China currently lives under a complex mishmash of the leftovers of communism, state capitalism, crony capitalism and laissez faire in the special economic zones. The communist party remains in power, but has progressively replaced the communist ideology by a mix of nationalism and mercantilism.
This new model has been very successful in terms of economic growth and attraction of foreign direct investment. Due to its huge population (1/4 of all humanity), China is now seen as a kind of manufacturing factory for the world.
Under Deng Xiaoping, China introduced in 1979 a policy to modernize their state owned companies by granting them more decision making power and the possibility of retaining a share of the profits. Along with this, marginal players operating outside the boundary of socialism were tolerated as long as they did not threaten the state sector or challenge the Party’s political power. The later spur a movement of entrepreneurial activity through private farming, township and village enterprises, private business in cities, and Special Economic Zones.
Three years after the Tiananmen Square Massacre the Communist Party officially endorsed the “socialist market economy” in 1992. This was followed from 1992 to 1994 by a second round of reforms aimed at creating a true internal market within China by abolishing or reducing the many trade and tax barriers at provincial borders and through the privatization of some state enterprises.
Two other important milestones were the membership of the World Trade Organization in 2001 and the constitutional amendment of 2004 recognizing the protection of private property.
The most radical departure from communism was the 1980 establishment of Special Economic Zones in Zhuhai, Xiamen, Shenzhen, and Shantou opened to foreign investment to experiment with the market economy, import advanced technology and managerial know-how, and sell goods to the global markets without undermining socialism in the rest of the country.
These were later extended to other regions and transformed China from a backward rural economy into the largest offshore processing center of the world. These areas attracted 70% of all foreign investment and contributed to over 70% of its exports. Foreign direct investment (FDI), including from Chinese living abroad, became the driver of an unprecedented export-led boom.
There are two remarkable features in the evolution of FDI in China. Its ten-fold increase during the 1990-1994 second round of reforms that followed Tiananmen and the fact that since 2005 China also became a major source of FDI. Most of the Chinese outward investment went to Hong Kong and offshore centers but the Chinese have also invested significantly in Australia, South Africa and other African countries rich in natural resources.
These flows are an unquestionable testimony and consequence of the success of China’s mercantilist dualist economy – a state owned economy supported by the largest offshore territory in the world. Indeed, in 2006 its foreign currency reserves, already the world's biggest, topped $1 trillion. They are also the best proof of the power of capitalism as an economic system, even in its distorted version of state capitalism.
The question is to know whether it can survive in its current form and how it may evolve. Judging from previous experiences it is unlikely that the current model will last more than 30-40 years.
For instance, despite the initial economic role of the Chinese military complex and a rising nationalism one hopes that it will not derive into a Nazi/Japanese-like military adventure that would kill its early success and endanger world peace.
Similarly, any drive to obstruct the growth of joint stock companies while transforming the still large and inefficient state enterprises into some form of Tito’s Yugoslav model of self-managed enterprises is equally doomed to fail.
An evolution towards a Scandinavian model of state capitalism would be equally short-lived and does not seem feasible given the cultural differences between the Nordics and the Chinese. Likewise with a move towards a Mediterranean corporatist form.
The Chinese state capitalism is already showing signs of fatigue. As usual, these are more visible in disastrous investments abroad and in a fragile banking system. The latter is a time-bomb in waiting. Some, like C. E. Walter and J.T.H. Fraser (2009), alerted to how the banks are risking the retirement of an ageing population of more than 300 million people. The “heroic savings capacity of the Chinese people” are being used to finance loss making state companies as well as property bubbles and gigantic “Pharaonic” infrastructure investments.
Despite these worrisome signs, the Chinese people have embraced a commitment to education and learning from the Western countries experience without parallel in history. For instance, in the academic year 2010-2011 there were about 340 thousand students studying abroad, most of them financed by their own families. Indeed, in the USA and the UK there are now Universities that survive on Chinese students. These students are very competitive and will foster a new rise in entrepreneurship and modernization as long as their drive to succeed is not diverted towards nationalistic adventures.
Indeed, contrary to what some claim, I do not believe that the peaceful transition from communist state capitalism towards a democratic market capitalism needs a new “third way”. I totally disagree with the Nobel Laureate Ronald Coase predicament that: “Capitalism will be much more robust if it’s not a monopoly of the West, but flourishes in societies with different cultures, religions, histories, and political systems.”
It is not possible to achieve true market capitalism within a communist political system. However, the two transition processes can reinforce each other rather than deter one another.
By correcting the many deficiencies in the Chinese pillars of capitalism, from relying less in joint ventures and better protecting private property to the abolishment of internal restrictions to labor mobility and the opening up of its domestic financial market to achieve international capital mobility on both current and capital transactions, China would ease its political transition towards representative democracy and constitutional liberalism. For instance, a strong adherence to a system of limited liability will enforce credit prudence in the banking sector and might avoid the foreseeable problems with old age pensions.
In conclusion, China is at a crossroad. If she wants to preserve its recent economic success and avoid descending into other forms of state capitalism or to become a crony capitalist system of the Russian type it must fully embrace market capitalism. The more it does so the greater the chances of also managing a peaceful political transition.