China: The rise of the World’s Factory

Napoleon once said, “Let China sleep, for when the dragon awakes, she will shake the world.” One of the most important economic and geopolitical phenomena has been China’s industrial revolution, which started 35 years ago. China’s rapid growth has perplexed many people, including economists. Moreover, it has ignited a new demand for raw materials across Asia, Latin America, Africa, and even the industrial West. Thirty-five years ago, China’s per-capita income was only one-third of that of the Sub-Saharan region of Africa. In contemporary times, China has grown into the world’s largest manufacturing powerhouse by producing nearly 50 percent of the world’s major industrial goods, including crude steel (800 percent of the U.S. level and 50 percent of global supply), cement (60 percent of the world’s production), coal (50 percent of the world’s production), vehicles (more than 25 percent of global supply) and industrial patent applications (about 150 percent of the U.S. level). It is also the world’s largest producer of ships, high-speed trains, robots, tunnels, bridges, highways, chemical fibers, machine tools, computers, cell phones, etc. In the early 1970s, China produced very few manufactured goods—a tiny fraction of the U.S. level. China’s manufacturing, however, started to take off around the 1980s, surpassing the industrial powers one by one, overtaking the U.S. in 2010 to become the No. 1 industrial powerhouse. The question that has been the most evocative is related to its enormous diaspora. A nation housing more than a billion people transformed itself relatively suddenly from a vastly impoverished agricultural land into a formidable industrial powerhouse whereas several nations have been unable to do so despite their more favorable socioeconomic conditions. Two conflicting views regarding China’s growth have been able to capture the attention of several researchers working on this topic. The first view explains China as a gigantic government-engineered bubble. It claims that this hyper-growth is not sustainable and sooner or later it will collapse as democracy is missing in China which has led to the absence of several important factors that are necessary to hold together such an extensive development of the nation. According to this view, the bubble will burst at the expense of China’s people and its environment. The second view sees the dramatic rise of China as a result of destiny while also claiming that the nation is returning to its historical position. China had been one of the richest nations and greatest civilizations from at least 200 B.C. to 1800 and would soon reclaim its historical glory. However, these views are not backed by thorough economic analysis but are instead based on either on prejudice or naïve extrapolation of human history.

The Industrial Revolution was one of the most important socio-economic events in human history. Before this, humanity lived essentially at a subsistence level confined in the so-called ‘Malthusian trap’. The Industrial Revolution transformed the living standards of humans by dramatically increasing the per capita income. However, it is also imperative to mention that the effects of the revolution were initially only felt in the United Kingdom. Due to this reason and because of the almost magical alterations in the living standards and national income, among other things, almost every nation tried to emulate the British Industrial Revolution. Stark changes were prevalent only in the Northern and Western Europe, the United States, Japan and the Asian Tigers, among others. According to the Institutional Theory, political institutions have been seen to play a key role in the sphere of these developments. For instance, Inclusive institutions that are prevalent in democracy advocate several restrictions on the elite class. Rule of law flourishes in these places and democracy allows the growth of the free market, free trade, private-property rights. This implies private incentives for wealth accumulation, innovation and growth. On the other hand, Extractive institutions that are prevalent in dictatorships (such as dictatorship) hinder not only freedom of choice but of protection of private-property rights and the rule of law, all of which leads to the lack of private incentives to work hard, accumulate capital and innovate. Such theories are however difficult to square with the facts. There are ample democracies with pervasive economic stagnation and continuous political turmoil, such as those of Afghanistan, Egypt, Iraq, Libya, Pakistan, Thailand, Tunisia and Ukraine, to name a few. Several extractive institutions have been economically strong, such as Germany (1850-WWII) and Russia (1860-WWII). The institutional theory also failed to explain the dismal failure of Russian economic reforms under democracy and shock therapy, Japan’s rapid industrialization during the Meiji Restoration, South Korea’s economic takeoff in the 1960s-1980s under dictatorship or Singapore’s post-independence economic miracle. Nor can the theory explain why under identical political institutions, property rights and the rule of law, there exist pockets of both extreme poverty and extreme wealth, as well as of violent crime and obedience to the law.

