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Chinese Social Structure Holds the Key to a Richer Nation

April 15, 2015

Changing the Chinese social structure may save the country from the proverbial ‘middle-income trap’, says Salvatore Babones, an expert on China’s political economy.

Since it was coined by two World Bank economists in 2007, the term “middle-income trap”, which stands for the stagnation in GDP per capita in some middle-income countries, has become a buzzword among scholars, the media and policy makers.

Chinese Premier Li Keqiang is the first official in China’s central leadership to have publicly addressed the concern that China, the world’s largest developing nation, is facing the risk of falling into the middle-income trap. During his speech at January’s World Economic Forum in Davos, Switzerland, Li said that China would overcome the trap if it succeeded in promoting entrepreneurship and innovation and continued to increase public goods and services—the so-called “twin engines” of growth.

However, not everyone is convinced of the middle-income trap theory and the standard measures to climb out of it. Some suggest that such a trap doesn’t even exist, while others indicate that statistically speaking, the growth slowdown in middle-income countries is just a result of “regression to the mean”, or the end of good luck.

While the debate continues among economists, an important sociological perspective is often overlooked, says Salvatore Babones, a sociology professor studying the political economy of the greater China region at the University of Sydney. Babones believes that the country’s astronomical growth phase is coming to an end not because of its current choice of economic policies, but because of how the Chinese social structure has been shaped since the founding of the communist state. He argues that if China maintains its status quo politically and socially, the country’s income level is likely to converge with that of economies like Russia, Brazil and Mexico, where similar social structures are observed, and not with that of developed economies such as the US and Japan.

“The only way to move from the global mean, the level of China, Brazil, Mexico and Russia today, to a rich-country status is by a systemic change in social structure, in the way society is structured, operated and governed”, which unfortunately is extremely hard to do, Babones says.

In a recent interview with CKGSB Knowledge, Babones explains why he thinks China’s economic boom is no longer sustainable and what social policy the country should adopt to continue moving up the income ladder.

Edited excerpts:

Q. You believe that China won’t be able to grow at a rapid speed like before. Why?

A. Most economists usually ascribe the growth to China’s opening [up] to the outside world and that’s certainly a big part of it. But most of the differences we find in the growth rate cross-nationally aren’t due to economic policy. They are actually due to social, political and environmental factors.

There are three factors in particular that gave China a massive boost to its growth rate. One is declining fertility. Most people associate declining fertility with the One-Child Policy, but in fact China’s fertility rate started declining in the 1960s. Once the country started educating their population, women and families tended to have fewer children. The declining fertility rate accelerated in the 1980s as well.

Declining fertility means that there are fewer children to care for. It also means that there are more adults compared to the number of dependents in the society. Countries benefit enormously when they reduce their fertility rate. In Korea, in Singapore, all across Southeast Asia right now declining fertility rates are leading to economic growth. The problem is that this is a one-time trick. Fertility rate can decline to two children per family, or [it] can even go down to one child per family; but at that time the population starts to shrink. When you combine declining fertility rate with an aging population, it’s a double-whammy: that instead of having children to care for, now people have elderly to care for. In fact, the official policy in China is now to increase fertility to bring the birth rate back up towards a normal level, which is about two children per family.

The second real boost to the Chinese economy was urbanization. China has rapidly urbanized from an agrarian society to being a mostly urban country between 1970 and today. But urbanization again is a one trick pony. It’s only something that the country can do once. Once a country reaches 100% urbanization, it can’t continue to urbanize. China is nowhere near 100% urbanization, but China’s urbanization now is starting to slow. Inevitably, over the next five or 10 years, it will slow even more. Cities can’t keep growing forever at the pace that they’ve been growing.

The third major boost to China’s growth has been using up its environment. If you sit back and think about it for a minute, you can only use your environment once. Lands can only be built on once; rivers can only be polluted once; the air can only take so much air pollution from factories until you have to say no more. Clearly China has reached that limit where the people and the government are all saying, “No more air pollution, this has to be rolled back; no more water pollution, this has to be rolled back.” As a result, the environmental bonus to growth, the fact that a country can grow by simply taking advantage of its natural environment has now reached its limits in China as well.

All three of these limits have all come ahead roughly the same time in the 2010s. We really should expect China’s growth to be more limited after this simply because it can no longer take advantage of these easy ways to grow.

Q. You have a theory that in terms of income per capita, China is simply returning to the level it was at during the 1800s. Can you explain the logic?

A. China became very closely integrated to the world economy in the 1600s. We shouldn’t think of China’s integration as something that happened in the 1980s. In the first era of Chinese engagement with the world, between 1640 and, say around 1840, China had about half the income levels per capita as Europe did. China was much more agrarian, much more rural than Europe, but in the cities China was very similar to Europe, and may have even surpassed Europe in the cities in that period. After 1820, as you are aware there was the imperialism of the western powers, the Opium Wars, the unequal treaties with the West, that really led to a massive economic decline in China relative to the West.

China had a very strong economy until the 19th century. Its decline was largely due to imperialism, later the Japanese invasion and the civil war. So China in the year 1949, is a country that is emerging from an entire century of calamities mostly imposed from outside. What we’ve seen since 1949 is China’s bounce-back to its historical level of income vis-a-vis the West.

