Understanding China’s Potential

Professor Gordon Redding

Intention: to provide context, information, and guidance to Russian
executives coming to terms with China
Agenda

The essential features to understand 3

How China got to be where it is now 21
Current challenges affecting the longer term 37
Possible ways forward for China 53
China today: unspoken truths 58
The legacy of history 59

2
The Essentials

1 2 3 4 5
Societies only The Cultural The Deng This is a social The Party with
make progress Revolution Xiaoping system tied its
in competition remains in the revolution together by nomenklatura
with others if family stories released the personal bonds dominates the
they master the to weaken huge creativity and otherwise economy, so the
art of achieving government of a new limited trust. economy is now
better total legitimacy. Middle Class (again)
factor and the re- politicized, not
productivity opening of the other way
increases. China. round.
This requires
much initiative
and creativity.

3
Understanding Authority in China: 1

• Traditional Imperial dynasties to 1911.

• The Emperor responsible for interpreting the Mandate of Heaven to deliver

peaceful order.

• The Mandarin class administer the state in detail and report to the Emperor.

• Each family to be responsible for order within it, under Confucian ideals.

• Very weak civic consciousness so trust remains interpersonal.

• Results: stability, conservatism. Then later relative poverty,

invasion, disorder, emigration.

4
Understanding Authority in China: 2

• Attempts at democracy 1911-1949.

• Sun Yat Sen, then Chiang Kai Shek.

• Foreign ideals and business.

• War and Civil war, invasions.

• Communist/Nationalist division.

• Result: eventual disorder then Taiwan breakaway with Western

protection.

5
Understanding Authority in China: 3

• Mao Zedong, 1949-1976.

• China ‘stands up’ as a nation.

• Party control gradually becomes personal control.

• Cultural Revolution 1967-77. Chaos. Deep suffering. Millions dead.

• Results: individuals coming to terms with autocracy and

disaster.

6
Understanding Authority in China: 4

• The Deng Xiaoping ‘revolution’ 1980-2010.

• 30 years of growth.

• Opening to global business, ‘workshop of the world’.

• Immense wealth creation and sharing.

• WTO rules.

• Foreign direct investment.

• Results: massive wealth, new ambition, new middle class, many

powerful cities. But CORRUPTION affecting party legitimacy.

7
Where Is the Virtue Now?

‘The net worth of the 70 richest delegates in China’s National People’s

Congress rose to 89.8 billion US$ in 2011, a gain of $11.5 billion
from 2010. That compares to the US$ 7.5 billion net worth of all of
the 660 top officials in the three branches of the US government.’

Rupert Hoogewerf, Hurun/Bloomberg

8
Market Leninism

1 A determined Leninist elite (i.e. tightly controlling Party).

2 Relative autonomy of this elite from society.

3 Powerful bureaucracy subordinated to the elite.

4 Controlled and mobilized civil society.

5 State economic interests dominate private and are the main engine
of accumulation.

6 Control retained: repression; performance legitimacy; defense of

national sovereignty.

Jonathan London (2017) ‘Varieties of states; varieties of political economy’ in T. Caroll and D S Jarvis (eds) Asia after the
Developmental State’, Cambridge University Press.
9
The Chinese Nomenklatura

• Use of mobile elite of Party members to control both government and the
economy

• Top leadership of all strategic SOE’s

• Top leadership of all regional and local govts

• Use of political advancement as reward instead of income

• Earlier connection between political power and opportunity for exploitation

now broken

10
Understanding Authority in China: 5

• Xi Jinping

• Restoration of Party legitimacy and total power by attacking corruption.