 To understand China’s transition, we must look closely at the historical development of China’s economy. The first attempt at industrially developing China was made between 1861 and 1911. It came on the heels of China’s defeat in 1860 by the British in the Second Opium War. In light of various unequal treaties imposed by Western industrial powers, the Qing monarchy that was then in control in China embarked on a series of ambitious programs to modernize the prevailing backward agrarian economy, which included the establishment of a modern navy and industrial system. Fifty years later, the government was deep in debt, and the effort turned out to be a huge failure. The nationwide demand for political reforms, followed by social turmoil, ultimately led to the 1911 ‘Xinhai Revolution’ that overthrew the “extractive” Qing monarchy and established the Republic of China, the first “inclusive” government in China based on Western-style constitutions. The new republic tried to industrialize China by emulating the U.S. political institutions, including democracy and the separation of powers. A famous slogan among the Chinese during this time was “Only science and democracy can save China.” Several revolutionaries of the educated elite opined that the failure to industrialize China and its overall backwardness was due to its lack of democracy, political inclusiveness and pluralism. But 40 years passed, and China remained one of the poorest nations on earth. In 1949, following the defeat of the republic by the Communist peasant army, a new government initiated the third ambitious attempt to industrialize China—this time by mimicking the Soviet Union’s central planning model. Thirty years passed, and the effort failed again. The reason for China’s three failures was not the lack of free-market and private-property rights as it is speculated that the Qing dynasty probably had in place a well-organized market system and private-property rights. Also, lack of democracy would not have been the issue as the government of the Republic of China was so inclusive that even members of the Communist Party were allowed in the government. Leader Deng Xiaoping initiated China’s fourth attempt to industrialization in 1978. This time the country refused to take advice from Western economists and it instead took a very humble, gradualist, experimental approach with its economic reforms. The keys to this approach have been to:

 1. Maintain political stability at all costs;

 2. Focus on the grassroots, bottom-up reforms (starting in agriculture instead of in the financial sector);

3. Promote rural industries despite their primitive technologies;

4. Use manufactured goods (instead of only natural resources) to exchange for machinery;

 5. Provide enormous government support for infrastructure buildup;

 6. Follow a dual-track system of government/private ownership instead of wholesale privatization; and

7. Move up the industrial ladder, from light to heavy industries, from labor- to capital-intensive production, from manufacturing to financial capitalism, and from a high-saving state to a consumerist welfare state.

 In the Mao regime, attention was mainly given to the capital-intensive heavy industries, whereas agriculture suffered neglect. Deng Xiaoping initiated reforms that were mainly concentrated on the agricultural sector as China was still an agrarian society, where a large section of the population was engaged in cultivation. The idea was to boost production by bringing in two landmark legislation: the household responsibility system and the dual pricing system (DPS). Production was severely deficient and the rural sector was capital-starved by 1970s. The late 1970s saw a slew of reforms that was meant to boost agricultural production. The then leader de-collectivized agriculture (dismantling the commune system) and started the household responsibility system (HRS), thereby dividing land into private plots. Under the DPS, farmers were able to keep the land’s output after paying a share to the state. This move enabled the producers of the rural areas to sell their produce surplus to the private market after complying with the output share that is to be given to the state. This eventually gave a massive shove to agricultural production led to an increase in the incomes by stimulating rural industry. The years 1978 and 1984 saw the growth of agricultural GDP at an annual average rate of 7.1 per cent, and the income growth in rural areas (almost 14 per cent per annum) increased aggregate demand in consumer and light industrial goods. Nevertheless, domestic expansion of the industry was limited and, as a result, imports were sought to meet demands. The import tariffs were brought down as part of trade reforms. However, rural reforms demonstrated that a rise in income would be inflationary if it is not for a corresponding increase in industrial supplies. The next phase of reforms accordingly focused on industries. But it was indeed agricultural reforms that kick-started the manufacturing revolution in China. Moreover, under the DPS the goods produced would be sold primarily at command prices, but to foster productivity, a small share of it would be sold at market prices in way of profit incentives. An empirical study has brought to light the fact that the impact of the reforms regarding agricultural productivity has been huge which was mainly due to the changes in the incentive schemes available in China. McMillan, Whalley, and Zhu explained that the effects of HRS also included a 32 per cent increase in total factor productivity (TFP) in agriculture.

