China's Political-Economic Institutions and Development

After more than three decades of economic reform, China has transformed from being one of the poorest economies in the world to being the second-largest economy measured by nominal exchange rates, or the largest economy measured by purchasing power. As such, it is important to elucidate the determinants of China's future development. This article will focus on China's institutions. I argue that although the size of China's economy is extremely important in terms of its impact on the global economy, it is misleading to ignore political and economic institutions. Indeed, forecasts based on extrapolating past trends could be erroneous (see Pritchett and Summers 2014). China was the largest economy in the world before the end of the 19th century but then lost ground to Western nations that established the rule of law and free trade. To understand China's past and future development, one has to examine its institutions. The existing literature presents two contradicting views of China's future: one optimistic, the other pessimistic. The late economic historian and Nobel laureate Robert Fogel predicted that by 2040 the Chinese economy would account for 40 percent of global GDP while the U.S. share drops to 14 percent (Fogel 2010). His prediction is consistent with a standard growth model, which takes market institutions as given. Other authors, such as Gordon Chang (2001, 2011) and Zoe Zhang (2014) are less sanguine. They claim that China faces serious problems and may collapse because of political and economic crises. Treating China as a monolithic entity can be misleading. Recent research has shown that Chinese counties where privately owned firms are concentrated experienced significantly higher growth rates--and less income inequality--than other counties (Guo et al. 2014). Another recent study found that China's state-owned firms are significantly less efficient than their counterparts in 27 other transition economies, while China's private firms are significantly more productive (Kim, Wang, and Xu 2014). Yet one of the major problems in China is that it is difficult for private firms to enter and to grow in many economic sectors due to institutional barriers and discriminations against the private sector. Meanwhile, state-owned firms obtain most of the resources from the government, which reduces their capital productivity and total factor productivity (TFP). (1) In the remainder of this article, I first compare China with other countries from a historical perspective and present cross-country data on distance from the "world frontier," measured by the ratio between a country's per capita GDP and that of the most advanced country, such as the United States. (2) This measure indicates the effects of institutions on long-term growth. Next, I provide an analysis of China's institutions and their origin, and illustrate their effects on China's economic performance. The concluding section argues that institutional reform is essential for China's sustainability and stability. Institutions and Development: Understanding China's History In the last 30 years, China has been on the path of returning to its historical status relative to other countries. President Xi Jinping has referred to this development as "China's dream," and it has brought positive reactions and hope from the Chinese people. However, will China be able to return to its previous international status? Will China be able to achieve more than merely returning to its historical status? To understand how far China can continue to develop, we should first comprehend the reason China drastically declined since the late 19th century for nearly 100 years, and how China managed to catch up since 1978. We can then evaluate whether the particular catch-up mechanism of China is sustainable. I will argue that the outcome will depend on the underlying Chinese institutions. China Is Returning to Its Historical Past China has the second-largest economy in the world by nominal GDP level, but its status remains distant from its global status in 1850, when China was by far the largest economy in the world. …