Twofish's Blog

January 18, 2009

The 80’s are dead

Filed under: academia, china, finance — twofish @ 9:45 pm
DB: As for the question whether or not China was in need of foreign capital to accelerate its economic growth, Huang Yasheng, Associate Professor at the MIT Sloan School of Management, argues that the main driver of China’s economic miracle up to the end of the 1980s were domestic private village and township enterprises.

Somewhat correct but completely irrelevant…..

What he doesn’t mention is that in order to drive this economic growth, these TVE’s had to borrow extremely heavily to the point where you had rural credit instititutions that were (and still are) insolvent. The TVE’s growth phase ended around 1990 when the countryside basically ran out of cash.

DB: Then at the beginning of the 1990s, the central government decided to shift the economic development scheme towards urbanization driven and controlled by the public and governmental sector

Because they had no choice in the matter. The boom in the countryside was not because private enterprise was particularly good but because Maoist communal agriculture was a total disaster. By 1990, the rural countryside had recovered from the Maoist disaster. At that point, there were no productivity gains to be made anymore, and the rural credit institutions that were designed to take advantage of these gains started going bust.

Also “privatization” is not a good way of describing rural land ownership. The “contract responsibility” system is something that is not quite private and not quite socialist. You can see it when people like Huang are saying good things about it that it becomes private, but when they say bad things about it, it becomes non-private.

DB: Now the point is: Huang argues in his studies that economic activity driven by the private sector in townships and villages in the 1980s have led to greater benefits for the Chinese people then the subsequent government- and public sector-led urbanization. What do you think of his view?

Maybe it is true, but it is completely irrelevant. The basic problem is that what worked in the 1980’s wouldn’t necessarily work in the 1990’s and the 2000’s and the 2010’s. The reforms of the 1980’s were designed to fix the problem of the 1970’s, and once those problems are fixed, you have to do something different. Times change, and policies that create a miracle in one place and time can be totally disastrous in another. Much of the “China miracle” wasn’t that privatization was very good, but because Maoist communal agricultural was particularly bad, and switch to another system (any other system) would have improved things.

This is the problem that I have with ideological people whether they are socialist or capitalist. They fail to adapt when the situation changes. People loved the Soviet model in the 1960’s not because they were total idiots but because the Soviet Union generated extremely large amounts of economic growth in the 1950’s. When talking about the failures of state planning in the 1990’s, we also have to consider the successes in the 1950’s. We can certainly learn things from the 1980’s, but we can’t repeat them because the world is different.

This applies to current issues. I personally think that Chinese industrial and banking reform in the 2000’s was a huge success. Does that mean that I think that we can relax and just follow exactly the same policies? Hardly. *Because* it has been a success, a lot of the problems that the policies had to fix have been fixed, which means that there is nothing more to do. China’s economic model in the 2000’s is highly capital intensive and highly export intensive. It worked well in the 2000’s because China is where the Soviet Union was in the 1950’s or where East Asia was in the 1980’s.

It’s going to stop working in the 2010’s Much of the export intensive part will never come back. Building one expressway is going to be very useful, but building two isn’t. Right now building stuff works because there are a lot of things that need to be built. As time passes there are going to be fewer and fewer things that can be usefully built.

So right now the big thing in China is trying to move the economy from an capital driven, export driven economy to an technology based, innovation based economy. This means basically tearing lots of things up and starting over again, and looking at how other countries (particularly the United States) promote innovation. It’s going to be wrenching and painful, change always is, and people will do a lot of stupid things and make lots of mistakes, just like they did in the 1990’s and in the 2000’s. Expect to make mistakes and set things up so they aren’t fatal ones.

I’m optimistic because managing an economy requires constant change and constant renewal, and my feeling is that the people in the Chinese government aren’t trapped replaying the glories of the past like the Soviet leaders of the 1970’s or frankly like Ya-Sheng Huang is.


  1. You do not appear to have read his books. The Chinese government does.

    Comment by Zanzibar — January 19, 2009 @ 9:25 am

  2. Just curious, but do you see current US policy attempting to replay past successes?

    Comment by TH — January 19, 2009 @ 8:32 pm

  3. A similar observation of changing policy what will probably only become recognised in a few years: the effects of the one child policy on human capital development (especially in more developed coastal regions). Both a concentration of resources on part of the population, and rapid development of such resources.

    It could be argued that throughout the 1990s there was insufficient skill development at so many levels of the economy to equip the education system to train and educate effectively. During the 1990s, when the cumulative impact of relatively few graduates in the 1980s increasing, and an increase in aggregate number of graduates, the early 2000s saw, for the first time I think, highly trained teachers and educators at a widespread level of the economy (especially in coastal regions). The effects of this, coupled with academic pressure a single offspring of 2 parents and 4 grandparents receives, I think are really only beginning to be appreciated: a massive flight up the development ladder resulting from economic policies of the 1990s and slightly before and after.

    Very much concurring with your premise. The actions of the past are often not appreciated until their results become clear, and by then policy has inevitably changed again.

    Comment by Alex — January 20, 2009 @ 2:23 am

  4. I’ve read his books on foreign direct investment, and curiously I agree with most of what he says there (i.e. China relied on FDI because of an underdeveloped financial system) and would go further to argue that the fact that export intensive industries had indirect access to more efficient capital is why China ended up so export centered.

    I haven’t yet read “Capitalism with Chinese Characteristics” (it just came out) but I have very strongly disagreed with him over why the 1980’s ended. He seems to think that it was because there was a government effort to redirect growth toward urban centers, whereas my view is that by the late-1980’s, the countryside had recovered from Maoist centralization, which meant that there were no more productivity improvements made available from decollectivization of agriculture or from fixing obvious shortages. The reason that you had such large amounts of growth in the 1980’s was that the countryside was “bouncing back” from the 1960’s and 1970’s and once you bounce back, then you run into the same developmental problems that rural regions in the third world all share.

