State and Private Economic Sectors Align

By JOHN ROSS

A striking feature of China’s economic development is the breadth of social layers benefiting from it. At the bottom of the economic ladder, China has lifted over 600 million people from internationally defined poverty – accounting for the entire global fall in the number of those living in poverty. Taking middle incomes, while median U.S. wages have fallen in the last seven years, China’s real urban incomes rose annually by almost double-digit figures. At the top income level Alibaba’s IPO, raising US $25 billion, the largest for any company in history, turned Ma Yun into China’s richest person.

But Alibaba is the tip of an iceberg. By 2012 China had 10.9 million private companies, employing 113 million people, plus 40.6 million individual enterprises, employing 86.3 million people. No equivalently rapid expansion of private enterprises has taken place in any other country. How, therefore, has socialist China produced not only the world’s biggest improvement in living standards for ordinary, and the poorest, people but also the world’s fastest development of private companies?

The reason is that China’s economic structure successfully aligns all major economic forces. This is strikingly unlike the current situation in the G7 – which was characterized by IMF Managing Director Christine Lagarde as “the new mediocre,” and where Pew International Research polling found that “pessimism is pervasive.” By contrast, the continued rapid development of China’s private companies demonstrates the advantages of China’s economic structure. This has major lessons globally.

Taking first the West, the G7 proclaim themselves “market economies,” in which large numbers of private companies compete equally to produce fair and efficient economic outcomes. Small and medium private enterprises are held up as their economic exemplar.

But this image of economies dominated by relatively small-scale production, with perfectly competitive markets, is a myth. A dominant feature of modern economies is increasingly large-scale production. In a number of sectors the investments required are so large that they produce pure monopolies – railways, the electricity grid, and metro systems in modern cities.

Even when pure monopoly does not exist, globalization illustrates that many branches of modern industry require production on an extremely large scale to be competitive – therefore it cannot be carried out purely nationally. The world only has two major civil aircraft manufacturers, less than 10 companies dominate world automobile production. 

In its most developed form this creates companies recognized as “too big to fail” – firms operating on such large scales that no alternative can take over their functions without dangerously destabilizing the entire economy. This is explicit in sectors such as banking but, as the state bailout of the U.S. auto companies after 2008 illustrated, it extends to far wider ranges of industries.

Some economic sectors, naturally, remain characterized by competition between large numbers of companies – in tourism, one of the world’s largest industries, no company holds even a one percent market share. But overall large companies dominate. The turnover of the world’s 2,000 largest publicly listed companies is equivalent to more than 50 percent of world GDP.

The ideology put forward in the West that a modern economy consists of huge numbers of small-scale competing enterprises is therefore a myth. Equally, the West treating a totally differentiated economic structure as though it were a single “market” has dangerously negative consequences  that actually inhibit the development of private companies. 

A key example is the financial system, which has been the core of economic crisis in G7 economies. The largest private banks being “too big to fail” necessarily incentivizes extreme risk-taking, even criminal, activity. In a purely competitive economy company risk-taking is constrained by the threat of bankruptcy. But once a private financial institution receives a state guarantee as “too big to fail,” pursuit of the highest potential return, and consequently the riskiest financial projects, becomes rational, because the private institution receives the profit if such projects are successful but the state absorbs the losses if they fail. The continuous series of private banking scandals – LIBOR, JP Morgan’s  “Whale” trading, foreign exchange manipulation etc. – are  therefore inevitable, as was the huge asset misallocation seen in developments such as the U.S. sub-prime mortgage crisis prior to 2008.

Far from being a single “market,” a modern economy has at least three major types of market – pure monopoly, competition between small numbers of very large companies (oligopoly), and competition between very large numbers of small producers (perfect competition). An undifferentiated economic policy, therefore, cannot be successfully applied across economic sectors of totally different economic structures.

China’s economic structure, “socialism with Chinese characteristics,” sharply differs. The very word “socialism” derives from “socialized,” i.e. large-scale, production. In China, monopolies, the purest form of large-scale production are state-owned. But, simultaneously, since 1978 China has rejected a distorted idea, originating in the USSR, that small-scale, i.e. non-socialized, production should be in state hands. China’s agriculture is not collectivized, and purely competitive industries are left to private companies. In competitive sectors dominated by large-scale production both state and private producers have advantages, so the best way to test their relative strengths is to let them compete – as China does.