Conditional Convergence In Economics And Why China Will Fail In The Long Run
China's economy is growing 10% per year. According to a 2003 report by Goldman Sachs, China would catch up with the United States as the world's largest economy in the 2040s and go on growing faster than the US until at least 2050. Finally, China would replace the US as the world superpower, Shanghai would replace New York as the financial center of the world, and the Chinese currency would replace the dollar in world markets.
How accurate is this forecast?
Convergence Theory: Every economy has the same potential for growth. Those lagging behind grow faster.
The only relationship that economics has ever established between the prospects for growth of different countries comes from Neoclassical economic models of the mid 20th century. These models did not actually give birth to a law, but when tested in real world economies, they appeared to hold true.
The Neoclassical models gave birth to the idea of convergence, suggesting that each and every country displays the same patterns for growth. Naturally, some had a jump-start and they were already prosperous, but others would over time catch up to the leaders. The further behind they were lagging, the faster they would catch up. This means that the workers in every economy would be heading towards the same average level of productivity, wages and standards of living.
Evidence suggested that countries that were far behind the leaders could make huge advancements by improving basic things like their health care, education, and infrastructure. They would copy technologies from the leaders rather than develop them on their own. However, as they catch up they would begin to compete with the leaders, and their progress would naturally slow down.
Unfortunately, this model of convergence didn't seem to actually hold true for certain parts of the world, such as Africa, whose counties actually lost ground after the 1950s. Similarly, in the 1980s, economists would predict that Japan was growing so fast that it would eventually pass the US as the world's leading economy. But it never happened, and now it looks like it never will.
What is it that holds some countries back?
Conditional Convergence Theory: Not every economy has the same potential for growth. Those lagging behind may catch up, but will fail to keep up.
When realizing that their model was not working, economists had a new theory. They said that the basic idea behind convergence might still be true in the long run, but only if the economies to which the model is applied have the same or at least similar sets of economic factors that form the foundations of their growth.
Such deep factors that would make or break an economy include geographical features, cultural traditions, legal philosophies and much more. These factors are easily perceptible, but hardly quantifiable. Some of them can be easily changed, others not so.
These foundations together create the setting for all economic activity. In the short run, economies will wax and wane in their natural cycles, but in the very long run, it is these deep foundations that will determine their potential for growth and living standards.
So it is useful to establish the notion of convergence groups, circles in which countries that share the same economic foundations belong. This idea is that without changing at least one of the deep factors, it is impossible for an economy to move from one such circle to the next one.
This new model of convergence based on deep economic foundations is called conditional convergence theory. It seems to succeed where the previous, simpler model has failed. The predictions of Japan overtaking the United States proved wrong. Japan faltered and failed, because it didn't have the same economic foundations underpinning its growth as the US. With its markets significantly less competitive, its bureaucracy much more of an obstacle, Japan fell short, because it didn't belong in the same convergence group as the United States.
This new model is called conditional convergence and there is plenty of historical evidence to support it. From African countries of the colonial period, to East Asian economies, to post-Soviet era Eastern European countries, economies that had the same deep factors underpinning their progress always seemed to perform similarly.
Economies may get ahead leaving others behind, but in the long term, meaning decades or even centuries, economies that belonged to the same convergence groups would stay within the same limits of potential.
What are China's deep economic factors that will prevent it from sustaining its growth?
China's deeply ingrained economic factors
Unfortunately for the Chinese, there are major differences between China and more prosperous economies. They will make China fall short of taking the lead of the world, because many of them are not changeable within a short time frame, if at all.
Two of these foundations that China has a hard time embracing are extremely important to economic growth and higher standards of living. They are the ease of starting a business and the openness to trade.
China's openness to trade
China joined the World Trade Organization in 2001, but the details of the agreement that allowed them to join are still being disputed today. How much of Chinese exports can undercut the prices of domestically produced good in the US and Europe is still being disputed.
China swarmed right in when other countries opened their markets for its cheap products, but at the same time failed or rejected to open its own markets for other economies' goods. You can buy from China, but you cannot sell to China.
Starting a business in China
In China, it is extremely hard to start a business. The World Bank's recent study ranked China 151st out of 181 countries with regard to how easy it is to start doing business in the country. It's hard for the Chinese, nearly impossible for foreigners.
In China, an entrepreneur will need to have financial capital amounting to over 130% of the average annual income to start a business. In most other economies there is no such requirement. Along with this comes the burden of bureaucratic procedures one need to get through and the legal requirements imposed by the strong central government.
Of course, these factors can easily be changed. China's leaders govern the country with an iron fist. They can initiate and enforce new regulations in no time, if they wanted to. However, these are not the only factors, and not even the most important ones that keep China back in the long term.
That infamous Chinese technology
China's most hindering economic factor is most likely its outdated technology. If this statement conjures up images of high-tech Chinese gadgets that you can pick in an electronic store, you might want to look at the definition of technology in Merriam-Webster. Technology is the practical application of knowledge to accomplish a certain task. And China's way of doing this is really tacky.
Talking in specifics, the level of corruption, the way managers treat their employees, the lack of protection that law provides for investors, negative cultural influences on competitive markets, counter-productive educational practices that discourage creativity, etc all pose very real challenges for the Chinese economy.
