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« Remember when America wasn't so democratic? | Main | African economy tied to rest of the world »
Sunday
Mar302008

China's capitalism isn't so foreign

Western powers today fear that China's stunning rise signals a real challenge to the notion that economic growth triggers democracy. While I understand such fears, let me tell you why they're unfounded: China's economy increasingly mirrors our own.

As business academics William Baumol, Robert Litan and Carl Schramm argue in their 2007 book, "Good Capitalism, Bad Capitalism," there are basically four types of capitalism operating today.

First, there's the family-style oligarchic capitalism found throughout much of Latin America, Africa, the Middle East and Central Asia. In these low-trust social environments, blood ties trump contracts for getting business done.

Second, there is state-guided capitalism that features heavy government protection of national flagship companies that seek to dominate home markets while fueling export-driven growth. In decades past, this was the type of capitalism employed by Japan and South Korea during their rise. Today, we're talking rising powers like China and Russia.

Third is the "big firm" capitalism that marked America's corporate heyday of the mid-20th century and now characterizes Europe and Japan. These are mature markets where major players dominate most industries, giving the economy a lot of stability even as these larger entities don't adapt themselves quickly to new markets and labor tends to be rigid.

Finally, there's the wide-open entrepreneurial capitalism that America always strives for but which waxes and wanes through our history. For example, most big firms that dominated our economy in recent decades actually began as far smaller start-ups around the turn of the 20th century, when America's regional markets were being knitted together into a larger whole that rewarded economies of scale. An entrepreneurial economy features lots of small firms constantly generating new products and technologies.

Globally, the purest examples of highly entrepreneurial economies tend to be small "island" economies like Israel and Taiwan, nations for whom an almost nonstop go-global strategy is the only way to achieve economies of scale in their high-technology products. Both are tumultuously democratic.

In their book, Baumol et al. argue that the current U.S. economy has located its happy historical medium: leading industries dominated by big firms but continuously invigorated by small, entrepreneurial start-ups that are regularly gobbled up by the big firms once their innovations mature. Good examples can be found in the information technology and pharmaceutical sectors, where a handful of giants represent the vast majority of go-to-market outcomes for start-up firms.

The authors single out this mixed model as any nation's best choice for sustained "smart" growth through continuous innovation, meaning America's basically there in terms of market evolution.

Is democracy required for this premium category? Entrepreneurs tend to be notoriously independent characters. If you don't give them the freedom they need, they tend to leave.

What does this tell us about China's challenge? Here's where I think we locate an underlying theory of market evolution lurking behind these categories, for China's rise has actually mirrored the American model more than we realize.

Because China started with a dominant state-run sector and refused to bite the bullet of shock therapy, its leaders adopted a strategy of gradually cannibalizing the economy by encouraging the development of big firms, arising from either the growing private sector or state-owned entities (SOEs), whose funding is obtained largely from state-controlled banks.

Here's the key part: These big firms are augmented by a growing constellation of private-sector entrepreneurial firms that largely access funding from foreign investors. Provincial governments, municipal governments and individuals can launch these firms.

China's strategy seems clear enough: "Let the seedlings of new enterprise grow while tending to the forest of the existing SOEs, with the hope that the new ventures eventually will become more important to the economy than the SOEs." As Baumol and his colleagues argue, "This is exactly what has happened, apparently with great success," as the SOE share of the national economy has dropped from virtually 100 percent in the early 1980s to approximately one-third of GDP today.

Point being, China's model of development constitutes more of an endorsement of American-style capitalism than an improvement - much less rejection. This strategy of "incremental change or entrepreneurial capitalism at the margin" allows China to gradually shift its economy toward the U.S. blend of big firms surrounded by entrepreneurial small firms.

What comes next? More and more freedom if China wants to hold onto those entrepreneurs.

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