Specialization and Economic Organization: A New Classical Microeconomic Framework, and Economics: New Classical Versus Neoclassical Frameworks.

The following interview with Yang Xiaokai took place shortly before his death in 2004.]

More Than the Statistics

Q: Some people are very optimistic about China’s economy, while others are very pessimistic. How do you look at this phenomenon?

Yang: Both ends of the extreme now exist in China. It is very easy to find cases that fall into either scenario. In regards to the economic situation in China, outsiders’ criticism will usually overlook the good part, for example, its international trade potential, particularly the potential for Pacific trade.

The official statistics from China are generally unreliable. The unreliability comes from two sides. On one hand the statistics about state-owned enterprises (SOEs) appear much better than the reality. On the other hand, they greatly underestimate the achievement of privately owned enterprises (POEs).

China is a country in transition. Statistics say little about the economy. I tend to agree with the Chicago School, which has reservations about the statistics on the National Income and Product Account. To study China’s transition, we need to look at many individual cases. You can see the transition of China’s economic system from the difference between generations of entrepreneurs. The first generation entrepreneurs, such as Mo Qizhong, could not survive without playing politics. He needed to develop political connections with communist leaders under the banner of “supporting reform.” He had to play many political tricks in order to survive, but in the end he did not succeed. The second generation entrepreneurs such as Feng Lun of Wantong Corp. had fewer political interests. But they still needed to deal with both political power and with under-world society, in addition to being capable of managing business operations. Then there are third generation and later entrepreneurs such as Pan Shiyi, who was Feng Lun’s assistant, and later established his own Ruby Corp. With a low profile and no involvement in politics, they are more capable of business management. From the changes in the models of management, overall attitude, and style of business operations, you can find more truth than what the statistics have to offer.

Recently Professor Thomas Rawski from the United States stated that China’s statistics are not reliable. He used the energy consumption to estimate GDP growth, so as to demonstrate that a 7% or 8% growth rate is not reliable. From my perspective, the debates did not have much significance. China is a country in transition, and you need to look at changes in the system.

The Importance of the U.S. market to China

In the early period, U.S. companies imported labor-intensive products of light industries from China. Now they are gradually importing parts of up-stream industry such as automobile parts, and even gearboxes made in China. Some machinery, electrical products, and products for heavy industry are made in China. The very cruel reality is that whomever the U.S. market opens to is the winner. The U.S. market is a huge market. Since World War II, the United States has become the engine of global economic growth. After the Marshall Plan, the United States opened its market to Europe, and Europe recovered. It opened the market to Taiwan and South Korea, and as a result, Taiwan and South Korea grew rapidly. The United States, with its population, is basically the largest unified market in the world. Europe is a divided market, with many languages and other differences. Some economists said that the United States is the biggest market. Any country will get rich as long as the United States opens its market to it. It’s basically true. As long as you make products for the United States, there is a market, even small things like mailboxes or rear view mirrors. In the early times, Taiwan produced mushrooms and South Korea produced telephone parts. A country will prosper as long as its products can be sold to the U.S. market.

No matter how many economic problems China has, the U.S. market is open to China. Most U.S. products can be made in China. You can find in the United States that the mailboxes from every household are made in China. Bigger things like car gearboxes, and some other mechanical and electrical products are contracted to China. In the earlier years, U.S. corporations tried to set up companies in China, but now they have completely changed their strategy. They don’t set up companies in China, but instead look for partnership with Chinese companies. The most successful business case discussed at the Harvard Business School is one such case; it seems to be an irresistible trend. As long as you can successfully contract automobile parts or up-stream products to China, you can defeat your rivals. Because the income level in China is low, the Chinese people will make money as long as you can generate revenue equivalent to one percent of the U.S. GDP. Many pessimists have overlooked this point. China’s current, huge trade surplus resulted just because of this. In history, The Marshall Plan helped enrich Europe in the same way. What I want to say is that you should not look at statistics to judge the potential for economic development. Instead you need to look at those small companies that produce parts for U.S. companies. Don’t look at the big (Chinese) companies, but instead look at private companies. Private companies in Zhejiang and Jiangsu Provinces make rear-view mirrors for U.S. automobiles. On the surface they appear to be made in the United States, but actually they were made in China.