    He seems to think that in a market system for allocating credit, that credit would naturally flow from the cities to the countryside, whereas I disagree and argue that without external intervention credit tends to flow from poorer areas to richer ones. What this means is that once you connect the cities and the countryside into the same credit system, the cities will suck the countryside dry of credit. If you don’t local production of wealth, then you end up with busted banks, which is what you see in the Chinese countryside.

    As far as what the Chinese government reads, I really hope that there are people within the government that are reading what Yasheng Huang writes, and I also hope that there are people within the government that try to advocate his views. I also think that he does a very impressive job of bringing quantitative data to support his conclusions. The trouble is that he tends to go beyond the data, and make interpretations which I think are invalid.

    It’s really important to maintain a healthy civil debate about these issues, and it’s a very bad situation when people don’t argue over what the situation is and what needs to be done.

    Comment by twofish — January 20, 2009 @ 5:30 am

  5. There is one important part of the story which Yasheng Huang doesn’t mention which is very relevant to what is going on right now in the United States. What happens is that if you have banks and credit institutions that are not regulated by someone, then what will happen is that they will extend more and more credit for riskier and riskier ventures, until you have a blowup and the entire system collapses.

    That is what happened in rural China in the early 1990’s and it what happened in American investement banks in 2008. Most of the township-village enterprises were financed by rural credit cooperatives which were controlled by local governments. By providing massive amounts of credit to rural enterprises, they did succeed in creating some examples of successful private business, along with huge amounts of failures. This is a by-product of successful entrepreneural systems. For ever world changing new business, you have dozens of failed efforts. So by 1990, you have rural credit institutions that were hopelessly in debt, and so the government simply could not have continued the policies of the 1980’s, and given that the rural credit institutions are already in so much debt and that the Agricultural Bank of China is busted, redoing the policies of the 1980’s is simply not possible.

    The awful financialsituations of the rural credit cooperatives that financed a lot of the TVE’s is something that I don’t recall Yasheng Huang ever mentioning. Also the awful situation of the RCC’s is related to the lack of productivity growth in the countryside. You didn’t have these sorts of problems with urban credit cooperatives or the urban banking system.

    Also I Yasheng Huang mentions entrepreneurship as if it is some sort of magic thing, but I don’t think he fully appreciates the problems that an entrepreneurial economy will cause.

    Entrepreneurship *increases* social stratification since people with good education do much better in a knowledge based economy than people with poor educations, and there is one interesting study that indicates the the factor that overwhelming determines income in China is education, if you are a peasant with an elementary school education then you will have problems finding a place in a knowledge based economy. Also knowledge based economies, *increase* regional disparities. Knowledge economies create centers, and if you are a smart, tough entrepreneur, but you have the misfortunate of living in Mississippi or Henan, you are at a massive disadvantage, since you do not have the social connections that you need to get the capital to develop your ideas.

    This isn’t to say that China shouldn’t be moving to a knowledge based economy, but rather that it is going to take massive government intervention (such as massive taxation on the wealthy) to keep that sort of economy from making social differences in China worse than they are, and I think that Huang disagrees.

    The type of government intervention I think are necessary are:

    1) massive spending on education and health care
    2) directed spending on infrastructure (you have to be careful here because infrastructure spending creates patronage networks)
    3) something like the “Community Reinvestment Act”
    4) something like small business guaranty loan program
    5) efforts to create local chambers of commerce
    6) reducing the “cult of the entrepreneur”. The “entrepreneur as hero” myth does a lot of good, but it also does some damage. In particular, most small business that need to be built don’t involve creating the next Microsoft or building a multi-billion dollar company.

    I don’t think that Yasheng Huang would disagree too much about these goals. I think the big disagreement is that I think that to get these things to happen would require massive government intervention and regulation to force banks to loan to small and medium businesses, whereas I think that Yasheng Huang thinks that “government is the problem” and that having more government intervention make the situation worse.

    Something that very strongly influences my thinking is that a lot of the dysfunctions you see in China, you also see in the United States. Small town rural Anhui has a lot of similiarities with small town rural Georgia. This makes me think that a lot of China’s problems come not from rejecting American economic models, but copying economic them. Another thing that is a huge difference is that he comes from management and I come from finance, and so I don’t think that he fully appreciates the financial constraints that the government was under in 1990.

    But all that is for the future. Right now the immediate problem is that you have lots of unemployed and angry people in rural China that are going to become increasingly angry over the next few months, and the obvious solution is a state-sponsored massive employment program to get people paid and keep them busy. Yes it may bust the banks and cause us to redo the NPL problem all over again, but I can’t think of anything better.

    Comment by twofish — January 20, 2009 @ 6:12 am

  6. I am not so sure that restricting the flow of capital to the richer parts is smart economically but I agree it would have had rather upsetting consequences. One of the keystones of East Asian development hs been to keep the farmers on the land until urban labor becomes scarce (one reason why Japanese and Korean farmers got to enjoy their protection which is probably an anachronism now). But no matter what you do (you point to educational gaps between cities and countryside), you end up with the cities taking the most productive individuals ultimately, and keeping them there. China as a much larger and geographically diverse country could probably afford more modern approach to agriculture alongside a policy that keeps the peasants on the land until they are needed (and in that case being far less productive than they could be). Socialism (even legacy socialist institutions and processes) has always had trouble with social (vertical, in practice city centred) mobility, except during the pioneering generations. And small plot rice based cultures tended to produce a peculiarly communitarian sort of stereotype. China (and parts of Vietnam) too have a legacy of both. If you want to pour molasses you have to apply heat first…

    Comment by Rien Huizer — February 4, 2009 @ 3:36 am

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