Keynesianism doesn't work: China edition

Privatization Imperiled
Five years ago, I studied the GDPs in each province, municipality and administrative region using regression analysis. The goal was to find China's economic growth drivers. Results show provincial expenditures are not significantly related to GDP growth; that is, government spending cannot propel growth.

I took this as an empirical rejection of the effectiveness of Keynesian policies. The three drivers I found were: privatization of GDP growth (private sector output divided by total output); urbanization (urban population divided by total population); and globalization (exports divided by GDP). I refer to these as the "three-izations." As a general statistical rule, the higher these indicators, the higher a province's GDP growth rate.

The relationship between three-izations and China's GDP growth is not only statistically significant. There is also an inherently logical relationship that can be illustrated with a brief, historical overview.

Privatization began in 1978 with the Chinese peasants' household production contract system, which improved farm efficiency and laid a foundation for urbanization. In the 1980s, the privatization of town and village economies broke the shackles of the planned economy. Through entrepreneurship, new production organizations, improved management, research, and better labor distribution, private wealth expanded rapidly.

The private economy attracted rural labor, propelling urbanization. An urban economy is more efficient than agriculture, so urban workers earn more than rural counterparts. Higher incomes enlarged markets, attracting more peasants to cities.

China joined the World Trade Organization in 2001, extending optimization of resource allocation beyond national boundaries. As supply capacities increased and domestic markets became saturated, international markets opened at the right time to delay adjustment due to overcapacity. Globalization did more for China than provide a huge market: Foreign capital and special economic zones opened a window through which Chinese people and the government could experience the market economy and learn how markets can replace governments in resource allocation.

The three-izations made for rapid progress; the private economy's output went from basically zero to nearly half of overall GDP in 30 years. Urbanization rose to 46 percent from 18 percent, while imports and exports climbed to 60 percent from 10 percent of GDP.
The author is Xu Xiaonian, professor at the China Europe International Business School of Management. As the title suggests, there are potential pitfalls to China's economy due to the slowdown and even reversal of privatization and urbanization, the latter because the government keeps land prices high as a funding mechanism. Read the whole thing...and note the similarities to current United States economic policies.

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