Who Is Responsible for China’s Growth: The State or the Private Sector?

In Markets over Mao: The Rise of Private Business in China, Nicholas Lardy has taken on an arduous task in tracing the increasing role of the market in China over the past three and a half decades. This is a must-read book for China hands because of both the vast amount of information it presents and the skillfulness of one of the leading authorities on Chinas economy in dissecting that information. Critical to Lardy’s argument is detailing the rise of the private sector relative to state-owned enterprises (SOE).

That this book is in fact so necessary is testimony to the widely diverging views on whether the market or the state is now the dominant force shaping China’s economy. The answer is that both sides may be right. Lardy has proved his case in favor of the private sector on the basis of facts, but those who make the case for SOEs have a legitimate claim on the basis of sentiments about the how state directly or indirectly has been able to influence economic outcomes.

In meticulously analyzing all facets of this issue, Lardy has presented a convincing case that China’s achievements have come from the rise of the private sector rather than from the virtues of state-led capitalism. A decade ago, this point might not have drawn as much attention. For most economists familiar with China it was already self-evident at that time that the country’s sustained double-digit growth rates were the result of the increased efficiency brought on by market liberalization as China took advantage of a globalization process that altered price signals for firms.

As Lardy points out, early on the state had given up on controlling market prices for most consumer goods (chapter one), and by allowing private firms to expand while the state retreated, the dominant share of industrial activity became the domain of the private sector (chapter three). Moreover, financial liberalization made it possible for the private sector to secure an increasing share of bank lending. If this is clearly the case, then why do so many feel that China’s economy is still largely state-driven?

The numbers showing that market forces and the private sector have steadily increased their presence are, importantly, about the direction of change. But others are also correct in assessing that the state continues to play an outsized role in influencing the behavior of economic entities, which is an argument about the extent to which the state is still involved.

The sense that the state is still dominant was revived by what happened in the aftermath of the 2008 global financial crisis. China’s stimulus program of four trillion renminbis was huge in relation to the size of its economy at the time. Moreover, the speed at which the stimulus played out led to a surge in activity that unexpectedly pushed GDP growth above 11% when it should have been trending gradually down to the 8%–9% levels.

In retrospect, the stimulus was overdone and the resulting pressure in driving up debt levels has created a financial problem that the new leadership is still trying to cope with. Of relevance to this debate is that much of the stimulus was undertaken through credit expansion rather than through the budget and channeled to SOEs and also to local authorities through the borrowings of their affiliated local government financing vehicles (LGFV). These LGFVs were created to borrow directly from banks and other financial intermediaries since local governments are prohibited from doing so. LGFVs took on major responsibilities in ratcheting up investment, not just for infrastructure but also for commercial activities that would normally be more appropriate for the private sector.

Although a significant share of the stimulus-related lending ended up benefiting the private sector, the massive amounts fed into the coffers of state entities gave rise to a general perception that the state was in ascendancy at the expense of the private sector. This was not helped by some glaring examples of waste, as in the much publicized images...