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China’s Social Capitalism

Benjamin Daniels

The Cold War has often been characterized as a conflict between diametrically opposed,

irreconcilable social systems. The popular manifestation of this outlook assumed that the

socialist economic structure was ideologically inseparable from the communist political system,

and that the capitalist system was similarly paired to the practice of democracy.1 When the USSR

failed, its two systems – socialism and communism – were thought to have been thoroughly

discredited. However, the binary description gives only an incomplete perspective on the

economic problems that were relevant to the conflict between the Western system and the Soviet

system. The pure Communist approach attempted in the USSR proved to be an unsustainable

construct, but it provided an experiential prototype for the practice of non-capitalist methods

since the Soviet collapse. The most visible and well-researched such system has been that of

“market socialism,” which was attempted in several ex-Soviet Eastern European economies. It

has been noted to combine the worst elements of capitalism and socialism, begetting wide

inequalities while simultaneously providing poor incentives for economic actors.2 The same

sources have been careful to note that the ostensibly similar system adopted by the People‟s

Republic of China has somehow produced unqualified success.3 A more careful look at the

Chinese approach, however, suggests that it is a different system altogether. Rather than pursuing

“market socialism,” China has adopted a model which provides effective incentives to individual

actors while maintaining a collective power and incentive to tackle the failures of a pure market

economy – what can be called a “social capitalism.”

The historically powerful central government of China has created a drastically different

approach to economic institutions than Western countries have historically taken. The

government has put its weight behind a system of explicitly enumerated institutions, rather than

supporting a broad set of implicit rights and freedoms. Chinese economic institutions have

1 S. M. Amadae, Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice

Liberalism (2003). 2 Joseph Stiglitz, Whither Socialism? (1994) 91.

3 Stiglitz 175-6.

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emerged via careful statutory development as the state transitions from a totalitarian model to

one which guarantees specific freedoms for its citizens. The trend has allowed more liberal and

Western-compatible institutional structures to develop while maintaining a high level of central

control over the development of the broader Chinese economy. The policy of “groping for stones

to cross the river”4 is suggestive of both the speed and the control with which China‟s

government expects to pursue this process. While the liberalization and integration of

institutional structures has been gradual, it has been deliberate, as exemplified by the

development of specific institutions such as contract enforceability and bankruptcy. The outcome

of the process has been a set of constantly updated institutions: China‟s bankruptcy law, for

example, was introduced in 1986 and revised in 2007;5 its labor contract law was implemented in

1994 and updated for 2008.6 The government has done an excellent job keeping pace with

economic pressures as it balances “[wanting] to stay in power and an international community

that wants access to that mythical market.”7 For example, increased scrutiny over labor

conditions by Western consumers has led to the creation of laws that increase the legal power of

workers against employees; humanitarian concerns have seen the filing of suits against the

government for the 1989 Tiananmen Square massacre.8 The government is actively creating

institutions, rights, and freedoms in response to the perceived need for them. Such a tradition of

positive rights (freedoms-to) rather than Western negative rights (freedoms-from) approaches the

question of economic institutions from a distinctively socialist direction.

The government‟s tight control over the development of these institutions has been a

critical factor in a stable development process for China. The characteristic gradualism of the

transformation has allowed court systems and other government institutions to evolve gradually

with the demands of legal enforcement. This approach comes in marked contrast to the “shock

4 Ran Tao and Zhigang Xu, “Groping for Stones to Cross the River versus Coordinated Policy Reforms:

The Case of Two Reforms in China,” Journal of Policy Reform (Sep 2006). 5 Dan Harris and Travis Hodgkins, “China's New Bankruptcy Law -- First Report From The Ground,”

China Law Blog (12 Jun 2007). 6 “Labor Contract Law of the People‟s Republic of China,” Beijing Review (4 Oct 2007).

