Blind heavy government investments don’t work: What India can learn from Dengist Miracle?

Deng Xiaoping economic reforms in China to transform Chinese economy

When we look towards china, we observe heavy government investments and fast GDP growth. But after exploring the China’s economic reforms during the reign of Deng Xiaoping, I observed a totally different phenomena that laid the foundation of china’s economic success. This article presents a brief analysis of the economic reforms that took place during the era of Deng Xiaoping.

Destruction of China during World War II

China’s situation was no different from most of the destructed European countries after the post war era. Japanese invasion in China during world war II between the period of 1937 to 1945 caused massive economic destruction. It is estimated that the Japanese caused worth of US $180 billion direct damage to various Chinese assets. The damage was equivalent to around 100 years of China’s GDP of the pre-1937 GDP peak. When Japan surrendered, China became a candidate for economic aid from USA as China had been an ally for USA in the World War II. USA came up with a reconstruction plan for China called “Marshall Plan for China”, but on the very second day of Japanese surrender, a civil war broke out in China, leading to a communist government into the power and the defeat of Republicans. After the advent of communist forces into power in China, China took a very different growth path from those post-war Asian industrialist countries such as Japan, South Korea, Taiwan, and Hong Kong.

How Mao Zedong destroyed Chinese Economy?

The communist leader Mao Zedong was highly influenced by Stalin and Comintern. He formed a totally communist and Eurocentric view to recast Chinese economy. His understanding towards China’s economy was feeble. He adopted Stalin’s despotism to silent china’s unrest during his reign. His communist agenda to control china completely took the form of despotism.

Mao’s intention to purge societal unrest stagnated the economic growth of China. Although the official data was showing development during his reign, the industrialization was not taking place and China became an agrarian economy. He also frozen the urban nominal wages from 1957 onward; therefore, urban worker’s wages started eroding with increasing inflation. Such a decline in the real wages of the urban workers confirmed a low demand for industrial growth in the economy. Due to such policies of Mao, in 1976, China’s 77 % of work force was locked in the agricultural sector.

Mao’s Blind investments in heavy industry stunted the economy of China. It was documented that under Mao the amount of state investment was a quarter of China’s GDP each year. and that the state capital assets to GDP ratio was about unity after 1957. It means that after each round of re-investment of a quarter of China’s GDP, the Maoist economy would enlarge by a quarter, ceteris paribus. Therefore, theoretically, after 25 years (1952 to 1977) China’s capital stock should have grown to 6,379.3 billion yuan in 1977 from 24.1 billion yuan in 1952. But in reality, the registered state-owned fixed capital assets in 1978 were mere 448.2 billion yuan. To achieve this level of capital assets, China needed to invest only 12.4 % of GDP each year during 1952 to 1977. So, 12.6 % of the annual GDP for reinvestment was wasted during the period. The China’s productivity was all time low in Mao’s era and therefore, Mao’s blind heavy investment was not able to revive China’s economy.

Deng Xiaoping’s reforms

When Mao Zedong’s era ended with Mao’s death in 1976, Deng Xiaoping came into power in 1978. Deng Xiaoping and his fellow enlightened leaders were well aware of the pitfalls of the Maoism. They identified that the overly controlled economy of China was one of the main reasons behind China’s low productivity. Deng Xiaoping started removing control over land, capital, and labor. Deng freed land, capital, and labor from hunger and poverty of communism and socialism by restoring individual incentives and personal wealth, known as “Socialism with Chinese characteristics” and “Socialist market economy”. Deng identified that pure socialism and communism cannot drive China’s economy towards growth. The Deng’s “Socialist market economy” was nothing but Capitalism under communist government. Capitalism brought competition and incentives in the market of China, making China more productive. It is now an open secret that in “Socialism with Chinese characteristics”, “Chinese characteristics” is nothing but capitalism. This can be visualized by the following statement of Deng, when he was in a visit to south China

“Our officials have hesitated in reforms. They have feared of too much capitalism in China. The criteria to judge whether we are with capitalism or with socialism is to see whether we improve people’s living standards” – Deng Xiaoping.

Deng brought about many structural reforms in Chinese economy. Deng and his followers took all the steps to tackle economic challenges. Some key reforms carried out by Deng and his followers are as follow

  1. Establishment of Special Economic Zones (1979).

Of all these measures, the single most effective one was the deregulation of the state control over the economy and resumption of Foreign Direct Investment (FDI). Deng used them as a lever to prize the urban sector open without immediate privatization of the state sector.

The Dengist state succeeded in re-orienting itself towards the market and towards its own people, its economy, and its rapport with the outside world. what we see China today is the outcome of the efforts of the Deng Xiaoping and his followers.

MBA, IIM Shillong