Learning from the Industrial Revolution

Q: Then what about the bad side of the problems?

Yang: In history, the economy of England grew through Atlantic trade. We wrote an article to explain why the Industrial Revolution started in England instead of Spain. We all understand that Atlantic trade was the basic engine for the sixteenth and seventeenth centuries’ economic development. Italy and the Eastern European countries with little Atlantic trade grew very slowly, while the West European countries involved in Atlantic trade grew very fast. At that time, Spain, which occupied the resourceful South America, had much better conditions than England, but why did its growth still lag behind England? Even today, many South American countries are still developing countries. The point is that economic growth was not solely dependent upon Atlantic trade.

In 1688, the Glorious Revolution took place in England. The difference between England and Spain lies in the political system. After the Glorious Revolution, England broke up the royal family’s monopoly power over Atlantic trade. In Spain, the royal family continued to control Atlantic trade, which meant that in Spain, only enterprises owned by the royal family benefited from the trade. The situation is quite similar to the state-owned enterprises (SOEs) in China. In England, after the Revolution, ordinary people who had no ties to royalty enjoyed most of the benefits of Atlantic trade. These people included small, private companies and some landlords. After political reform or constitutional reform, those people were able to exert their political influence by paying taxes. In this period, many institutional innovations emerged. They include separation of royal assets and state banks, forbidding the ruling party to engage in lucrative business, deregulating the process required to establish new enterprises, and abolition of the restriction on usury. It’s very interesting that after the restriction on usury was lifted, usury disappeared. Now in Wenzhou, there are many private usury credit cooperatives. They exist because the government put restrictions on private banks. What we know from England is that once the restriction is lifted, the usury disappears. All these institutional innovations occurred after the Glorious Revolution, which turned a system of dictatorship into a system based on a constitution put in place by the Glorious Revolution. A system of constitutional government is not the same as a democracy, which did not appear in England until 1830. The system of constitutional government means that people who have paid enough taxes have the right to vote. Although not a democratic system, it allows political freedom such as the freedom to join a political party, and also forbids political and religious persecution. The royal family’s monopoly over Atlantic trade and establishing enterprises was abolished. The current problems of China exactly center on the same issue. In China, more than 30 industries will not allow the entrance of private capital. The situation is the same as the monopoly on many business opportunities in England before the Glorious Revolution. For industries like banking, insurance, auto manufacture, telecommunications, and lucrative trading businesses, doors are closed to private entrepreneurs. Even SOEs are not allowed to become involved in international trade without a special permit, which is controlled by several government branches.

United States is a free trade country. Anyone can import a product from China as long as he finds it to be profitable. Nowadays American businessmen all know that China is a poor country. Anyone can make money just by importing from China. It is, on the contrary, difficult to export to China. For that reason, once the United States opens its market to a country, that country will quickly become rich. However, China has not become rich. The reason is because the government and SOEs to a great extent monopolized the benefits of Pacific trade, just as the Spanish royal family controlled the Atlantic trade. China is taking a path once walked by Spain; therefore it is very difficult to develop for lack of institutional innovations.

The government is both the referee and a player

Q: What’s your evaluation on the Chinese Communist Party’s Sixteenth Congress?

Yang: The Sixteenth Party Congress institutionalized the collusion between money and political power, and legalized capitalists joining the Communist Party. New members of the Central Committee of the Chinese Communist Party consisted of presidents of shareholder companies. In the United Kingdom, a businessman is not allowed to manipulate politics with money. In the United States, there is a limit on the amount of donations allowed to go to political entities from companies. The President of the United States is not allowed to make money. He can only spend money, and is not allowed to take advantage of his political position to make money for himself. Moreover, the President must turn over his private assets to a trustee. This also applies to the period before the President is elected. For example, people can expose any business scandals relating to President Bush before an election. In a country with constitutional governance, the law prohibits any collusion between money and political power.