7 Doug Guthrie, China and Globalization (2009) 216.

8 Guthrie 66.

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therapy”9 reforms that were attempted in many of the former Soviet states; the rapid transition

approach promoted by the economic orthodoxy of the time was founded in the Cold War

ideological conflict and sought total institutional reform, considering the socialist political

structure incompatible with the development of a liberal economic regime. China, however, has

utilized its socialist tradition to ease the transition phase. It has gradually unraveled Mao‟s

totalitarianism without throwing the economy into a period of disorganization.10

In doing so,

however, China views the “market as the servant … not the master”11

of its economic

development process, and the manner by which it has implemented its institutional reforms

shows a serious policy of refusing to let market forces overcome social goals. This careful

execution of transition has been evident in the measured pace of the legal changes as well as by

the manner in which they have been instituted. As noted earlier, the socialist influence on the

mode of government – leading to creation of institutions by fiat rather than the presupposition of

their existence – provided a legitimacy to them that stems from their immediate need. However,

it also lent an extra level of stability to them. In particular, courts are limited to settling legal

disputes in light of the law rather than having the power to redefine existing rights and

institutions in respect of implicit higher principles. Reforms are inherently more credible under

such a rule of law, especially since the government has proved willing to continue driving reform

agendas and successively updating its catalogue of enumerated protections as social and

economic demands for legal improvement continue.

Property rights have been constituted in a nonstandard fashion by way of this gradual

process. The transition from total state ownership to a market-oriented structure required a new

allocation of property rights so as to provide appropriate incentives to resource managers. The

socialist aspect of the Chinese development path, however, has entailed a divergence from the

Western understanding of property as a binary term: either something is owned by an individual

or it is not. China has instead developed a property-rights regime which traditional analyses

viewed as “ill-defined”12

due to its unusual mix of state ownership and private control. Without

9 Peter Nolan, China’s Rise, Russia’s Fall (1995) 58.

10 Peter Nolan, China at the Crossroads (2004) 27.

11 Nolan (2004) 175.

12 Stiglitz 176.

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the Western binary understanding of property, critical tools for examining those institutions, such

as Coase‟s theories, could not be applied. More recent examinations have adapted to the Chinese

system; they have considered property not as a singular institution, but as a “„bundle of rights,‟

where questions of managerial control, the ability to extract revenue, and the ability to transfer

ownership must all be addressed.”13

Within that framework, questions of property in Chinese

society are more easily understood with traditional economic analyses. Managerial control, along

with marginal revenue extraction, has been devolved to local governments and managers

throughout China‟s industries. The incentives of managers and local administrators for

increasing profitability and productivity have been improved at the enterprises they manage.14

The same version of partial property rights has been applied at the margin for domestic

agricultural production; in particular, once households have supplied the specified quota of

output to the government, the remainder can be sold at local market prices.15

Both of these

changes move Chinese economics toward a system that replicates the ideal marginal incentives

of a privatized regime without changing the “ownership” of the assets. The adaptation is “the

gradual receding of the state from control over the economy, a process that brought about a shift

in economic control without privatization.”16

That balance is the defining characteristic of

China‟s social capitalism. It has recognized that liberal markets and complementary marginal

incentives can be developed within an economy without reassigning the full plethora of property

rights. The regime privatizes control over flows rather than stocks of commodities, allowing

market pricing to occur in such a way that determines socially beneficial exchanges without

instigating disputes over resource distribution.

China‟s system of social capitalism has maintained the institution of state ownership as a

tool to address the market failures of a laissez-faire system. A rapid move to a Western model of

property rights and the ensuing privatization of large swaths of industry would have pushed

China‟s economy into a period of “primitive capitalist accumulation”17

such as those that were

13

Guthrie 47. 14

Nolan (1995) 202. 15

Guthrie 42. 16

Guthrie 38. 17

Nolan (2004) 63.

