I find this explanation of the Chinese system by Prof Keyu Jin (in a recent lecture at Harvard’s Fairbank center) absolutely fascinating.
Keyu Jin is a professor of economics at LSE (London School of Economics) and serves on the board of companies like Credit Suisse. She’s also the daughter of Jin Liqun, former Vice Minister of finance of China so she’s a rare West-based academic (maybe even the only one) who actually has insight into the Chinese system from the inside.
Essentially what she’s explaining is that a key reason why China was so successful economically is because of its decentralized nature, which creates two mutually compounding loops of competition, as opposed to one loop in the West.
What does that mean? Well, contrary to popular belief that imagines China as being this centrally planned economy where almost everything is decided in Beijing, the inverse is actually true: China is actually one of the most decentralized countries in the world. To illustrate this, a metric that’s always amazed me is the fact that in China local governments (provinces, cities, villages, etc.) control a crazy 85% of the country's expenditures. On average that same metric for OECD countries is 33% (as in 64% of the expenditures are controlled at the federal/national level to China’s 15%). In the US for instance, which is already more decentralized than most given it’s a federation with states, only 45% of the country’s expenditures happen at the state and local level: almost twice less than in China!
The effect of this, as Keyu Jin explains, is that provinces and larger municipalities in China have an immense degree of autonomy over the way they run their respective economies and fiercely compete with each other. This is the first loop. And then of course the second loop is that you have companies competing with each other in the market.
As a result what constantly evolves in China is not only companies themselves but the environment in which they evolve: you constantly have this or that province running a new policy that proves very effective, making them gain an advantage vs other localities, initiative which is then copied by other localities. This makes the economic environment incredibly dynamic as it allows the state to move in unison with the economy, as opposed to slowing it down as is often the case in other countries.
So what’s the role of the central government in all this? The key role, Keyu Jin argues, is setting broad objectives as well as personal management and promotion. And this is what makes the whole system work as therein lies the incentive for localities to compete with each other: because local officials know that if they do a better job than their peers, they’re on track for promotion by the central government. In “China Inc”, the central government is the board of directors and HR, presiding over an army of local CEOs with immense degrees of autonomy over their own “companies”.
Keyu Jin gives the example of the solar industry. There was at some point (around 2005) a directive by the central government to develop the solar industry. The graph she shares in her talk is incredible: within a few years you had solar companies as well as patents related to research on solar technology pop up literally everywhere in China. With the result we all know about today: China today completely dominates the solar industry and solar technology (according to the International Energy Agency China's share in all the manufacturing stages of solar panels exceeds 80%).
As she explains, this makes the Chinese system somewhat paradoxical as it is at the same time incredibly decentralized but also incredibly effective at mobilizing the country for centrally-decided objectives, in fact she goes as far as comparing this effectiveness to the country being in a constant state of “wartime mobilization”. An interesting comparison would be if you had all the countries in North America, the EU and North Africa (altogether roughly the population of China) all united under a common leadership deciding on common objectives and on the career path of all these countries’ officials, based on how well they achieve these objectives in their respective countries.
We’re seeing this system being mobilized in its full strength today on leading edge semiconductors after US sanctions, and this is why these sanctions will undoubtedly ultimately prove so self-defeating: once the Chinese “wartime mobilization” machine is given an objective - and you can be sure this objective is prioritized very highly - the fight is essentially over, you can consider it done. Once you have hundreds of thousands of PhDs, companies and officials all at the same time competing and working within the same broad “China Inc” roof to make something happen, it will ultimately get done. If you want China NOT to develop a technology, the very last thing you want is to make them mobilize the full strength of the machine on it. With the sanctions the U.S. effectively told China: “please we beg you, do dedicate your formidable economic mobilization power to becoming a semiconductors powerhouse as fast as possible” 🤦
Another particularity of the system that Keyu Jin highlights - and I’ll end on this - is that this system also allows China to “allocate losses to certain groups of people, interest groups and sectors” in order to “enact system-level changes'', something she says is “very difficult for other governments with more political constraints to do”. For instance we’re seeing this play out in real-time with the real-estate industry: China recognized there was a housing bubble and Xi issued its “houses are for living in, not for speculation” directive. We’re since witnessing an engineered deflating of the bubble, ensuring to the extent possible that the losses are borne out by real estate developers and speculators, and not too much by society as a whole. This is part of the reason why China has never suffered a recession in the modern era: it does controlled demolition when necessary but tries to ensure it doesn’t suffer massive crises like we’ve repeatedly witnessed in the U.S. for instance.