The real question we have is will it go from half of that level up to that level? Will it converge fully with Western countries? I don’t really think it will. If we look at China’s social structure today, which resembles, in almost every way studied by academics, that of Mexico, Brazil or South Africa, it resembles the middle-income countries of the world. If China’s social structure resembles that of middle-income countries, I would expect its economy to follow. That is, China is not converging with America or Europe, China is converging with Brazil, Mexico, Russia and South Africa.

Q. What do you think will it take for China to go beyond that income level?

A. I think the only way to move from the global mean, the level of China, Brazil, Mexico and Russia today, to a rich-country status is by a systemic change in social structure, in the way society is structured, operated and governed.

That is incredibly difficult to accomplish. The reason why social structures are so stable is that social structures benefit people who already have power and money in the society. China’s political elites, China’s business elites are doing just fine. The problem in China is only a problem from the perspective of the poor and less powerful, for the workers in the large factories and for the farmers in rural China.

The problem is that social policy is not made by farmers and factory workers. So it’s very difficult for a country to create or to innovate more beneficial social policies when the people doing the innovating benefit from the policies that are already in place.

[Watch video below]

Q. In an ideal world, what can the Chinese government do to achieve such structural changes?

A. The government should pursue policies that provide public goods to the entire population of the country. Public goods include all sorts of things. China has been excellent at providing physical public goods—metro systems in the cities, housing and water supply. China in many ways has been exemplary in its provision of public goods that are represented by physical infrastructure.

On the other hand, many public goods are less tangible. The rule of law, good and responsive government, good education systems, universal healthcare and general promotion of public health… On these kinds of public goods, China has been less successful. Some people say that when countries get rich, they can afford to have generous social policies. I would put that on a tab. I would say that countries that have generous social policies are those that become rich.

Q. What about the standard treatment for an economy to escape the middle-income trap, which is to focus on innovation and technology?

A. Let me contrast three ways about looking at the future economic development for countries like China. The first is a typical business school approach. The usual business school approach is to focus on entrepreneurship and the very cutting-edge technology. Those things are very important for people of higher education, with capital to invest, with higher levels of knowledge. Those are the important things for their personal development.

Second, there is an economics profession approach. The economics profession has collectively done an enormous amount of research into growth rates, and new growth theory, as it’s called, really focuses on the human institutional elements that are necessary for growth. Unfortunately, the economists tend to focus on just one institutional element, which is the existence of free markets. I think economists are absolutely right that free markets, backed up by the rule of law, contracts and property rights, are important; but that’s only a small part of what makes rich countries rich. What’s really important, and the third perspective, is to add all the social baggage that goes with that. That is, free markets and rule of law are wonderful, but countries also need public investment in education, public investment in infrastructure and universal healthcare system to embrace the whole population.

I think, too often, economists and business school professors are caught up in ideological debate or, maybe, wear ideological blinders. They see the important things that they want to see, but they forget all of the things that go with them. That is, the societies that have rule of law, entrepreneurship and creativity also have fantastic public education, strong public health systems and social security systems that prevent people from falling down. The higher rate of entrepreneurship is actually not in America, but in Europe. More Europeans are entrepreneurs because in Europe, you can afford to fail as an entrepreneur and you won’t lose your health insurance and your children will be able to go to school. There is a net below you if you fail.

So, contrary to popular imagination, there are actually more entrepreneurs in Western Europe than in the US in percentage of the population. Entrepreneurs in the US, if they are successful, tend to be extraordinarily successful. So if you ask, where are the big fortunes made? They are made in the US. But if you simply ask, where do people start more businesses? It’s Europe.

Q. But it seems that the US is moving away from providing such a social security network, and the reason is that too much welfare is the cause of Europe’s decline?

A. The US is moving away from the universal provision of social protection and social security, but it is doing it very slowly. So the extraordinarily strong social security system built up in America between 1930 and 1970 is still there. It has not been dismantled although there are strong pressures to dismantle it. The place in America where social security really is falling apart first is the educational system. I think that America until the 1990s was widely admired as having the best education system in the world. In the 2010s, America still has the best elite universities in the world. But American mass education is no longer a model for the world. The US universities below the elite level are no longer top universities in the world.

What we see in America is that the elites of the world go to America. Certainly Europe is still a better place to live for normal people, for anyone who’s not a business executive. It’s a much more complicated story than saying Europe has declined and America has advanced. It’s clearly true from the standpoint of military power or power over the world, but in terms of the lives of ordinary citizens, I would say that most western Europeans enjoy a higher standard of living than most Americans do.

Q. In China’s political dialogue, there is a debate about which model China should follow, the American one or the European one. What do you think?

A. I think that either the American or the European model would be an excellent choice for China. As an American, I think that life in Europe is better for most people.

I wouldn’t say that China has to choose one or the other because China is very far away from either model. China should move in a direction toward Europe and America, not a direction that Europe or America is moving. So the Republicans in America want to reduce the role of the state in the country. But the role of a state in America is much larger than the role of the state in the Chinese society. That might sound very strange to hear from an American, but the fact is that the US government is more deeply involved in regulating businesses, setting standards for businesses, providing unemployment insurance, providing social security insurance and providing healthcare for all Americans over age 65, subsidizing hospitals for other Americans. We provide universal primary and secondary education for free. We provide highly subsidized university education. The American government is extraordinarily deeply involved in the American society.

I think what China needs is for the Chinese government to become even more deeply involved in promoting the well-being of Chinese citizens.

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