It is these firmly fixed factors that are most hard to change, because they are the outcome of the cultural traditions of thousands of years, as well as it is in the interest of the current Chinese regime of leaders to maintain them. It is clear that based on these foundations China and the United States must be considered very far apart in terms of potential for growth and convergence groups.
What exactly are these foundations that will thwart China's long term ambitions?
Communism meets Confucianism
The Chinese government employs a mixture of communist ideologies and Confucianism's tenets (twisted to fit their own needs) to determine the country's course for present and future growth.
Confucianism is thousands of years old and is based on the teachings of Confucius. The wise Confucius attributed more value to the collective than the individual, however, in his views the supremacy of the collective did not justify conformism. In other words, he believed that there was plenty of room for individuals to stand out within the collective as long as the environment stayed in harmony.
His teachings has been twisted and turned by the Chinese government who sought to use them according to their own devices to keep the country under control. They used Confucianism to legitimize their uindisputable authority over all aspects of citizens' lives. Confucianism taught adherence to tradition and respect for elders, who could be the heads of family, rulers, masters or employers.
However Chinese authorities did not use these tenets for good. The interpretations of Confucianism's tenets in modern China contribute to rigid hierarchies in businesses. Young people engaging in critical thinking are generally frowned upon and not tolerated. Before one could have their own ideas, they have to learn the teachings of their elders and attain seniority within the collective.
It is easy to see how this environment destroys creativity and innovative thinking. In businesses, it is always the head of the company, the elder, who makes decisions. These decisions then have to reach employees on many levels of the hierarchy and probably get misinterpreted along the way.
Similarly, junior workers rarely get their ideas implemented, because they can get lost on a stubborn or incompetent senior manager at any stage up the chain of command.
Another important implication of Confucianism is that large Chinese companies have to be dominated by the government, the ultimate elder. The government rarely considers aspects like productivity and profitability when it comes to their interests in a company. This situation yields to inefficient management and unhealthy cash-flow situations. For instance, publicly traded companies in China may have up to five classes of shares, while in the West companies seldom have more than two.
One people, one ruler!
On the other hand, we should not, for one second, think that this cultural faux-Confucianist situation is escalating towards disintegration in China. Quite the contrary. Throughout their childhood and young adulthood, Chinese people are taught how the strongmen of their country's history united the nation under one flag, often by violent means, despite the efforts of villains who sought to disintegrate and destroy it.
These rulers, such as the emperor Qin Huang Ti, are always the heroes of these tales. China has had a very peculiar history with its endless internal wars between separate kingdoms and the countless dynasties that rivaled to unite them in one huge empire.
The one leader who emerged out of this mess time and again to unite the country under his rulership by mercilessly killing his enemies in wars of tens of thousands of men is always the hero in the current interpretation of China's blood-soaked history as it is taught in classrooms.
This kind of conditioning sends a clear message to young Chinese people: To be united under one leader is the only way to realize the dreams of the great Chinese nation. Those who do not consent to the will of the leader will perish in their struggles for disrespectful, subversive individualism.
This attitude is not only prevalent in the power struggles within single companies, but also the main drive behind the efforts of the hugest to gobble up their competitors and monopolize the market. Big Chinese firms can grow at astounding rates while they do this, but eventually, when everything is consumed, they will hit a wall. Not to mention, these same companies are rarely fitted to operate under the conditions of competitive international markets.
At the same time, the Chinese business environment is drowning in corruption because of their lack of transparency and the personal interests of business leaders who are also representatives of the communist party and the government.
They use the legal system to bully foreign firms. Also, foreign companies do not get to access verifiable economic data that could form the basis of their business operations. Major business negotiations happen between people who are in a personal relationship with each other and be assured it's not numbers and hard economic data that they are conversing over.
China is unable to grasp the reality of world markets
To sum up, in China, there seems to be no way out of the current climate characterized by corruption and government supremacy, on account of the fact that the deep factors that helped to build it and that run deeply ingrained in Chinese history are hard to change, should anyone even want to try.
It's been over 30 years now since China's open door policy began, and what we see is that not much has changed. The government is still heavily involved in all of the country's biggest firms. They are overpowering the market and rule out the possibility of anyone starting competitive businesses. They intrude upon people's minds by conditioning future generations to respectfully adhere to their policies.
The government does not seek to coordinate and protect businesses like in the case of Japan, South Korea, or Taiwan, rather they want to own and control businesses. All in the interests of the modern-day dynasty of corrupt Chinese leaders.
From a more technical perspective, China aims at much lower material living standards than developed Western countries, simply because the emphasis is somewhere else. They cannot enter the convergence group that the United States is in, because they do not think they have to, in order to dominate the world economy. Instead, they choose to converge to a reduced level of per capita income, which in turn limits their potential for growth in the long term.
There is no question that China will overtake the United States and this will happen in 3 to 4 decades. But there is also no question that their growth will come to a halt, and soon after their economic power eclipses that of the United States and China gets into a competitive situation with Western economies, it will enter into a cycle of decline again. And there comes another dark age of internal struggles for China.