1. WHAT IS “CHINA MODEL”? MIT Sloan School of Management Yasheng Huang Professor MIT Sloan School of Management Founder China Lab and India Lab 1

2. AGENDA  What is China Model? – Beijing Consensus: State capitalism – Gradualism: Gradual reforms but acceleration over time – Reversal story: Substantial reforms but followed by reversals  Major challenges – State capitalism and consumption decline – Rebalancing Chinese economy – Personal income, not GDP growth – Prospects – Can urbanization contribute to rebalancing? — Effect of rebalancing on energy demand from China 2

3. IS CHINA MIRACLE DUE TO STATE CAPITALISM?  Microeconomic studies contradict this claim  Case study: Zhejiang Wenzhou model: Capitalism and financial liberalization Middle of the country in per capita income in late 1970s Now the richest (outside Beijing, Shanghai and Tianjin) Higher asset income Higher personal income/GDP ratio Business innovations: Alibaba.com, Wanxiang, Wahaha  TFP studies: TFP growth of private sector outpaced that of state sector 3

4. BUT STRONG FEATURES OF STATE CAPITALISM  No democracy  Top-down political controls – Tightening rather than loosening – 1980s vis-à-vis 1990s  Funding bias: – 90% of the stimulus program went to SOEs – 80% of bank loans to SOEs with 20% of employment  National champions are overwhelmingly state- owned 4

5. A CHINA-INDIA COMPARISON  Boston Consulting Group: “The 2009 100 BCG New Global Challengers” – Research on emerging firms based in developing economies  Of 100 firms selected: – China: 38 – India: 19 5

6. THE CHINA-INDIA DIVIDE The biggest difference between China and India: India’s growth is far more driven by private sector. 6

7. STATE CAPITALISM IS NOT A CONSTANT  Relatively liberal phase: 1980s  Fast personal income and consumption growth  No mercantilism: Fast GDP growth with an overvalued exchange rate and trade deficit in several years  Some initial improvement in income distribution  Reversal: 1990s  Intensification and entrenchment of state capitalism: Since late 1990s 7

8. THE TRUE CHINA MIRACLE  How did China miracle begin?  Getting the political economy right  Financial liberalization  Reversal of policies in the 1990s 8

9. POLITICAL ECONOMY PUZZLE  Vibrant rural entrepreneurship but why did rural entrepreneurs trust the Chinese state?  Many landlords were executed in the 1950s  Cultural Revolution (1966-1976): “Nasty, brutish and long”  Capricious politics: The Chinese prisoner’s dilemma  Policy credibility hinges on constraints on rulers  Academic literature (Weingast, North, Acemoglu and Johnson, and many others)  Is China different?

10. CHINESE POLITICS IN THE 1980S  Statics vis-à-vis dynamics in Chinese politics:  Statics: China is/was not a democracy  Dynamics: A substantial move away from the status quo ante of the Cultural Revolution  Entrepreneurs’ incentive depends  Not on a convergence with the best-practice political institutions  But on a dynamic movement toward convergence with these institutions

11. THE DENG XIAOPING EFFECT  Final puzzle: How did rural entrepreneurs know that politics had changed?  Tens, even hundreds of millions of them  Uncoordinated actions  Lack of information and transparency  The Deng Xiaoping effect: Observability of policy/political changes  Deng was observably different from Mao.

13. THE DENG XIAOPING EFFECT  Deng Xiaoping:  Purged three times by Mao Deaf ear to Mao  His son was crippled by Mao’s red guards  These Deng attributes: Widely known and cognitively easy to interpret  Implications:  The signaling was unambiguous  More policy credibility than implied by political changes alone

14. CHINA WAS NOT LIBERAL; IT WAS DIRECTIONALLY LIBERAL  Directional liberalism of the 1980s  (All discontinued after 1989)  Substantial media freedom in the early 1980s (by Chinese standard)  Village elections introduced  Recruiting capitalists into the Party (1981)  Returning confiscated properties to former capitalists (1979)  Timing matters: The political effects were exogenous to, not endogenous of, growth.

15. FINANCIAL LIBERALIZATION AND REVERSAL 15

16. 16 FINANCIAL REVERSAL DEFINITIONS AND MEASUREMENTS Rajan and Zingales (2003)  Financial development: the ease with which any entrepreneur or company with a sound project can obtain finance, and the confidence with which investors anticipate an adequate return;  Motive of reversal: an interest group theory where incumbents oppose financial development to deter competition;  Measurements: size of financial system -- Bank deposit/GDP, equity market capitalization, # of listed firms/population, equity issuance/fixed capital formation.

