447. Does China need democracy for growth?

This is a third piece on dogmatism in economics. I discuss an article by Cheryl Long in a recent volume on ‘A research agenda for New Institutional Economics’[i]. It raises the familiar issue whether ‘ultimately’ economic growth requires the liberal democratic economic institutions familiar in the West: universal laws concerning property, access to markets, low government interference, especially in business, and low taxes.

In China things are different. Instead of universal laws of property, supported by an independent judiciary, there is decentralization to regions in the scope allowed for regulations and interference by local government and its collaboration with business, in expropriation and allocation of locations, tax, and the granting of permissions, and with an opaque sharing of interests and deals of give and take. Also, instead of legal ordering, activity to a large extent rests upon ‘guanxi’, networks of family members and partners supporting each other on the basis of reciprocity, reputation and trust. Long calls these ‘substitutes’ for Western institutions, implying that they compromise what is taken to be the ideal, i.e. the Western institutions. This raises doubt concerning Chinese perspectives for continued growth.

Yet, China has had an ongoing record of growth, and still continues to grow, albeit less, ostensibly due to trade conflicts with the US. So, perhaps one should consider the possibility of other paths to growth than only Western institutions. What might be the rationale for that?

The diversity of associations between local government and business, in China, yields competition between regions that may stimulate growth. It also turns the country into a huge laboratory of experiments in economic arrangements that may be a source of innovation. And after all, in other countries there have also been experiments with public-private enterprise.

Second, concerning the guanxi, in Japan also, trust networks of family and associates play an important role in business.[ii] That has the possible downside of locking activities into the network, closing it off to possibly more productive alternatives and inspiration from outside. On the other hand, the alternative of extensive contracting, via the law, carries high transaction costs. As argued elsewhere in this blog, innovation is a crucial source of growth, and under the uncertainty of innovation trust is needed as a ‘leap of faith’, backed up by  relational goods. And apart from its instrumental value, trust may also yield a higher intrinsic value of relationships.

Third, concerning government involvement, much of economic growth in the West has also arisen from government initiatives and subsidies, i.e. in defence industries and its spinoffs. The EU offers large subsidies to a variety of projects in research and development. Japan also has based its prosperity partly on large government planned and financed projects.

So, it may not be good news politically, but a sense of realism compels one to recognize other paths to growth than democratic institutions.      

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[i] Cheryl Long, ‘The China experience: an institutional approach’, in: Claude Ménard & Mary M. Shirley (eds.), A research agenda for New Institutional Economics, Cheltenham UK: Edward Elgar, 2018, p. 135-142.

[ii] Bart Nooteboom, ‘Uncertainty and the economic need for trust’, in Masamichi Sasaki (ed), Trust in contemporary society, Leiden: Brill, 2019, p. 60-76.