Party loyalty central to the design.
• Weak civic consciousness being dealt with via Social Credit Index: total
surveillance/reward/punishment.
• Nomenklatura elite spread throughout the system of control, and then delegation
on basis of performance outcomes imposed. Freedom to vary how these are
achieved. Simultaneous loose-tight control.
• Highly intelligent Party elite. The economy under their control with market forces
subservient.
• Results: Innovativeness, creativity, and entrepreneurship all now
politicized. Responsiveness weakened by centralization. Slowdown.
11
The Empowered Condition / Cool Water Factor and Civicness
Cool water societies such as north-west Europe
and Japan in ancient history provided humans
with regular mild rainfall, cool clean rivers, and
plenty of land. People survived by hunting and
gathering and later small farming and cattle
rearing and they lived in separate small self-
sufficient groups. The led to high individualism,
strong views on freedom, intolerance of
dictatorship, and the decentralizing of
authority. In contrast in tropical river valleys,
dense populations concentrated around highly
fertile river valleys, but subject to flood, seasonal
drought, warm water diseases, and competition
for land. Such societies could only survive under
strong central authority which provided flood
control, food storage and redistribution, and
strong control over land ownership. These
ancient conditions left societal patterns of
response as part of the culture and they account
for most of the cultural variation seen today,
thousands of years later.
Christian Welzel (2013) Freedom
Rising, Cambridge University Press. 12
Implications of China’s Authority System

1 Everything is possible but nothing is certain, including law.

2 Party support crucial to get things done.

3 Great spirit of competitive entrepreneurship.

4 Great reliance on personalism to establish reliable trust. Morality of

honor is strong within the circle, but not outside.

5 Foreigners do best when they have become partially insiders. This

takes time and working together. If not they may be exploited.
technology or design.
6 Often a need for a trusted go-between to handle the dealings between
local and foreign. The traditional ‘comprador’ in the middle.

7 Do not assume that employees display initiative/responsibility on

your behalf. They are used to following orders.

13
The Hockey Stick of Income Development in Human History

14
Ancient Trinity vs Modern Trinity

Ancient Trinity Modern Trinity

Elected
Autocracy Extraction of the Rule of Law
Leadership
Surplus

Sedation of the Competition

Masses and Free Markets

The Five Catalysts

15
Catalysts that Help the Transition of the Society

1. Freedom (individualism, competition, pluralism).

2. Virtue (communal duty, human heartedness).

3. Reason (science, specialization, organization, rationality replaces personalism,

trust).

4. Empowerment (representation, education).

5. Progress (belief in growth, escape from poverty).

16
The Cool Water Condition and Human Empowerment

17
World Value Survey Cultural Map 2005-08

Inglehart, R. and C. Welzel. (2010). ‘Changing Mass Priorities: The Link between Modernization and Democracy’.
Perspectives on Politics 8(2): 551-567. Figure 1 on p. 554.
18
Declining Impact of Cool Water Effect / Societal
Empowerment on Economic Growth

19
Two Key Phase Transitions

Source: Richard Baldwin (2016) The Great Convergence,

Harvard University Press.
20
How Did China Get to Where It Is Now?

• In ancient history the first modern state (with a professional bureaucracy).

• An emperor in total charge of interpreting the ideal of heavenly peace.

• From 1800 two hundred years of disorder, famine, civil war, invasions, revolutions,
and loss of pride.

• Mao got them to ‘stand up’ but he came to dominate personally and lost connection
with reality. 50 million deaths. In the memory.

• Deng Xiao Ping saved China by bringing in market forces, property rights, WTO rules,
and foreign investment. Took 400 million people out of poverty.

• But success led to corruption.

• So Xi Jinping has tightened control and is now extending it with the Social Credit
Index to counteract the absence of trust.

• The dynamism remains but for how long?

21
China and Traps?

• Elvin – High level equilibrium trap

• State Council - Middle income trap

• This lecture - Mercantile equilibrium trap (govt runs the economy)

22
Escaping the Middle-Income Trap

23
Globalization and GDP

24
The Share of World’s GDP in China Will be Increased by 2030 and
then Level Off

25
The Two Forms of Societal Order

There are two main forms…

1. Relation-based (most Asian societies) - much variety. Few fixed costs

but marginal cost of additions is high (executive time). Rules fuzzy.