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frequently experienced during the early stages of free-market economic development, especially

in countries which adopted the shock-therapy transition model. The widespread looting of assets

that occurs throughout such an “Age of Plunder”18

would have deteriorated China‟s capital base

and left it in a squalid, vulnerable position similar to that of post-Soviet Russia. Instead, the

Chinese state has retained control of an enormous proportion of the country‟s capital assets. State

ownership of corporations is so pervasive that while “state-owned firms officially only account

for 2 percent of firms … shareholding corporations … are firms in which the state controls up to

70 percent of the shares.”19

The refusal of the government to privatize the majority of capital has

prevented an asset grab by managers at the administrative level. Simultaneously, the sale of

significant portions of corporate stock to institutional and private investors has outsourced

valuation and scrutiny responsibilities to the international investors who have taken stakes in the

enterprises. As it did in the local agricultural markets throughout the 1980s, the state has layered

a liberal market economy on top of a publicly-owned institution. The partial privatization creates

appropriate incentives for free exchange and demands efficiency gains from all enterprises, even

government-owned ones, because of the impacts on share price and market capitalization that

would result from mismanagement. The dual-track system of marginal privatization is utilized in

this context to create a robust market without eroding the core tenet of socialist public

ownership. This capture of market incentives and distributed decision making is combined with

the strong central government, high level of public ownership, and social objectives of Chinese

central management. The blend cuts to the core of the social capitalist model as it attempts to

reap the benefits of both structural models without sacrificing core social or institutional tenets.

Instead, the government has taken a vested financial interest in the country‟s economic

performance and pursued a capital structure for business that incorporates a “third way” tradition

of balancing economic interest with socially-conscious governance.20

The Communist Party of China has effectively bound its legitimacy to the

accomplishment of economic goals, creating a strong incentive to pursue socially optimal

18

Ibid. 19

Guthrie 129. 20

Nolan (2004) 174.

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policies. The collective ownership represented by large government stakes in corporations

provides a strong incentive to the government to manage policy in a way that maximizes the total

value of Chinese enterprises. This is particularly useful when questions of industrial or social

policy questions demand cooperative outcomes. For example, China‟s energy needs, which have

in the past been met only at high environmental cost, are now being approached by the

government in a manner that reflects the need for sustainable, independent energy production by

Chinese firms. The long-term, government-directed program is coordinated by the newly-formed

National Energy Commission to provide an efficient, socially-minded utilization of resources.21

The program contrasts starkly with stalled efforts in the United States to promote renewable

energy development, where a laissez-faire mindset has prevented the federal government from

coordinating the collective action needed to drive large-scale change. For China, the collective

incentives provided by the government‟s vested interest in economic performance have created a

remarkably robust system. During the Asian financial crisis, China‟s government discovered that

its banking system had amassed an inordinate volume of nonperforming loans. In 1997, “the

World Bank said the net value of the banking system was already negative.”22

The government

was able to mitigate the crisis, however, by pursuing a policy with a positive social outcome:

“„cutting the trees to save the forest‟ (i.e. to make GITIC go through bankruptcy proceedings in

order to save the rest of the financial system) … provided a breathing space for the central

government to attempt to undertake deep structural reform in the financial system.”23

Those

reforms appear to have been successfully executed since that time. In 2002 Moodys commented,

“China‟s banks walk on a tightrope,”24

but in the wake of the global financial crisis of 2008,

China‟s banking system and broader economy stood strong, beating expectations to grow by

8.7% in 2009.25

The need for such sustained growth to ensure social stability has forced China‟s

government to assimilate into the world economy. Party officials recognized the need to reduce

21

James Murray, “China to unveil multibillion-dollar renewable energy plan,” BusinessGreen.com (5 Mar

2010). 22

Philippe Riès, Asian Storm: The Economic Crisis Examined, trans. Peter Starr (1998) 175. 23

Nolan (2004) 57. 24

Ibid. 25

Leo Lewis, “China‟s GDP soars as it shrugs off global crisis,” The Times (22 Jan 2010).

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barriers to foreign markets so that China could exploit its comparative advantages in unskilled

labor and reverse the trade deficit which it had run until the early 1990s.26

Additionally, capital

markets needed to be synchronized with Western institutions in order to attract outside funds to

Chinese investment opportunities. The necessity for integration and openness sparked a series of

reforms throughout the 1980s and 1990s, including recognition of and equal legal status for

foreign firms, joint ventures and foreign direct investments.27

Similarly, the creation of special

economic zones for export-led growth encouraged foreign investment even as it spurred

domestic development: “of the top forty exporters from China, ten are U.S. companies.”28

The

technology transfer and capital inflow had immense effects on the structure of government and

business. To continue reaping the benefits of the investments, laws and corporate practices have

developed “institutional accommodations that support rational-legal accountability and the rule

of law within the firm.”29

In essence, Chinese economic actors had their hands tied by the liberal

expectations of massive multinationals. To seek the wealth of the world, China was forced to

play by its rules; it had to be a good global citizen and domestic master in order to continue

receiving the rewards of economic success. China‟s desire to continue to hold that place in the

world‟s view is reflected clearly, for example, in its efforts to exceed its WTO commitments.