This era also introduced massive institutional as well as structural changes in administration. China owes its economic reforms to these changes as well, and this came in the form of decentralization of power to local bodies. This time the provincial governments had been assigned to play an important role in both Chinese reforms and the ensuing high growth miracle. According to the Chinese Institute for the Reform of the Economic System, provincial governments in the 1980s were responsible for 37.8 per cent of total mandatory production targets. Chung and Lam claimed that decentralization was a key component of change. Provincial governments were expected to perform specific policy functions and decide legislative fine points. In 1979, legislative powers were granted to the People’s Congress of each province for the first time. As a result, provincial governments passed over 2,000 laws between 1979 and 1991. A majority of these laws were related to the various economic policies of that time. This set the stage for formulation and implementation of location-specific and endowment-specific reforms concerning various provinces. The provinces, by acquiring budgetary powers, have been seen to deal with trades up to $30 million. The cap was later raised to $100 million. In July 1979, the Standing Committee of the National People’s Congress passed the Special Economic Zones (SEZ) law, which opened China to the world. Rules regarding SEZs were made favorable to foreign investments and policies. Money began flowing in heavily. The coastal provinces of Fujian and Guangdong saw the creation of SEZs which in turn helped to further open China to the international economy. The success of the SEZs in enabling FDI-led growth led to the extension of the policy across China, as other local authorities rushed to establish their own Special Economic or Technological Development zones. Pieces of evidence show that much of the SEZ success in China has been led by provinces and their governments where foreign investors have come in direct contact with these local governments. Coase and Wang observed that the planning and developing of SEZs, which were transforming China’s economy since 1979, was part of the Communist Party’s adaptation towards capitalism by way of privatization, marketization, and expansion of international trade. Modern domestic manufacturing industry was one of the main concerns of the government and thus, they designed a policy to achieve that. These changes helped China to benefit from positive spillages and underwent value addition.

According to Yi Wen, by compressing several centuries of Western (and Japanese) development into three decades, China formulated its unique path to industrialization. Their journey can be separated into three major phases:

 1. 1978-1988: This phase can be claimed as ‘proto-industrialization’. It saw the sprouting of several rural enterprises (collectively instead of privately owned by farmers). Consequently, these enterprises acted as the engine of national economic growth during the first 10 years of economic reform. The number of village firms increased more than 12-fold (from 1.5 million to 18.9 million), village industrial gross output increased more than 13.5-fold (from 14 per cent of gross domestic product, or GDP, to 46 per cent of GDP), village peasant-workers grew to nearly 100 million by 1988, and farmers’ aggregate wage income increased 12-fold. Growth in the supply of basic consumer goods ended shortage in the mid-1980s and simultaneously solved its food security problem.

 2. 1988-1998: This phase can be termed as ‘first industrial revolution’. It featured mass production of labor-intensive light consumer goods across China’s rural and urban areas, relying mainly on imported machinery. China emerged as the world’s largest producer and exporter of textiles, the largest producer and importer of cotton, and the largest producer and exporter of furniture and toys, during this period. Rural enterprises continued their hyper-growth, and their workers reached 30 per cent of China’s entire rural labor force (not including migrant workers). Village industrial output grew by 28 per cent per year, doubling every three years (an astronomical 66-fold increase) between 1978 and 2000.

