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China's economy is likely to become the largest in the world within a matter of months
China’s economy is likely to become the largest in the world within a matter of months, if not years. This will happen as a matter of course. What remains to be seen is whether or not the majority of China’s citizens will ever attain a first-world standard of living. This will require a transformation in China from an autocratic, centralized economy to a democratic, free market economy. It has happened in other Asian nations, and can happen in China as well. If it does happen, Hong Kong will play a key role.
The official narrative of China’s history is one of victimhood that ended with the 1949 establishment of the People’s Republic of China. China now faces the prospect of not being merely an equal amongst the great nations of the world in terms of economic size, but the economic leader of the world. But aggregate economic activity is of little worth to individuals in a country where the average per capita personal income in 2012 was $6,067 USD. By comparison per capita personal income in the United States for the same year was $42,693. China can catch up and even surpass other countries in this more important economic metric, but the process will not be without its challenges.
These challenges were outlined in some detail in a keynote speech delivered at last week’s Tipping Point Hong Kong conference by Professor Gordon Redding, Senior Fellow, INSEAD. Throughout his talk, Redding pointed to challenge China’s economy faces due to a dependence on interpersonal trust in business transactions. On the surface interpersonal trust may sound like a good thing, but people only do business with those they know and trust, to the exclusion of those with whom they have no personal relationship. Economically this is crippling because it undermines the division of labor and the efficiencies it creates which allow for the widespread diffusion of wealth. In order for China to bring the standard of living for its citizens to first-world levels, it must foster trust not just in specific individuals, but in individuals generally, or in the system. “The key invention here is modern free market capitalism, the heart of which is not accumulation but innovation,” says Redding. “Inside that the dynamo is entrepreneurship (the search for new combinations) and the mechanism is widespread exchange. A core feature is rationality and trust in the fairness of the system.”
James Surowieki, staff writer at The New Yorker and author of the 2004 bestseller The Wisdom of Crowds, says much the same thing in his book. Far from being an unfortunate byproduct of capitalism, it is this impersonal trust, or trust in culture, systems, and individuals generally rather than only specific individuals one knows well, that makes the system work, providing us with everything from smartphones to health care. If I only do business with those I know and trust, my ability to trade for my gain is limited to my immediate circle of contacts. In his book Surowieki quotes economist Stephen Knack who states, “The type of trust that should be unambiguously beneficial to a nation’s economic performance is trust between strangers.” Knack continues, “Particularly in large and mobile societies where personal knowledge and reputation effects are limited, a sizable proportion of potentially mutually beneficial transactions will involve parties with no prior personal ties.” Restricting trade to only those with whom you have a preexisting personal tie restricts trade across an entire economy.
Taken to an extreme a reliance on interpersonal trust in business transactions would result in a society that is incapable of producing something as simple as a pencil. China makes plenty of pencils, not to mention much more sophisticated products, while remaining under an autocratic government, but this will only take it so far. Redding points out that China’s continued prosperity will prove illusory if they do not transition from an autocratic system which forces economic transactions to a free one where trade is voluntary. Just as the United States was stunned by the growth of the Soviet Union during the 50s, 60s, and 70s, only to see the USSR ultimately collapse, China has also impressed the world with it’s growth over the past 30 years but will likewise fail to sustain its growth under the current system. Redding says China will hit a wall as average per capita income in that country nears $15,000 per year. At this point the economy will not be able to continue its progress without a transformation.
The way all developed economies have jumped this hurdle is through some form of free market capitalism. Redding contrasts the old way an autocracy forcibly extracted surplus from the economy, using a portion of it to sedate the masses, with the new way of elected leadership, rule of law, and free markets. “Domination by capitalists emancipates society from harsher previous modes of domination,” says Redding. He points to other Asian countries who have successfully made the transition, including Japan, South Korea, Taiwan, Singapore, and Hong Kong. But knowing what the goal is and being able to make it happen are two separate things. Redding asks, “How will China escape from the mistrust-based reliance, without an indigenous equivalent to civil society and strong legal institutions?” Without going into detail as to how these other nations overcame the challenge, one might be tempted to think the template is already there, and the example of those nations is enough. Surowieki details just such a transformation led by example in his book.
Surowieki points to a historical example of how trust of the free market system developed in Western society by way of the Quakers. Quakers, because of their religious affiliation and the existence of a discriminatory state religion in Great Britain, were excluded from trade professions and were relegated to the lowly practice of business. Quakers found it easy to trade with fellow Quakers, and because of their standard of honesty and fair dealing, they became quite prosperous. Then an interesting thing happened. As Surowieki writes:
Quaker prosperity did not go unnoticed in the outside world. Quakers were well-known already for their personal emphasis on absolute honesty, and as businessmen they were famously rigorous and careful in their record keeping. They also introduced innovations like fixed prices, which emphasized transparency over sharp dealing. Soon, people outside the sect began to seek Quakers as trading partners, suppliers, and sellers. And as Quaker prosperity grew, people drew a connection between that prosperity and the sect’s reputation for reliability and trustworthiness. Honesty, it started to seem, paid.
Is the example of the prosperity of surrounding Asian nations enough to move China to follow in that same direction? Not in any sort of timely manner, no. The complicating factor is “face.” For China to publicly follow in the footsteps of a Japan or Taiwan, for example, would bring national embarrassment. China’s government wants to lead, not follow. Hong Kong gives it a way to lead without losing face.
Hong Kong differs from all other Asian nations in that it is now part of China, even if it exists as a Special Administrative Region (SAR) under China’s “one country, two systems” policy. Started by Deng Xiaoping in the 80’s, this policy originally allowed for territories China considered its own such as Hong Kong, Macau, and Taiwan, to continue under capitalist systems while the rest of China remained socialist. But the rest of China has not remained socialist. In addition to the SARs, China has created Special Economic Zones, free-trade zones, and high-tech industrial development zones. Altogether there are more than 100 such zones including high profile cities such as Shanghai and Shenzhen. At the Doing Business With China Conference held at Utah Valley State University on April 15th, 2013, James McGregor, a 25-year resident of China and author of No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism, shared his personal impression of socialism in China when he stated rather bluntly, “There are more socialists in Washington D.C. than in all of China.”
China is rapidly adopting capitalist ways, and Hong Kong is its guiding light. In following the Hong Kong example there is no loss of face for China because, after all, Hong Kong is part of China. Hong Kong provides both the blueprint for transformation and a way for China to save “face” while going through it.
As China makes this transition, Redding names five catalysts we will see at work, allowing us to gauge China’s progress:
A society that values these traits will engender the kind of impersonal trust necessary for an advanced and large scale economy. As we see improvements in each of these areas, we can expect economic improvements to follow.
As a final note, while it seems unlikely, it is possible China could not only lead economically but leapfrog Western nations by fully embracing human rights, rule of law, and free markets. Stranger things have happened on the world stage over the past 200 years. If China were to take the lead when it comes to individual liberty, rule of law, and free markets it would provide the means by which China could not only make the transition to first-world living standards for the majority of its citizens, but it would also make its leaders wealthy beyond our current ability to comprehend.
In all this Hong Kong is key. It provides the example of impersonal trust, rule of law, and other catalysts and ideals necessary for China’s transformation. Many people refer to Hong Kong as the gateway to China. It may also be China’s gateway to lead the modern world.