(By Jiangyu Wang)

         B. GOVERNMENT INVOLVEMENT AND THE USE OF INDUSTRIAL POLICY

Rodrik observes that ‘‘China has benefited both from good fundamentals ... and from a determined government effort to acquire domestic capabilities and to build a modern industry.’’ To him, the success of China’s exports are rooted in consumer electronics, which however is not a result of the orthodox assumption that China’s export capability is merely supported by ‘‘cheap labor,’’ but it is based on China’s ability to make a productivity jump. As Rodrik notes,

[In terms of fostering domestic capabilities while still opening door to foreign investors,] China has used several policies to ensure that technology transfer would take place and strong domestic players would emerge. Early, reliance was placed predominately on state-owned national champions. Later, the government used a variety of carrots and sticks. Foreign investors were required to enter into joint ventures with domestic firms (in mobile phones and in computers). Domestic markets were protected to attract market-seeking investors, in addition to those that looked for cost saving. Localities were given substantial freedom to fashion their own policies of stimulation and support, which led to the creation of industrial clusters in particular areas of the country. Huchet characterizes China’s policies as of the mid-1990s thus: ‘‘China’s technological acquisition strategy is clear: It allows foreign firms access to the domestic market in exchange for technology transfer through joint production or joint ventures.’’

In response to the counter-argument that many government-sponsored Chinese companies ended up with failures, Rodrik makes two further points. First, although accounts of industrial policy in China have led to the low productivity and low technology absorption of many state-owned enterprises, on the whole ‘‘government attitudes have been pragmatic and open to trying new approaches when old ones fail.’’ Hence, after the proved failure of the TV industry at the early stage of reform due to fragmentation of productions (caused by the large number of firms), national and local governments took efforts to consolidate the industry through forced mergers and joint ventures with foreign firms, which helped turn the industry into a profitable, export-oriented one. Secondly, the significance of the weakness of the Chinese bureaucratic model might have been exaggerated:

The essence of self-discovery model of economic development is that you need only a few successes: once a small number of high-productivity activities are identified, they act as the lever for economic convergence by pulling resources in from lower productivity activities. Without state support and publicly funded R&D, a company like Lenovo (previously known as Legend), which recently became large and profitable enough to purchase IBM’s personal computer business, would never have come into being. Better to experiment and to identify these higher-end activities than not try at all. Lack of coordination can be an advantage in these circumstances, as it allows different things to be tried and for successes in one region to be copied elsewhere. Somewhat paradoxically, the hesitant, gradual, often conflicting manner in which policies have been formulated and implemented in China might have presented a more suitable environment for entrepreneurial experimentation and cost discovery than one that is centralized, top-down and overly coordinated.

C. PACE AND SEQUENCING OF LIBERALIZATION

China’s trade reform also suggests that the pace and sequence of liberalization should be carefully designed and that appropriate regulatory and development space should be preserved for the national government involved. The pace (or speed) of reform refers to the time elapsed from the initiation of the reforming measures to the point that they are made operational and accepted in general. The sequencing of reforms means ‘‘the order in which either macroeconomic policy actions or specific reforms are introduced.’’ With respect to the pace of reform, there are two suggested strategies: shock therapy (or ‘‘big bang’’) and gradualism (or incrementalism). In the literature economists have been remarkably divided on which is the better strategy. As an IMF study notes, ‘‘[t]here are cases where fast and gradual reformers have succeeded and where they have failed.’’

The choice of a particular strategy might very much depend on the initial conditions as well as the development stage of a country, together with other factors. However, in carrying on capital account liberalization East Asian countries generally followed the gradualist approach, albeit some countries moved faster – with painful cost suffered during the financial crisis – than the others. The sequencing of reforms is never an easy job. There are two important reasons for sequencing. First, there are limitations on any government’s time, focus and resources and thus priority must be decided. Secondly, maximized economic and social benefits as well as minimum economic and social risks relating to the liberalization of one area can only be achieved after the liberalization in another area was completed. Appropriate sequencing of reforms can be realized without necessarily indulging the gradualism versus shock therapy debate. However, inappropriate sequencing can be very damaging to the economy.