 3. 1998-present: This was the period that saw the beginning of the ‘second industrial revolution’. It featured mass production of the means of production. The rapid development also introduced a surge in the consumption and production of coal, steel, cement, chemical fibers, machine tools, highways, bridges, tunnels, ships, etc. In all, 2.6 million miles of public roads were built, including more than 70,000 miles of express highways (46 per cent more than in the U.S.). Twenty-eight provinces (out of 30) have high-speed trains (with a total length exceeding 10,000 miles, 50 per cent more than the total for the rest of the world).

The development of markets has always encouraged modernization of a nation. Market creation requires state power, correct developmental strategies and correct industrial policies. Researchers have noted that the Industrial Revolution in China has been driven not by technology adoption per se, but instead by continuous market creation led by a capable mercantilist government; the market creation is based on mutually beneficial trade instead of the gunboat diplomacy methods of earlier Western powers. From China’s experience, we can see that the development of an industrial market is a sequential process (from the agricultural and artisan stage to the proto-industrial market and so on). A nation, to start its development, must repeat earlier stages by clearly following the principle of organization in an orderly fashion if it wants to succeed. It is almost like learning a new trade; you never learn one haphazardly. China’s industrialization picked up not only the positives aspects of Western development but also the negatives, including rampant corruption and organized crime, unprecedented pollution and environmental destruction, rising divorce and suicide rates, widespread business fraud and scandals, low quality goods, pervasive asset bubbles, rising income inequality and class discrimination, frequent industrial accidents, etc. Various other challenges such as building social safety nets, completion of social and economic reforms in the health care and education sectors, finishing rural urbanization and agricultural modernization, establishing modern financial infrastructure and regulatory institutions, establishing a modern legal system are also to be met by China. However, as long as China follows the right sequence of economic development, these should merely be scant problems and not the same daunting structural obstacles like the Malthusian poverty trap or the middle-income trap faced by many developing nations. The rise of China provides a golden opportunity for many other nations to ride the ‘free China train’ that would help one to allow industrial and technological advancements. Nevertheless, the benefit a nation can reap from China’s rise depends entirely on its capabilities, worldview, developmental strategies, and the present industrial policies of that nation. Although the 21st century appeared initially to be shaping up as China’s century, the manufacturing sector has undergone massive changes, bringing new opportunities and challenges to business leaders. The prevailing pandemic has made it very much unclear as to which country will now dominate the global manufacturing market. It can be said that after three immensely successful decades of gigantic growth, China’s manufacturing engine has largely stalled. These changes in the sphere of manufacture have come not only as a result of the tepid economic situation of the world but also due to the realization of various industrialists regarding the difficulties one can face when depending on a single country for manufacturing and the consecutive geographical spread.

 – Sagarika Mukhopadhyay

Bibliography

 McMillan, John, Whalley, J., & Zhu, L. (1989). The impact of China’s economic reforms on agricultural productivity growth. The journal of political economy, 781-807.

 Sahoo, P., & Bhunia, A. (2014). China’s Manufacturing Success: Lessons for India. IEG Working Paper No. 344, pp. 7-11.

 Wen, Y. (2015, November). China’s Industrial Revolution: Past, Present, Future. Retrieved June 2020, from https://www.stlouisfed.org/dialogue-with-the-fed/chinas-industrial-revolution-past-present-future

Wen, Y. (2016, April). China’s Rapid Rise: From Backward Agrarian Society to Industrial Powerhouse in Just 35 Years. Retrieved June 2020, from https://www.stlouisfed.org/: https://www.stlouisfed.org/publications/regional-economist/april-2016/chinas-rapid-rise-frombackward-agrarian-society-to-industrial-powerhouse-in-just-35-years

 Wen, Y. (May). The Making of an Economic Superpower: Unlocking China’s Secret of Rapid Industrialization.