Also, the Sixteenth Party Congress set a new order for bureaucratic business in China. Before the Congress, there were limitations on Communist Party members, such that Communist Party members were not allowed to make money and pursue profit. The old system was not all that good, but at least it restrained some of the bad conduct. Nowadays, if you go to China, all the provincial Party Committee Members and Party Chiefs are taking on major projects, and every project is about making money for themselves. They use their position and their power to make big money. This is an extremely bad trend. It is causing China more harm and more corruption. This is a deviated capitalist system. It is not like the United States, which have straightforward capitalist systems. Like Spain, it is a bad system. Therefore, the current system is China’s main problem. In my view, the current system can be called Institutionalized State Opportunism.

The Institutionalized State Opportunism and the collusion between money and political power is China’s biggest problem. We can’t just look at the statistical figures. We need to look at its characteristics. To establish a business in China, you have to get approval. In Australia, you don’t need approval to establish a business, which is called automatic registration. With the payment of 60 Australian dollars, you can run your business. In China, someone must authorize it first. You have to go through 20 to 30 procedures. It is very difficult to establish a business there… There is an Australian company in China that took a year before it could register and obtain a permit. You have to get who knows how many officials’ stamps and seals for approval. It is such an authoritarian system. However, the worst part is not the low efficiency of SOEs, which are controlled by government officials. Within this system, the government officials play both the referee and the player in the ball game. How can you compete fairly? The more the referee who is also a player calls the game, the less fair the game is.

Inside and outside China, many economists are arguing whether the efficiency of SOEs has been improved. I’d say that is not the real issue. No matter what the answer is, the real situation is this: The higher the efficiency of state-run enterprises is, the less fair the rule of the game is, and more the more opportunity a deviant capitalist system would be. Because it is not a good capitalistic system, the statistics don’t represent the real situation. That is to say, a business is bound to fail without strong connections to the bureaucrats and support from the government. Doing business in an honest way by paying taxes will not be successful. A recent example is Mr. Sun Dawu. He wanted to set up a private bank, with a higher deposit rate than the state banks, to attract customers. However, he did not bribe the proper government officials. Various officials then made trouble for him. Some businessmen are smarter, and do business honestly, but cater to the needs of government officials. There are many people who do business by corrupt and criminal means.

The biggest problem in China is that private banks are forbidden. Many overseas economists have said that China’s four big state banks are already bankrupt. Recently, the head of People’s Bank, Chen Yuan (son of Senior Chinese leader Chen Yun) also acknowledged the fact that China’s four big state banks are bankrupt. The Chinese banks depend on taking advantage of rate differences. Monopoly power is fundamental to maintaining the banks. However, in the long run, monopoly only deteriorates the situation. If the monopoly is abandoned, and private banks begin offering a much lower interest rate, the state banks will collapse immediately. In others words, without reforming, it is just an issue of either waiting for death, or they can seek that same death by reforming. Therefore China’s major problem is that constitutional reform is falling behind.

Second-Mover Disadvantage or Second-Mover Advantage?

Q: Does China have Second-Mover Disadvantage or Second-Mover Advantage?

Yang: Many of my articles discuss the issue of constitutional and governmental reform. One of my articles discussed second-mover disadvantage. Inside China, people all talk about second-mover advantage, which refers to a development model that skips many steps and instead develops in leaps. Mancur Olson once proposed the idea that developing countries have second-mover disadvantage. Developing countries can avoid that tortuous path by mimicking developed countries. They can imitate the social system, free association of political parties, and the patent system. However, China has been mimicking the technology and the mode of industrialization but not the social system, a typical second-mover disadvantage. Mimicking the technology, like manufacturing automobiles without building the highways, will be effective only in the short term.