2. Rule-based (most democracies) –largely similar. High fixed costs in e.g.

legal/regulatory infrastructure but low marginal cost of additions. Rules
clear.

26
Rule-Based Societies – General Tendencies

• Public rules fairly made.

• Separation between rule-making, adjudication, enforcement.

• Rule-enforcement fair, efficient.

• Public information highly reliable and accurate.

• Those affected help make the rules.

27
Relation-Based Societies – General Tendencies

• Public rules biased towards the privileged and with inadequate

checks and balances.
• Legislative and judiciary overshadowed by the executive.
• Executive and judiciary likely to be controlled by ruling elite.
• Govt secrecy, censorship, information control.
• Industries and markets controlled by insiders.
• Networks of corruption.
• Rule by people not by law.

28
The Governance Cost of Rule-Based and Relation-Based Systems

Shaomin Li (2009) Managing International Business in Relation-Based versus Rule-Based Countries, New York, Business
Expert Press.
29
Management Implications: the Nature of a Relations-
Based Society

• Reliance on private information.

• Manipulation of information.
• Secretive private relations with careful monitoring before and during.
• Ostracism for default (law seen as useless).

NOTE 1: in some conditions because of its flexibility and low cost, this can be
efficient (at some stages in some sectors, e.g. workshop of the world).
BUT: scale and scope require rule-based order.
NOTE 2: shifting power at the top can result in an excess of petty new regulations
as admin units defend their territories.

30
Working In a Relations-Based Society

• Be aware of the contrast.

• Find and cultivate the industry insiders.
• Bring a unique competence so as to claim respect.
• Use old relations to establish new.
• Become a new insider, knowing the rules.

Note a reverse benefit: some relations-based behavior may enrich a rules-based

enterprise.

31
From Those with Deep Knowledge

• Joel Mokyr

• William Overholt

• Yongnian Zheng and Yanjie Huang

• George Magnus

32
The Study by Joel Mokyr

Two ‘games being played’ in the economic miracles

1. The game against nature (via technology).

2. The game of interacting with other people (via institutions):

► ‘It is in this complex of interactions that the answers to the big historical
questions must be sought.’
Joel Mokyr,
The Enlightened Economy
33
The Study by William Overholt

An uncontrolled unstable condition of metastasis

Full of paradoxes
• Anti-corruption and environment protection needs whistleblowers but system threatens them
• State sector efficiency needs autonomy but gets more control
• Economic efficiency needs better legal system but Party control of law gets stronger
• Upmarket moves need foreign investors but these are antagonized
• Talent needs globalizing but global information flow is censored
• Admin decisiveness needed but now centralized and slower
• Competition-based efficiency needed but prevented by national champions
• Good for making money but not for keeping it
• Middle class needed but now de-stabilized

William Overholt (2018) China’s Crisis of Success, Cambridge University Press.

34
The Study by George Magnus

Core problem of investment efficiency:

1978-2006: between 2 and 4 yuan investment to get an additional 1 yuan of GDP.
By 2015 - 9 needed.
Credit intensity: 2007/2008 to raise nominal GDP by 5 trillion needed 6.5 trillion credit
2015/2016 needed 20 trillion / 60 % of world railway building

Four traps
1. Debt
2. Renminbi. No global currency without a current account surplus
3. Age. Old before rich
4. Middle-Income Trap. Previous forms of slack now all used up:
Exploitable labor (cheaper elsewhere).
Exploitable land (exploited).
Globalization boom/workshop of the world (can leave).
External know-how (outsiders have new defenses).

George Magnus (2018) Red Flags: Why Xi’s China is in Jeopardy, Yale University Press
35
The Study by Yongnian Zheng and Yanjie Huang

Two deep-seated beliefs in the civilization’s heritage

1. Market-in-State. The market is not a free part of the society that the state supports.
Instead the state uses the market for its work of running the society.
► ‘Has prevented China from developing an independent entrepreneurial merchant
class.’
► ‘Finance the most jealously guarded market in China.’