China provides a good example of gradualism and, arguably, appropriate sequencing. As Stiglitz observes:

Historically, the Chinese were not immune to the Bolshevik mentality [of radical shock therapy change], but they seem to have gotten it out of their system in the Great Leap Forward and the Cultural Revolution. They learned the hard way where that mentality would lead. In choosing a path to a market economy, they opted for the path of incrementalism (‘‘crossing the river by groping for stones’’) and nonideological pragmatism (‘‘the question is not whether the cat is black or white but whether it catches mice’’). Chinese policymakers had the wisdom to know that they did not know what they were doing, so they did not jump off a cliff after being assured by experts that they would clear the chasm in just one more great leap forward.

Noting China’s success in managing external liberalization, Zhao (2006)’s empirical study of China’s foreign exchange system suggests a few lessons drawn from this success, of which two are related to pace and sequencing. One is timing strategically the liberalization to smooth capital flows. Using foreign exchange policy as a tool, ‘‘China accelerated the liberalization of inward foreign exchange flows and enhanced controls over capital outflows when overall balance of payments surplus shrank or turned deficit, and enhanced controls over inward exchange flows and liberalizes exchange outflows when there was excessive external surplus.’’ Resultantly, this tactic might have helped maintain a stable economic growth. Further, ‘‘China’s external liberalization process reveals a clear sequence.’’ Liberalization of FDI in manufacturing industry in costal regions was carried out at the earliest stage. When market infrastructure and modern corporate governance was roughly established, FDI liberalization was then extended to inland regions and to more industries. Financial liberalization was started only after China built a comprehensive banking system and accumulated relatively large foreign exchange reserve to fend off reversal of capital flows.

V. CONCLUDING REMARKS

China’s transition from a closed to open economy went through some unique experiences. As UNCTAD summarizes, ‘‘the process of China’s economic transformation over the past 30 years may be characterized as ‘‘experimental gradualism,’’ with the use of heterodox policies in a creative and often innovative manner.’’

China clearly has embarked on the road of trade liberalization for decades since 1978, when the Chinese government began to reduce tariffs, expand trading rights, reform the pricing of traded goods, and adopt market-oriented exchange rate policies. China’s WTO accession, representing a new milestone in its trade reform, produced liberalization commitments, which ‘‘on market access and on rules-based issues, far surpass those made by the founding members of the [WTO] and, in some cases, go beyond those made by countries that have joined the organization since its founding in 1995.’’

A unique feature of China’s transformation, though accompanied by the above-mentioned liberalization measures, involves active state intervention in the economy. The Chinese government played a vital role in China’s economic development through setting economic and industrial policy to grant privileges to exporting firms, guiding foreign investment, designing the pace and sequencing of liberalization, and balancing the development of state-owned sector and the private sector, among others. The existence of a strong state is probably necessary at China’s current development stage, as it can more effectively mitigate the adverse effects of globalization on domestic economy. This is of course very contrary to the neo-liberal prescriptions for economic development, which emphasize free markets and enterprises. However, as Rodrik responses,

The usual criticism of industrial policy is that government cannot pick winners and, therefore, should not try. However, this is not the right way to think about industrial policy. In environment that are rife with uncertainty and with technological and informational spillovers, markets under-provide investment in non-traditional products. The appropriate role for industrial policy is to fill in this market incompleteness by subsidizing investment in new products. It is a given that not all of these additional investments will prove to be socially profitable. Good industrial policy is not that ‘‘only winners should be picked’’ (an impossible task) but that ‘‘losers should be let go’’ (a much less demanding and more doable task).

Having made the above propositions, it is essential to point out that industrial policy supporting domestic economic sectors should not be turned into permanent protectionism. The government providing support to domestic industries should be wise enough to know at which point the protection should be terminated, although it is not always easy. This occurs at two junctures: either the domestic enterprises are strong enough to face ordinary, market-based competition, or the ventures under government support seem to underperform. Especially in the latter case, the government must ‘‘let it go.’’ This is particularly relevant in China’s context. After almost three decades of reform and integration into world economy, many domestic enterprises and industries should be ready to stand normal competition in both domestic and international markets. Further, with the end of China’s WTO transition period, China is obliged to phase out most of the elements of its present industrial policy, including infant industry protection measures, preferential tax treatment to exporting companies, and some forms of direct financial contribution to industries. With this challenge, China should probably act promptly to revise its development strategy.

(Edited by: China West Lawyer)