The system is like a freeway system. You cannot go any further after traveling a certain distance unless there is a freeway system. All your previous efforts may end up in vain and possibly, all of a sudden, everything will break down. The Former Soviet Union was such an example. Its economic development was a success in the 1930s and the 1950s, when its growth rates were higher than that of current China. The former Soviet Union learned about mass production, the production assembly line, standardization, and about Taylor scientific management, which the production control management in the Soviet Union was named after. The Soviet Union learned every single technique of advanced capitalism management and technology, but neglected the social system. The Soviet system is characterized by public ownership and a planned economy. The country used an extremely backward system to initiate the production of extremely advanced technology. Of course, the growth rate was very high. You can find that its growth in the ‘30s was much higher than that of China by more than 10%. On average, the Former Soviet Union maintained a high average growth rate of 9% for a very long period of time. But so what? Eventually it just broke down. It broke down all of a sudden. This is a major problem.

China now basically imitates the technology and industrialization mode. Its industrialization has gone even further than the former Soviet Union. China imitates the export-oriented labor-intensive industrial model of Hong Kong and Taiwan. It uses Pacific trade to export labor intensive products to the United States. However, without learning the system, the country will break down like the Soviet Union when the potential of its technology imitation is exhausted. One of the strengths of China’s exports is television. Television sets made in China are all over the world. This is a typical example of second-mover disadvantage. It basically only imports the technology of the television production line. Those factories that produce televisions are basically state-operated factories. Without learning advanced systems and institutions, and instead maintaining only the goal of surpassing other countries by taking advantage of the export-oriented market, the strategy is doomed to fail in the long run.

People in China don’t want to hear about second-mover disadvantage and only talk about second-mover advantage. I went to China to talk about second-mover disadvantage in Shanghai, Beijing, and many other places. Many people, including the liberal intellectuals, thought that the Sixteenth Party’s Congress was a good thing. In my opinion, it was a very bad turning point. Now the collusion between political power and business people has been institutionalized. Many members of the Central Committee are the heads of businesses. Many of them were from formerly state-operated or bureaucratic business companies, which are now referred to as the share-holding companies. Those companies are still operated by bureaucratic business-people. Some of the people who share benefits or have close ties with the government have now turned into members of the Central Committee. They make money through power, and further manipulate politics with money. This is the typical deviated capitalism. The United States very much resembled this in the 1920s and ‘30s, although it was a little better. At that time, there were no antitrust laws. Therefore, rich people could manipulate politics and even the judicial process. With the establishment of antitrust laws, the deviated capitalism was returned to a working capitalism, which prevents the usage of money to manipulate society and politics.

After the Sixteenth Party’s Congress, inroads towards the collusion between the bureaucracy and business were cleared. Money can manipulate power, and power is used for making money. This is a major problem in China. More specifically, state-operated banks are now facing serious problems. Is there any solution to the problem? In my opinion, there is. China can learn from Taiwan in the late ‘80s. Taiwan did not implement privatization at that time. Several big banks were exclusively state-owned and operated by the government. However, Taiwan launched liberalization, allowing the existence of private banks. Therefore, private banks became solvent very fast. After private banks had developed to a certain degree, the process of the state-owned banks becoming private was initiated by selling stock in the state-owned banks. Generally speaking, the privatization process reduces efficiency, which means that the efficiency will be affected during the transfer of property right. However, according to Taiwan’s experience, the efficiency was not affected by liberalization. Scholars in and outside China talked a lot about that. The problem of the Chinese government is the vested interests. As I have just said, once it gives up its monopoly, it does not have any means to manipulate the difference in the interest rate. The technical breakdown will immediately present itself, which will then accelerate the bankruptcy. That will be the case.

After China joins the WTO, foreign banks may come into China. Who will put their money in China’s state banks after that? They will all save their money in foreign banks. It is merely a matter of time before the system breaks down. It will not do any good to prohibit Chinese people, but allow foreigners, to engage in the banking industries.