When will it be “1989” in China?

Many market commentators are trying to assess whether China will manage to fully implement the decisions of the Third Plenary Session of the 18th Communist Party of China Central Committee, held from 9th to 12th of November 2013.The top of the Communist Party seems to be convinced that, as former Premier Wen Jiabao said, the Chinese economy is fundamentally unbalanced and needs a significant redirection [1].

An important part of this redirection is a slowing down from a growth plateau around 10%, which was achieved on average over the last three decades of the last century, to around 7.5%. While views are divided on the probability of success of this redirection, my overall reading of the different analyses is that a cautious optimism prevails. Basically, there seems to be confidence in the ability of the Chinese rulers to put the Chinese economy on a lower, more sustainable path. Still, the immediate future of the Chinese economy is one central factor in the assessment of the ongoing Emerging Market turmoil.
The main message of this post is that the focus on the probability of success of the current redirection of the Chinese economy is not, at least when taking a long run view, the right one. The really important issue is how the contradiction will be solved between a growing economy and what Acemoglu and Robinson define “extractive political institutions” and  “still partially extractive economic institutions” [2] . Basically the question is whether China will first stagnate, as the Soviet Union did in the late seventies, and eventually enter into a severe economic and political crisis, again as the Soviet Union at the end of the eighties, or whether sustained, even if more moderate, growth will be supported by the move towards fully inclusive economic institutions and accompanied by a smooth move, of which no trace is visible as yet, towards politically inclusive institutions, the most advanced form of which is a democratic set-up.
Long term growth extrapolation are treacherous. My sense is that their usefulness is to illustrate what could, but most probably will not, happen. In 1957, when Khrushchev held his speech on the occasion of the Forty years of the Great October Socialist Revolution Jubilee, the USSR’s 10 year average growth rate of GNP per capita was 6.5%, compared to the 1.8% of the United States (Chart 1). He then stated: “In absolute volume of industrial production the Soviet Union long ago far outstripped the biggest capitalist countries of Europe – Britain, France, and Germany. We are successfully coping with the task of overtaking and surpassing, within a historically short period, the most advanced capitalist countries, including the United States, in per capita output[3]. More surprisingly, one of the greatest economist ever, Paul Samuelson [4], provided a similar projection (in the 1961 edition of his book): Russian GDP would exceed that of the US by 1984 or 1997 at the latest, based on the observed growth rate. Later editions of the book confirmed the forecast but pushed the event into the 2000s.

Chart 1: Change in GDP per capita in USSR and US (YoY)
Source: Author’s calculations based on Bolt, J. and J. L. van Zanden (2013). The First Update of the Maddison ProjectRe-Estimating Growth Before 1820. Maddison Project Working Paper 4.
Similarly Jim O’Neill, former chairman of Goldman Sachs Asset Management, made long term projections in 2009 for China to exceed US GDP by 2027, shortening the previously set deadline of 2041 by Wilson & Purushothaman. In a 2003 Goldman Sachs report these two authors had written: “high investment rates, a large labor force and steady convergence would mean China becomes the world’s largest economy by 2041″ [5]. The 2009 report stated: ” Our current projections show that China may now overtake the US 14 years earlier than we thought originally—we now expect it to become the  largest economy in the world by 2027, vs. 2041 previously.’ [6]
How the Soviet Union story ended is well known. Growth slowed down in the sixties, and seventies and finally the economy stagnated in the eighties (Chart 1). Then, as the Berlin Wall came down in 1989, the Soviet Union started trembling and it disappeared altogether in 1991. Subsequently Russian GDP per head fell at an average of 4 to 7% per annum (Chart 2), depending on the methodology used, for the following 7 years and is now at an estimated  level of 18.000 international dollars for 2013, compared with more than 53.000 in the United States and 34.000 in the €-area.  In terms of the Acemoglu and Robinson approach, only a brave observer could say that there has been a fully fledged move towards inclusive economic and political institutions.


Chart 2: Soviet Union – Russian GDP per capita


Source: Bolt, J. and J. L. van Zanden (2013). The First Update of the Maddison Project; Re-Estimating Growth Before 1820. Maddison Project Working Paper 4.

The big question, with more important economic and political consequences than the success in slowing down the Chinese economy from 10 to 7.5% and rebalancing it towards a more sustainable pattern, is whether something analogous to what happened to the Soviet Union will take place in China.
Those holding a more optimistic view underline two, interrelated, factors. First, they stress the ability of the current Chinese rulers to promote and manage change. Second, the experience of the Soviet Union is the exact negative example not to be followed.
Those with a more pessimistic opinion, and I tend to put myself in this camp, do not dispute either the ability of the Chinese rulers to govern change or the admonishing value of the tragic Soviet Union experience. The claim is that the move towards democracy in a place like China is so difficult that neither an extremely able political class nor a perfect negative example can make it smooth.

The morale of this post is that you should choose with care what you worry about when thinking about China, and beyond.

*** Research assistance was provided by Mădălina Norocea

[1] “As the economy has developed, it has caused unfair distribution, the loss of credibility, corruption and other issues. I know that to solve these problems it’s necessary not only to enter into economic reform, but also political reform. I believe China’s democratic system will, in accordance with China’s national conditions, develop in a step-by-step way. There is no way to stop this. (…)[Otherwise] Mistakes like the Cultural Revolution may happen again.  Translation as per The Telegraph, March 2012

[2]  Daron Acemoglu , James Robinson: Why Nations Fail: The Origins of Power, Prosperity and Poverty, Profile Books,2012.
[3] Forty Years of the Great October Socialist Revolution; Report by N.S. Khrushchev to the Jubilee Session of the Supreme Soviet of the USSR on November 6th, 1957; published by  The Press Office of the USSR Embassy in Canada, p 28.
At a November 1956 ambassador meeting in Moscow, he famously  said, referring to the USA :” We will burry you”, In his memoirs he then clarified this by stating: “ I once let slip an incautious remark in relation to America when I said that we will  bury the enemies of the revolution.(…)At a press conference, when  this question was brought up, I explained that it was not we that were going to bury anyone, but the working class of the United States itself would bury its enemy, the capitalist class.”  Memoirs of Nikita Khrushchev, Vol 3,p 659
Later, in October 1961, at the 22nd Party Congress the stated that the Soviet Union will have a higher living standard than any capitalist country by 1981. 

[4] Paul A. Samuelson: Economics: An Introductory Analysis, McGraw-Hill, 1961
[5] Dominic Wilson; Roopa Purushothaman: Dreaming With BRICs: The Path to 2050, Goldman Sachs Global Economics Paper No: 99, October 2003.
[6]Jim O’Neill; Anna Stupnytska: The Long-Term Outlook for the BRICs and N-11 Post Crisis, Goldman Sachs Global Economics Paper No: 192, December 2009.