17. MIT, March 9 2011 17 KEY RESULTS (QIAN AND HUANG 2011)  We document a financial reversal that occurred during the early 1990s in rural China.  There were liberal financial policies in the 1980s to encourage market operation and competition, but tight government controls in the 1990s.  As a result, there was a sharp curtailment of credit flows to the rural population and reduced financial resources to fund the nonfarm business operations run by Chinese rural entrepreneurs.  Little support for the view that emphasizes endogenous determinants such as formal/informal loan substitution, labor migration etc  Reversal was due to deliberate policy.

18. MIT, March 9 2011 18 EVIDENCE FROM BANK DOCUMENTS

19. Han Lei, President of the ABC, July 20, 1984  “Rural areas need state-owned banks and credit cooperatives for finance but at the same time, under bank supervision, we need to allow the existence of private ( 私人 ) free lending and borrowing.”  Chen Muhua, Governor of PBoC (1987):  “Non-governmental ( 民间 ) capital mobilization and non-governmental rural cooperatives have emerged. The various methods of financial mobilization have made a positive contribution to local economic development.” 19 FINANCIAL LIBERALIZATION IN THE 1980S

20.  Surveys and research in the 1980s:  Average of six surveys of private firms (1987): 41% received banks loans (Highest=66% in Shaanxi)  World Bank TVE study (1990): Private firms in Tianjin financing 39-44% of investments with bank loans.  William Byrd: “Banking institutions already see well- established private enterprises as solid borrowers.” 20 SUBSTANTIAL CREDIT ACCESS IN THE 1980S

21. THE GREAT REVERSAL Chen Muhua (1986): Under the banking regulations, individuals are not allowed to engage in financial operations. The emergence of private ( 私人 ) credit shows that our financial work falls short of what is needed. This requires that our credit cooperatives and agricultural banks improve their services.  State Council (1998):  Those funds, mutual assistance associations, savings associations, capital service departments, share capital service departments, fund clearing centers, and investment companies established prior to this order and operating above the state law should be restructured with a deadline according to the regulations of the State Council. Those entities that operate after the deadline and continue to engage in illegal financing should be stamped out according to this order. Those with serious violations of a criminal nature should be held accountable for their legal responsibilities. 21

22. MIT, March 9 2011 22 THE SURVEY  A fixed-site rural household survey (FSRHS), conducted by China’s Ministry of Agriculture;  Implemented annually from 1986 to 1991; once in 1993, and again annually from 1995 to 2002.  Nationwide, 300 to 400 villages, stratified by socioeconomic development level and geography, were sampled each year, 20 to 120 households from each village were selected randomly.

23. MIT, March 9 2011 23 THE SAMPLE  Limiting to the six province data may in fact operate against our hypotheses – i.e., underestimate the degree of the 1990s’ financial reversal.  Two out of the six are among the most developed provinces  Sample average income level is higher than national average, so is the access to bank loans, particularly so in 1990s. (National average values for certain variables are published by the Central Committee, Policy Research Office and the Ministry of Agriculture 2000).  Using the over 100 reconciliation equations to check the quality/consistency of the survey answers.  Our final sample includes 34,571 household* year for the 1986–1991 survey and 32,460 for the 1995–2002 surveys.

24. MIT, March 9 2011 24 ACCESS TO FINANCE

25. MIT, March 9 2011 25 Baseline result -- a sharp drop in households’ access to bank loan in the 90s.

26. MIT, March 9 2011 26 Informal loan and household financial assets --- Is the decrease of formal loan due to substitution of informal loan or households’ increased financial strength?

27. MIT, March 9 2011 27 Total loan balance -- Does the loan decrease because of a high amount of cumulated remaining balance?

28. MIT, March 9 2011 28 Interest payment -- was the cost of loans higher in 90s than in 80s?

29. MIT, March 9 2011 29 Is the reversal due to bad loan performance in the in the 1980s? Historical bank performance data  We hand collect historical data on bank lending activities and loan performance (the Agricultural Bank of China’s Statistical Yearbook 1979– 2008 and the China Finance Associations’ Almanac of China’s Finance and Banking 1985–2004).  Balance sheet information, annual transaction flows at the province level, including new loans, pay back rate, and new loans classified by borrower type, etc for both the Agricultural Bank of China’s (ABC) and the Rural Credit Cooperatives (RCCs).

30. MIT, March 9 2011 30 Bank activities

31. MIT, March 9 2011 31 Bank performance

32. MIT, March 9 2011 32 -- Reduction of loan follows good performance. -- Reversal is worse in provinces that had performed better in the 1 st period.

