Will China Be Nicer When It is Richer?

China may not be able to maintain growth if it continues its Communist ways.

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Four-year-old Shao Wei holds the Chinese national flag while his father prepares another for his sister outside Beijing's Revolutionary History Museum Sunday, June 29, 1997. Thousands of flags, including the new Hong Kong regional flags, have been sold in recent days outside exhibitions at the museum which are dedicated to the Hong Kong handover. Hong Kong reverts to Chinese sovereignty July 1.

Robert Hahn is director of economics at the Smith School, University of Oxford and chief economist at the Legatum Institute. Peter Passell is a senior fellow at the Milken Institute and the economics editor of the Legatum Institute's Democracy Lab. They are cofounders of Regulation2point0.org, a web portal on regulatory policy.

With the Great Chinese Growth Machine apparently on the verge of downshifting, it's a good time to revisit an old argument: Can China continue to expand at near double-digit pace if the Communist Party doesn't loosen its the iron grip? Or, coming at the problem from a different direction, is the tension between a (partly) free economy and an autocratic political system in China likely to be self-resolving—that is, will growth lead to liberal government?

Daren Acemoglu from MIT and James Robinson from Harvard, whose book Why Nations Fail, provides a neat matrix for thinking through the issue (and summarizes much of what's known about economic development along the way), are pessimistic.

Acemoglu and Robinson distinguish between "extractive" economic institutions—those designed to skim the bounty of production for the benefit of the elite—and "inclusive" institutions, which motivate people to work, invest, and innovate by assuring economic rights and a level playing field. Likewise, they classify political institutions as extractive or inclusive. The former protect the interests of the rulers, while the latter nurture pluralism.

[See a collection of political cartoons on the economy.]

So, what does all this have to do with China's growth potential? Nations with both extractive political and economic institutions can grow—up to a point. Thus both China under Mao Zedong and Russia under Joseph Stalin grew very rapidly in the first decades, at least in part because the rulers were able to extract all the economic surplus from households (actually, more, since millions starved) and directed most of it into building industrial states. Both ran out of gas, though, because extractive economic institutions undermine individuals' incentives to be productive, while extractive political institutions can go only so far in motivating effort. As the old Soviet joke put it: "We pretend to work and they pretend to pay us..."

It's worth noting here that economic systems are rarely entirely extractive or entirely inclusive; economic interests sometimes succeed in creating pockets of privilege, even in liberal democracies. By the same token, the economic reforms orchestrated by Deng Xiaoping in the 1980s moved China's system only part of the way from extractive to inclusive. Yes, farmers were freed to own land and to sell their crops to anyone; yes, it is possible to start a business and keep the profits. But woe unto those who challenge state-owned enterprises or businesses tied to the political leadership in the marketplace.

The Chinese economy has done very, very well since Deng proclaimed "to be rich is glorious!" But Acemoglu and Robinson argue there are limits to what can be had from a mix of highly extractive political institutions interacting with moderately inclusive economic ones. And, the warning signs of a secular slowdown are already visible if one looks closely.

While the Chinese economy is certainly entrepreneurial, it isn't especially innovative. Nor, for that matter, are banks eager to loan money to those ready to build better mousetraps. Why would one expect otherwise, in light of the risks in taking on incumbent elites or in trying something entirely new without the protection of enforceable contracts? Yet at this stage of development, Acemoglu and Robinson say that what's really needed to sustain the momentum is "creative destruction "—initiatives that upset the well-padded apple carts of state-owned enterprises and, more generally, the friends and family of the rulers.

Thirty years ago, it was in the interest of China's autocrats to ignore ideology and liberalize the economy. Today, it's far from clear that the Beijing political class would, on balance, benefit from further liberalization. On the one hand, another doubling of GDP (seven years' worth of growth at the pace of the last decade) would go a long way toward reducing social tensions that constitute a long-term threat to the dictatorship of the former proletariat. On the other, greater freedom to challenge incumbent interests may gore too many well-connected oxen to be acceptable.

But what if growth itself catalyzed the sort of political change needed to make further liberalization possible? That, of course, has been the hope of observers like Tom Friedman, as well as the rationalization for opening the door to trade with communist countries in the 1980s. But Acemoglu and Robinson point out that this "modernization" theory has yet to deliver: Beijing has managed to tamp down political restlessness that is nurtured by the Internet and the cell phone.

There's an interesting irony here. To date, we've all been rooting for Chinese growth, which, after all, has saved a half-billion people from grinding poverty. But should we still be leading the cheering section if the political system remains resistant to inclusiveness?

Back in 1956, the west quaked when Nikita Khrushchev declared "we will bury you!" Of course, the Soviet economy ground to a halt in the 1970s, and the U.S.S.R. collapsed in 1991. But the Chinese communist party may yet pull off what its Soviet counterpart party couldn't. And while there is no inherent reason for the country to become aggressive, its potential as a military and economic power ought to elicit a quake or two.

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