Globalization: Custom-Made in China

The rapid pace of China’s economic growth has been remarkable, but the country’s success did not magically result from opening to the world, writes economist Fan Gang. China’s experience shows that countries must plot their own individualized paths towards market liberalization. Early in its development, China protected its infant industries from the rigors of global competition – thus allowing them to grow and mature at an appropriate pace. Free trade may attract more international capital, but also introduces risks for which a developing country is not always equipped. Lack of established legal and regulatory frameworks and sound financial management skills may lead to crises reminiscent of the late-1990s Asian financial crisis. “It is natural to dream of achieving developed-country living standards as quickly as possible,” writes Fan. “but it is dangerous to copy the models overnight without achieving certain preconditions.” – YaleGlobal

Globalization: Custom-Made in China

By controlling the pace and scope of reforms, China succeeded in minimizing negative impact of opening the country
Fan Gang
Friday, October 15, 2004
Electronic power: Foreign capital and technology are being used to build China's domestic capacity and efficiency.

BEIJING: As a developing country with less than US$1,000 in per capita income in 2002 and struggling with many problems, China is not an economic and political power that can set the rules for globalization to its advantage. Yet China has profited to a certain extent from opening up and has thus far avoided economic or financial crises.

China's economic growth and structural changes did not result directly from opening to the world; rather, the crucial factor was the manner in which China switched from planned to market economy. What, then, may other developing economies learn from China's successful globalization? First, you must do your homework in order to benefit from globalization. Second, reforms must fit the country's initial conditions. Third, any reform policy or policy combination must consider economic and social stability.

The key elements of China's market-oriented reforms are development of the private or non-state sector, price liberalization in the domestic market, relaxation of government control and central planning, privatization of state-owned enterprises, and development of the legal framework for private business. The reforms, in turn, have helped to improve the environment for foreign direct investment and building of an appropriate legal framework. Many argue that China will be more successful if it undertakes more "radical" changes, particularly in the political and financial arena, in order to attract more foreign investment. This may be true. And China is indeed facing some bottlenecks in its reform process. Regardless, the most important consideration should be policy coherence.

In a few select cases, China started to invite foreign direct investors early on – almost as soon as the domestic reform began – to take part in a form of joint venture. The subsequent establishment of special economic zones and a better investment environment dramatically increased foreign investment and played the most positive role in early growth. This is not only because investors introduced capital and technology – as globalization is supposed to do in order to create jobs for underemployed workers in developing countries – but also because they introduced business experience and management know-how.

As China's experience shows, countries must plot their own paths of market liberalization. China, for instance, protected its infant industries in their early stages of development, but gave special treatment to equipment and technology imports.

Experience shows that the less developed countries, whose per capita incomes may be 20 or 50 times lower than those of advanced countries, may initially grow through free trade, pulled along by employment growth in primary industries such as mining and agriculture. But if trade is totally free at their early stages of development, these countries may end up specializing only in primary or low-end industries. In the short run, infant economies may achieve efficient resource allocation in the global market, but in the long run, they will fall behind.

The argument for infant industry protection is still valid, particularly because globalization does not amount to the free movement of all production factors. Capital and technology – along with the "brains" behind them – may cross national borders, but ordinary blue-collar laborers do not move. In fact, capital and technology travel to developing countries to use the cheap labor available under certain conditions. The pure economic theory of long-run growth states that as long as all kinds of capital and technology are mobile, the economic gap will narrow. The reality, however, is that intellectual property laws will always protect the more advanced nations' new technology and higher value-added industries, most of which will remain within their own national boundaries. Only low-end, labor-intensive industries, or those using technologies not protected by intellectual property rights, will be relocated.

Because of conditions imposed during China's early period of protection, foreign investment funneled capital and technology to automobile and electronic sectors. Spillover effects and demonstration effects of new technology, management, and the distribution system improved the country's domestic capacity; market size grew with income growth, so that producers could benefit from economies of scale. Supply chains built up, the local-component ratio in production increased, and institutional efficiency improved.

Another important factor in China's success has been its ability to maintain capital controls and refusal to lift them until conditions are ready for capital account liberalization or free convertibility of Chinese Renminbi. Capital controls are one of the key factors that have allowed China to avoid major financial turmoil, including during the Asian financial crisis between 1997 and 1998. Burned by the experience of the 1997 crisis, in which many economies with convertible currency collapsed, the International Monetary Fund has dropped its recommendations for quick financial liberalization for developing countries. Experience has shown that early markets liberalization may enable a developing country to attract more international capital, but at the same time, it may introduce risks the country for which the country is not equipped – for lack, say, of legal or regulatory frameworks, tax policy, and financial management skills. Another important reason for maintaining capital controls early-on is to fight corruption and prevent capital flight due to the ease of money transfer.

Human capital is key not only for growth, but also for benefiting from globalization. Thus, education has to be a priority. Even very basic primary education can enable rural laborers to work for multinational companies, rather than being left out of the modernization process. Indeed, as technology progresses and more modern equipment is used in production and services, all blue-collar jobs are likely to require at least a rudimentary education. After all, the primary issue of development is whether the massive rural labor force can be transferred to the modern sectors, and workers can remain globally competitive in their workplaces.

Finally, though obvious, it bears repeating that governments must develop independent policy according to country-specific conditions, without being influenced by developed countries or multinationals. Globalization is led by multinational corporations, and its main political protagonists are the developed countries where those multinationals are headquartered. Further, the multinationals not only "capture" their own national governments, so that the developed countries' policies favor the interests of their shareholders, but are also able to capture the governments of the developing countries by various means. If the economic policies of a developing country favor multinationals over the interests of its own people, it will be more vulnerable to the volatility of the international financial market – and will eventually result in domestic political turmoil.

In the era of globalization, a developing country should be fully aware of the trap of "great-leap-forward" policies designed to attain instant high standards of living, or of emulating the policy objectives of developed countries. It is natural to dream of achieving developed-country living standards as quickly as possible, nationally or individually. But it is dangerous to try to copy the models overnight without achieving certain preconditions.

Fan Gang is Director of National Economic Research Institute, China Reform Foundation, Beijing. Adapted from his essay in forthcoming book, “The Future of Globalization.”

© 2004 Yale Center for the Study of Globalization