33. MIT, March 9 2011 33 Patterns consistent with with policy changes: -- sectoral priority, party/government control, and mandatory collateral requirements

34. 34 KEY RESULTS (QIAN AND HUANG 2011)  Rather than simply not having launched any financial reforms, China actually reversed those were initiated;  The financial reversal was related to exogenous policy changes rather than to endogenous economic or political economy determinants.  The financial reversal in the early 1990s mattered for credit access, rural entrepreneurship, development of non state-owned financial institutions, and rural income.

35. THE BIGGEST CHALLENGE: CONSUMPTION DECLINE 35

36. PROBLEMS WITH STATE CAPITALISM  Two functions of state capitalism – Able to build infrastructures rapidly – Resource mobilization to target funding  Biggest problem with state capitalism: – Low personal income growth (relative to GDP growth) – Huge and growing imbalances: Declining consumption 36

37. 37 THE GREAT CONSUMPTION COLLAPSE Household final consumption expenditure % GDP. From World Bank’s WDI.

38. 38 THE ROOTS OF GLOBAL IMBALANCES: THE GREAT DIVERGENCE Household final consumption expenditure % GDP. From World Bank’s WDI

39. 39 CHINA’S UNUSUAL CONSUMPTION DECLINE Household final consumption expenditure % GDP. From World Bank’s WDI.

40. 40 IT IS NOT AN EAST ASIAN PHENOMENON Household final consumption expenditure % GDP. From World Bank’s WDI.

41. 41 CHINA AND INDIA: CONSUMPTION GAP Household final consumption expenditure % GDP. From World Bank’s WDI.

42. HAS CHINA RELBANCED? 15% RETAILS GROWTH in 2009 and 18% in 2010 42

43. 43 NO.

44. INSTITUTIONAL RETAIL CONSUMPTION HAS RISEN SHARPLY 44

45. 45 HOUSEHOLD CONSUMPTION HAS DECLINED FURTHER IN 2008 AND 2009 Household final consumption expenditure % GDP. From World Bank’s WDI.

46. STABILIZING THE CONSUMPTION SHARE OF GDP DURING THE CRISIS PERIOD 46

47. THE KEY TO REBALANCING IS PERSONAL INCOME, NOT GDP OR SAVINGS RATE. 47

48. 48 WHY DID CONSUMPTION DECLINE IN CHINA?  Precautionary savings hypothesis: – High and rising savings rate is the problem – Measures to reduce the savings by 1) product marketing and distribution and 2) social protection  Cautionary spending hypothesis – Low income growth, not high savings rate – Policy and institutional reforms to improvement employment and income growth

49. NO EVIDENCE ON RISE OF SAVINGS RATE  Rural income and consumption growth: – 1980s and since 2003: Consumption growth matched income growth – 1990s: Income growth exceeded consumption growth but by a slim margin  Zhou Xiaochuan (07/09, governor of China’s central bank) – No increase in household savings rate in recent years  No support for the pre-cautionary savings hypothesis 49

50. CAUTIONARY SPENDING HYPOTHESIS  Cautionary spending hypothesis: – Low personal/household income growth relative to GDP growth – Low expectations of future income growth  The case of rural migrant workers – Low consumption due to both precautionary savings and cautionary spending 50

51. 51 GDP AND PERSONAL INCOME DIVERGENCE

52. GDP AND HOUSEHOLD INCOME GROWTH: 1978-2008 52

53. REAL RURAL CONSUMPTION GROWTH (1978 PRICES) 53

54. DATA INCONSISTENCIES  National Bureau of Statistics data – Moderate growth in the 1990s but still there was growth – Relative decline of income at the lowest income group but absolute gains  Ministry of Agriculture household survey data: – No income (nominal) gains from 1995 to 2000 at the lowest quintile 54

55. Ministry of Agriculture data: No income (nominal) gains from 1995 to 2000 at the lowest quintile

56. 56 RURAL ECONOMY AND URBANIZATION

57. WHY RURAL SECTOR MATTERS  Demand side: – 721 million rural residents in 2008 – 230 million rural migrants (NBS 2009) – There are many “rural cities” in China (contrast with India)  Supply side (=Entrepreneurship): – Rural China is more entrepreneurial due to lack of social protection and less political control – Households=business units in rural China – Households are unambiguously private  Global crisis: – Huge supply effect of rural migrant workers but almost no consumption effect – Policy discussions to revive rural entrepreneurship and rural finance 57

58. URBANIZATION AS THE KEY?  Most policy makers and economists believe that urbanization is the key to the rural development  But China’s urbanization is: – Politically driven due to state ownership of land – Instigating substantial social conflicts due to land disputes – Accompanied by a sharp consumption decline and stagnant service sector 58