2. The family plot. The authority has the right to make use of the assets held by the
citizens (as a paternalist father with the family’s holding of land). The state banks hold
the peoples’ savings.

Y. Zheng and Y. Huang (2018) Market in State: the Political Economy of Domination in China. Cambridge University
Press
36
Current Specific Challenges Affecting the Longer Term

► The Middle-Income trap: delivering productivity.

► Financing the future.

► The advantages used up and no longer available.

► The problem of innovativeness under tight control.

► A culture of endemic mistrust.

37
The Plateau on the Way

1 It is possible for a pre-modern society to reach a plateau at about

15,000 US$ per capita.

2 China has currently US$ 8,159 (in ppp 25% of US).

3 The modern societies: US 56,000, Sweden 50,581, UK 44,255 Japan

34,616, France 37,580. (Data from The Economist 2018 Pocket World
in Figures)

4 From the plateau to the peaks is where the political genius comes in.

38
Lessons from Elsewhere

► Seven forms of modernization so far.

► Will China be the eighth?

39
China: Opportunities for Russian Business Leaders

• Russians know about nomenklatura.

• You are used to personalistic responses to surrounding mistrust.

• You are used to centralized authority.
• China needs other markets and therefore connections.
• China can usefully absorb external know-how especially in hi-tech and
services.

• Old connections are remembered.

40
Varieties of Asian Business Systems

• Japan: Coordinated

• South Korea: Plutocratic state-led.

• Taiwan: SME oriented.
• Singapore: Open state-led.
• Hong Kong: Hybrid catalyst (in transition).
• Indonesia: Oligarchic.

• Malaysia: Personal.
• Philippines: Inequality-trapped.
• Thailand: Post-developmentalist.
• China and Viet Nam: from Authoritarian to Market Leninist.
41
The Elements of a Societal Business System

42
Back to the Agenda

Will China succeed in finding another

form of the modern?

43
Societies are Built on These Two Axes

1. Innovation (science, growth, inventiveness, adventurousness).

2. Cooperation (increasing scale of efficient organizing and exchange).

► The richest countries have the most of each. Keeping them high
and in balance in society is a very advanced human achievement.

44
The Full Achievement Depends On…

• The intensity of cooperativeness (productivity per person).

• The extent of cooperativeness (scale and scope of organizations; transacting with

strangers).

The power of innovativeness rests in its being directed to the most fruitful aspects of
societal progress. THE ADDING OF VALUE.

45
Delivering the Universals

1 Innovativeness: entrepreneurs free to take risk and science to

stimulate ideas.

2 Cooperativeness: trust of strangers.

3 Empowerment: critical thinking, freedom of expression,

communicative action.

4 Public good consciousness: ethics of public good. (NOTE: the

Social Credit Index)

46
The Balancing of Adventurousness and Cooperation

► The genius of the institutions invented to take societies from the pre-modern to the
modern has been to ‘prevent the sins of envy, or of anger, or injustice from killing
innovation’*.

► The key invention here is modern capitalism, the heart of which is not accumulation
but innovation.

► And inside that the dynamo is entrepreneurship.

*Joel Mokyr, The Gifts of Athena, Princeton University Press, 2002

47
Deep issues not faced in China

• New urban-living, service sector employed middle class.

• Need for regime legitimacy beyond just raw economic growth (now slowing down).
• A properly innovative culture.
• An education system that supports independent thinking as well as technical learning.

Questions?

• For how long can appeals to nationalism cover this up?

• For how long can The Party control the narrative?
• Will the Social Credit Index produce backlash?