Maintaining its attractiveness as an investment destination is critical to Chinese efforts to keep

the economic tide rising, for “if the „bubble‟ of foreign direct investment in China were to burst,

it would have serious consequences for the whole growth path and for China‟s stability.”30

In

order to keep drawing foreign funds and driving domestic development, China will have to

continue converging its corporate institutions to world norms. These pressures are almost certain

to have developmental effects on Chinese society; increasing Western scrutiny over labor

conditions and workers‟ rights have already led to internal labor reforms as well as a rise in the

26

C. Fred Bergsten, Charles Freeman, Nicholas R. Lardy, and Derek J. Mitchell, China’s Rise: Challenges

and Opportunities (2008) 109. 27

Guthrie 118. 28

Guthrie 116. 29

Guthrie 136. 30

Nolan (2004) 24.

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volume of successful litigation brought by workers against corporations.31

Development in that

direction only seems set to continue.

The mechanisms of privatization and institutional development have been utilized by the

Chinese Communist Party to provide a foundation for sustained growth in the country. The

national leadership, however, avoided the errors of the post-Soviet economies, which were

generally subjected to „big-bang‟ reforms by Western-trained economists following the collapse

of the Soviet system. In China, by contrast, fundamental economic institutions have been steadily

created since the death of Chairman Mao. Economic freedoms and market institutions now exist

where once there were none, yet the government has maintained tight control over the process of

liberalization. It has integrated Western institutions and standards only where they benefit the

economy as a whole, and held onto socialist ideas in key areas to institute a “social capitalist”

model. Rather than create a fully privatized, free-market system, the Chinese government has

been able to develop a dual-track system of marginal privatization and marketization. This

regime, which separated property rights into the distinct institutions of control and ownership,

created high levels of social cohesion, appropriate private incentives, and a large government

stake in the performance of the Chinese economy. Thanks to those characteristics, the

government‟s vested interests have driven it to solve coordination problems and pursue high-

benefit policies and reforms throughout the country. At the same time, the reforms have enabled

Chinese managers and entrepreneurs to create increasingly valuable corporations and

partnerships with existing multinational firms. The result has been an extraordinarily successful

development process that defies traditional classification, yet one that solves key distributional

and institutional challenges facing post-Communist and primitive-capitalist countries.

31

Guthrie 210, 215.

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Works Cited

“Labor Contract Law of the People‟s Republic of China.” Beijing Review. 4 Oct 2007.

Amadae, S. M. Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice

Liberalism. 2003.

Bergsten, C. Fred, Charles Freeman, Nicholas R. Lardy, and Derek J. Mitchell. China’s Rise:

Challenges and Opportunities. 2008.

Guthrie, Doug. China and Globalization. 2009.

Harris, Dan and Travis Hodgkins. “China's New Bankruptcy Law -- First Report From The

Ground.” China Law Blog. 12 Jun 2007.

Lewis, Leo. “China‟s GDP soars as it shrugs off global crisis.” The Times. 22 Jan 2010.

Murray, James. “China to unveil multibillion-dollar renewable energy plan.”

BusinessGreen.com. 5 Mar 2010.

Nolan, Peter. China at the Crossroads. 2004.

Nolan, Peter. China’s Rise, Russia’s Fall. 1995.

Riès, Philippe. Asian Storm: The Economic Crisis Examined. Trans. Peter Starr. 1998.

Stiglitz, Joseph. Whither Socialism? 1994.

Tao, Ran and Zhigang Xu. “Groping for Stones to Cross the River versus Coordinated Policy

Reforms: The Case of Two Reforms in China.” Journal of Policy Reform. Sep 2006.