59. A VERY SMALL SERVICE SECTOR 59

60. 60 URBANIZATION AND PERSONAL INCOME: SURVEY EVIDENCE

61. IS URBANIZATION A SOLUTION TO IMBALANCE?  Features of Chinese urbanization  State ownership of land  No recognition of incumbency rights  Substantial institutional rigidities during fast urbanization (such as Hukou system)  No evidence that urbanization has boosted household consumption 61

62. URBANIZATION (CHINESE STYLE)  Agglomeration effects of market-based urbanization  Reduce transaction costs and lower the provision costs of public goods.  Raise income and consumption: Middle class  Political urbanization  Geographic expansions  Government pricing of land transactions 62

63. SPATIAL MEASURE: URBAN AREA ( 市区 )

64. SPATIAL MEASURE: CONSTRUCTED AREA ( 城建区 )

65. 65 CONSUMPTION DECLINED SHARPLY AFTER 2000 Household final consumption expenditure % GDP. From World Bank’s WDI.

66. SURVEY EVIDENCE ON RURAL MIGRANT WORKERS  4 waves of survey data  2006  2008  2009  2010  Key results:  One-time increase from rural to industrial reallocation of labor  No or modest subsequent wage increase until 2005  Wage growth substantially lagged GDP growth 66

67. 2009 SURVEY ON RURAL MIGRANTS IN GUANGDONG  Wage growth is very recent  95% of respondents experienced first on-job wage increase in 2005 53% of the sample migrated before 2000 Wage increase through job change: 3 times on average  10% wage growth between 2005 and 2008  A small decline in 2009: Survivor bias  Stagnant wage growth in the 1990s  German survey in Shenzhen (1993)  Real annual wage growth between 1993-2005: 1% 67

68. GUANGDONG’S GDP PER CAPITA (DEFLATED BY CPI) 68

69. GDP AND WAGE DATA IN GUANGDONG (SURVEY DATA) Rural migrant survey data from Zhongshan University 69

70. 2009 SURVEY ON RURAL MIGRANTS IN GUANGDONG  Consumption:  High savings rate: 40% (Urban: 20%) But 47% with zero deposit balances  Very economical on food: 10 yuan per day  But substantial spending on children education: 1/3 spent on private education on children  2010 survey  Average electricity consumption: 70 kwhs  Median electricity consumption: 45 kwhs 70

71. 2009 SURVEY ON RURAL MIGRANTS IN GUANGDONG  Hukou system and precautionary savings  27% have expectations for a hukou change #2 savings motivation: Build house and return to home village  Exclusion of public goods Barred from access to local public schools Education of children ranked #1 savings motivation 71

72. 2009 SURVEY ON RURAL MIGRANTS IN GUANGDONG  Human capital trap  But almost no expenditure on skill training  No public investments in private schools for migrant children  Substantial achievement gaps  Public/private school teacher pay: 5:1  Barred from college entrance examination in Guangdong Forced to return to and attend inferior high schools in home provinces 72

73. REBALANCING CHINESE ECONOMY: WHAT IS REQUIRED  Matching personal income growth with GDP growth  Reforms, not government spending – Land reforms – Urban registration reform – Social provisions – Political reforms 73

74. ENERGY INTENSITY OF GDP 74

75. 75 PER CAPITA ENERGY USE: CHINA AND INDIA

76. ELECTRIC POWER CONSUMPTION kWh per capita. World Bank’s WDI. 76

77. “CHINA EFFECT” ON ENERGY MARKET  China vis-à-vis India – Energy consumption gap between the two countries dated to the 1970s – Bigger GDP – Faster growth – More energy intensive – Despite smaller share of imported energy Net import of energy use (World Bank WDI) 77

78. KEY FEATURES OF CHINESE ENERGY CONSUMPTION  Acceleration of energy intensity since the 1998- 2001 period – Not due to consumption boom – But due to urbanization and intensification of state capitalism  China’s energy use is dominated by industry/commerce rather than by household sector – The household energy consumption only experienced modest growth over time 78

79. % OF HOUSEHOLD ELECTRIC CONSUMPTION PEAKED IN 2000 National Bureau of Statistics, Statistical Yearbook,, 2009 79

80. PERSONAL ENERGY CONSUMPTION SURGED VERY RECENTLY NBS data; kg coal equivalent 80

81. MODEST HOUSEHOLD ELECTRIC CONSUMPTION NBS data; kWh per capita 81

82. WOULD CHINA’S ENERGY DEMAND FALL SUBSTANTIALLY IF CHINA SUCCEEDS IN REBALANCING? 82

83. 83 THANK YOU!