> Bernard Yeung, Dean of NUS Business School:
The Best Laid Plans in China Co-authored by Randall Morck
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n a single generation, China has transformed itself from one of the poorest places on Earth into a rising industrial superpower. Yet despite the speed and scale of the transformation, China’s economic miracle remains a “work in progress”: many stress points have developed and some pose serious threats to its continued success. Widening income disparity, worsening pollution, serious product quality scandals, artificial entry barriers to many sectors and regions, severe resource constraints, an aging population, and the often chaotic and discretionary administration of laws and regulations are just some of the issues that have come to the fore. Approved by the National People’s Congress in March 2011, the 12th Five Year Plan recognises these stress points, and proposes goals aimed at transforming China into an advanced market economy. The Plan’s long list of objectives will take years to complete. Rather than being attained by decree, achieving most explicitly require a switch from central to decentralised planning: changing the government’s role from that of economic engineer to economic referee. The need for this decentralisation is evident in plans to professionalise China’s bulky stateowned enterprises, banks, regulatory bodies, and other institutions. The Plan envisions this process largely eliminating corruption and cronyism, with important economic decisions made on the basis of economic principles rather than connections. However, efficient decentralisation and delegation are easier planned than implemented. Managers of banks and other financial institutions for example will allocate resources in accordance with the economic logic of these objectives only if appropriately incentivised to do so. If bankers’ careers are advanced by allocating loans politically, to gain favour with cadres, loans will be allocated politically. Similarly businesses will invest to upgrade their productivity only if this proves better for their top managers than investing in political rent-seeking (i.e. doing favours for politically powerful individuals or their families). These unfortunate truths arise because large, dynamic economies are inherently so
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“First, connections tend to be passed along through families, so a connection-based economy quickly becomes an economy controlled by a powerful hereditary elite composed of a few old-moneyed families.“ complicated that even the most diligent and energetic honest overseers cannot possibly monitor all the millions of decisions people in banks, businesses, and government offices must make. Moreover, government agents will use their powers to promote the Plan’s goals only if they benefit more from doing so than from doing otherwise. Even before 1978, in a vastly simpler Chinese economy, the direct government control system worked poorly and often created serious economic and political problems. In the China envisioned by the 12th Five Year Plan, reform by decree and exhortation invites catastrophic failure. Other developed countries have found that only well-crafted incentives can generate broadly efficient decision-making. The goals listed in the Chinese plan demonstrate that central government officials appreciate that the fundamental economic underpinnings of an advanced market economy are strong institutional foundations that make it economically rational for people to work hard and use resources efficiently. These include laws, regulations, customs, and morals that lay down the expected scope of people’s self-interested actions. Rule of law One of the most important institutions in advanced market economies is the rule of law – the generally correct expectation that most people obey laws and regulations, which are enforced even-handedly. The expectation that most people will act this way makes doing business dramatically easier than it is where such institutions do not constrain behaviour. Certainly, there are exceptions. Wealthy American financers may violate the rules and get away with it by bribing politicians. But if such things happen too often – as perhaps in Italy or Greece – the economy suffers. Likewise politicians who
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use public monies to bail out ill-run or corrupt businesses deemed “too big to fail” often put their future careers in grave peril. People in advanced market economies genuinely value the rule of law. This reasoning can gel into a self-sustaining cycle. If the law is enforced fairly and without regard for personal or family connections, people accept the rule of law; and this includes the people charged with enforcing it. Obeying the law becomes a source of personal and family pride. But the circle can also be self-defeating. If the law is administered selectively or for private gain, the rule of law cannot become established. Instead, people look to family or close associates, rather than public officials, for protection or retribution. Successfully evading the law can even become a source of personal and family pride. Because officials have discretionary power to allocate resources and economic opportunities, businesses expecting “help” from high-up government officers invest in connections in ways that enrich those officials, their families, or their associates. This gives officials incentives to gain further powers, making connections an even more essential investment. And businesses that have already invested money in official connections encourage this because it makes their past investments even more useful. The result is that the economy becomes mired in - at best - middle income levels, and can easily slip back into poverty and backwardness, as has been the unfortunate story of some Latin American countries. We view the “institutional reforms necessary for the successful realisation of the 12th Five Year Plan goals” as basically those necessary to achieve the rule of law – to transform China into a huge Germany, rather than a huge Peru. Obviously this is not easy: the world has many economies like Peru and only a few like Germany. Unfortunate cycle The challenge is the stability of the unfortunate cycle. In the absence of rule of law, the only people who can run businesses are those able to draw on strong political connections. Without such connections, a successful business entrepreneur risks losing everything to corrupt