Of course no system is perfect. Weaknesses of the Chinese system include for instance local protectionism: there’s a perverse incentive for local officials to protect their local companies in order to give them a leg up vs companies from other provinces, which ultimately comes at the detriment of everyone. Another weakness is corruption, a sempiternal problem in China, where local officials - who are extremely powerful due to the nature of the system - will decide that getting promoted isn’t incentive enough and will try to cash in on their position of power. Cracking down on this is also a key remit of the central government and of course one of the major initiatives of Xi since he came to power.
Lastly, another clear weakness is obviously that everything ultimately relies on the wisdom of what the system gets mobilized for, on the wisdom of these broader objectives coming from the central government. If they’re ill-thought, you effectively have a whole country working towards the wrong objectives… On this we’re often told that this problem doesn’t happen in countries where what the economy works towards is set more organically by the “invisible hand of the market” but if you think about it, it actually happens just the same as the “invisible hand of the market” actually equates “what’s good for shareholders” and what’s good for shareholders isn’t exactly always a perfect proxy for what’s good for society, to say the least... For instance it’s absolutely insane that we’ve just had 2-3 generations in the West where the best and brightest went to work for the finance industry to engineer ever more convoluted schemes to make money out of nothing, simply because it’s insanely profitable to do so. Anyone looking at this rationally can see it’s not exactly the best use of our precious human resources as a society… So all things considered, if I had to choose I’d much rather have our broad societal objectives set by human beings rather than by the theoretical concept of “what makes the most money deserves the most focus”. And as it turns out the Chinese system actually fares decently well against capitalism: human beings aren’t evidently too bad at deciding what human beings should work on if they’re being thoughtful and strategic about it.
Keyu Jin is a professor of economics at LSE (London School of Economics) and serves on the board of companies like Credit Suisse. She’s also the daughter of Jin Liqun, former Vice Minister of finance of China so she’s a rare West-based academic (maybe even the only one) who actually has insight into the Chinese system from the inside.
Essentially what she’s explaining is that a key reason why China was so successful economically is because of its decentralized nature, which creates two mutually compounding loops of competition, as opposed to one loop in the West.
What does that mean? Well, contrary to popular belief that imagines China as being this centrally planned economy where almost everything is decided in Beijing, the inverse is actually true: China is actually one of the most decentralized countries in the world. To illustrate this, a metric that’s always amazed me is the fact that in China local governments (provinces, cities, villages, etc.) control a crazy 85% of the country's expenditures. On average that same metric for OECD countries is 33% (as in 64% of the expenditures are controlled at the federal/national level to China’s 15%). In the US for instance, which is already more decentralized than most given it’s a federation with states, only 45% of the country’s expenditures happen at the state and local level: almost twice less than in China!
The effect of this, as Keyu Jin explains, is that provinces and larger municipalities in China have an immense degree of autonomy over the way they run their respective economies and fiercely compete with each other. This is the first loop. And then of course the second loop is that you have companies competing with each other in the market.
As a result what constantly evolves in China is not only companies themselves but the environment in which they evolve: you constantly have this or that province running a new policy that proves very effective, making them gain an advantage vs other localities, initiative which is then copied by other localities. This makes the economic environment incredibly dynamic as it allows the state to move in unison with the economy, as opposed to slowing it down as is often the case in other countries.
So what’s the role of the central government in all this? The key role, Keyu Jin argues, is setting broad objectives as well as personal management and promotion. And this is what makes the whole system work as therein lies the incentive for localities to compete with each other: because local officials know that if they do a better job than their peers, they’re on track for promotion by the central government. In “China Inc”, the central government is the board of directors and HR, presiding over an army of local CEOs with immense degrees of autonomy over their own “companies”.