48
Cooperativeness?

► ‘…every interaction is seen as power-maximizing and zero-sum. Trust is at a

minimum, and therefore, in the Chinese world-view, collective action cannot
possibly be based on common ideals or values. A lack of commonly shared
social values – in the aftermath of the Cultural Revolution and three decades of
go-go growth – has produced a society of individual indifference and lack of
collective responsibility. As a result a moral void pervades Chinese society.
What this means for China and global governance is clear: a society composed
of self-seeking, power maximizing individuals who are dismissive of domestic
social responsibilities and public goods are certainly in no position to embrace
arguments concerning international responsibilities and public goods’

David Shambaugh (2013) China Goes Global: the Partial Power, Oxford University Press. p.154.
49
Innovativeness?

In China. US registered patents, bio-pharma, 2003-2011

For Domestic firms 2430*~

MNCs 3950
Hybrids 7650
* 57% from one firm –Huawei
~ Govt R&D subsidy to domestics 99% (2000), 87% (2009), 87% (2011)

In 2017 Chinese domestic chip makers are expected to supply US

$25 billion worth of the $200 billion China market in integrated
circuits. (The Economist 26-5-2018)

50
Lean Principles and Barriers to Implementation

51
But…

• Relations between listed and non-listed are invisible.

• Rise of local government – invested firms raising capital from state

banks (so less resource constraint) but also unlisted, so are opaque.

Source: Teng, Fuller and Li (2018) ‘Institutional change and corporate governance diversity in China’s SOEs’, Asia Pacific
Business Review, 24, 3, 273-293.
52
Will China Continue to Develop?

Perhaps

• If it can adapt to be capable of deep change, while remaining stable

Four options available:
1. Free market capitalism Chinese style (tried but now running into the middle –
income trap like most others).
2. Developmental state like Japan, S.Korea, Taiwan, Singapore (no chance
without political change).
3. Market Leninism (on trial) - Never worked anywhere before as a long term
formula.
4. Mercantile (i.e, state-licensed) hybrid globalizing enterprise.

53
Market in State

• Blockage to progress

• In general terms an inability to reconcile:

(A) the perceived sacred duty of a state elite to protect order with

(B) the release of the energies of an ethically empowered business ownership class
(a virtuous bourgeoisie) free to pursue trade-tested betterment and productivity

54
The Fourth Option

Mercantile (i.e., state-licensed) hybrid globalizing enterprise

1. Regional ethnic Chinese know-how.

2. Foreign MNC technology.

3. China operations.

4. State support.

Fuller (2016) Hidden Dragons, Mathews (2006) Dragon multinationals

55
Why?

• Borrowing as strategy.

• New era - the firm - not the state.

• Regional experience 100 years.

• Affinity of ethnic Chinese with CCP.

• Affinity of ethnic Chinese with foreign assets.

• Regional exemplars.

• Many sectors as well as hi-tech.

• Comprador role strategic necessity.

56
Why not?

• Stifling of market-based initiative by control of capital, monopolies

• Legitimacy of bourgeoisie constrained

• No common good consciousness

• Critical thinking restrained/information rationing

• The burden of keeping order at societal scale

• And: New era of the firm and not the state?

57
China Today: Unspoken Truths

• European miracle fed by colonial assets.

• US miracle fed by resources of an empty continent.
• China miracle by govt. ownership of all land and de facto of labour.

• Not market capitalism but state / corporatism /

mercantilism.
• Immense pride but unspoken shame / resentment/ chauvinism.
• Legacy of ‘The worst man-made catastrophe ever’ (Cultural Revolution).
• Final triumph of intelligence and common sense (Deng).
• No grand plan, except control.
• Growth now via capital investment by the state.

58
The Legacy of History

• The state has a duty to provide order.

• Family has (again) duty to provide welfare.

• Power rests in paternalism.

• Trust only those you know.

• The bird that flies first gets shot.

• You can’t trust the system.

• Fault leads to punishment.

59
And…

• It will not dominate the world economically unless the Party learns
to give the Chinese people the rights to own their own country…

• Which it might do (on Chinese cultural terms).

• But at this scale?

• And with its 3000 years of ideals?

60
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