Keyu Jin gives the example of the solar industry. There was at some point (around 2005) a directive by the central government to develop the solar industry. The graph she shares in her talk is incredible: within a few years you had solar companies as well as patents related to research on solar technology pop up literally everywhere in China. With the result we all know about today: China today completely dominates the solar industry and solar technology (according to the International Energy Agency China's share in all the manufacturing stages of solar panels exceeds 80%).
As she explains, this makes the Chinese system somewhat paradoxical as it is at the same time incredibly decentralized but also incredibly effective at mobilizing the country for centrally-decided objectives, in fact she goes as far as comparing this effectiveness to the country being in a constant state of “wartime mobilization”. An interesting comparison would be if you had all the countries in North America, the EU and North Africa (altogether roughly the population of China) all united under a common leadership deciding on common objectives and on the career path of all these countries’ officials, based on how well they achieve these objectives in their respective countries.
We’re seeing this system being mobilized in its full strength today on leading edge semiconductors after US sanctions, and this is why these sanctions will undoubtedly ultimately prove so self-defeating: once the Chinese “wartime mobilization” machine is given an objective - and you can be sure this objective is prioritized very highly - the fight is essentially over, you can consider it done. Once you have hundreds of thousands of PhDs, companies and officials all at the same time competing and working within the same broad “China Inc” roof to make something happen, it will ultimately get done. If you want China NOT to develop a technology, the very last thing you want is to make them mobilize the full strength of the machine on it. With the sanctions the U.S. effectively told China: “please we beg you, do dedicate your formidable economic mobilization power to becoming a semiconductors powerhouse as fast as possible” 🤦
Another particularity of the system that Keyu Jin highlights - and I’ll end on this - is that this system also allows China to “allocate losses to certain groups of people, interest groups and sectors” in order to “enact system-level changes'', something she says is “very difficult for other governments with more political constraints to do”. For instance we’re seeing this play out in real-time with the real-estate industry: China recognized there was a housing bubble and Xi issued its “houses are for living in, not for speculation” directive. We’re since witnessing an engineered deflating of the bubble, ensuring to the extent possible that the losses are borne out by real estate developers and speculators, and not too much by society as a whole. This is part of the reason why China has never suffered a recession in the modern era: it does controlled demolition when necessary but tries to ensure it doesn’t suffer massive crises like we’ve repeatedly witnessed in the U.S. for instance.
Of course no system is perfect. Weaknesses of the Chinese system include for instance local protectionism: there’s a perverse incentive for local officials to protect their local companies in order to give them a leg up vs companies from other provinces, which ultimately comes at the detriment of everyone. Another weakness is corruption, a sempiternal problem in China, where local officials - who are extremely powerful due to the nature of the system - will decide that getting promoted isn’t incentive enough and will try to cash in on their position of power. Cracking down on this is also a key remit of the central government and of course one of the major initiatives of Xi since he came to power.
Lastly, another clear weakness is obviously that everything ultimately relies on the wisdom of what the system gets mobilized for, on the wisdom of these broader objectives coming from the central government. If they’re ill-thought, you effectively have a whole country working towards the wrong objectives… On this we’re often told that this problem doesn’t happen in countries where what the economy works towards is set more organically by the “invisible hand of the market” but if you think about it, it actually happens just the same as the “invisible hand of the market” actually equates “what’s good for shareholders” and what’s good for shareholders isn’t exactly always a perfect proxy for what’s good for society, to say the least... For instance it’s absolutely insane that we’ve just had 2-3 generations in the West where the best and brightest went to work for the finance industry to engineer ever more convoluted schemes to make money out of nothing, simply because it’s insanely profitable to do so. Anyone looking at this rationally can see it’s not exactly the best use of our precious human resources as a society… So all things considered, if I had to choose I’d much rather have our broad societal objectives set by human beings rather than by the theoretical concept of “what makes the most money deserves the most focus”. And as it turns out the Chinese system actually fares decently well against capitalism: human beings aren’t evidently too bad at deciding what human beings should work on if they’re being thoughtful and strategic about it.
This is the original video the extract is from. Absolutely worth a watch in its entirety!
• • •
Missing some Tweet in this thread? You can try to
force a refresh
