China needs to choose

Almost recovered from a trip to China last week. Actually it was my first time in East Asia. Seeing the impressive economic growth that happened in China close-by is simply amazing. We spent most of the time in Hangzhou–a city with 8 million inhabitants. When you consider that this is a small town for Chinese standards you’re left amazed even more.

In Hangzhou we organized a small workshop on innovation and high-tech entrepreneurship with the local Zheijiang University. Also some influential Chinese policy people participated. Big topics in almost every talk from the Chinese side were China’s times of “new normal” and “overcoming the “middle income trap”.

The Chinese growth miracle has lost its momentum in recent years. And the Communist Party (CPC) is busy to commit its people to an ambitious restructuring of the economy. They realized that China reached a stage where the old recipe of investment-driven growth will slowly lose its effectiveness. New paths have to be forged to further “catch-up” with the developed countries and to eventually “leapfrog” to the top of the income distribution (the other two policy buzzwords that were popular in the past and still are).

In the end, the CPC experiences the basic “dilemma” that every autocratic regime faces. In a dictatorship, a ruling party can quite easily organize a reallocation of production resources to sectors with higher productivity, like manufacturing. Stalin was quite succesful with it. Also infrastructural mega projects and the rapid import of foreign technology are in the tactic book for able autocrats.

But sustained growth can only come from technological innovation. Once you reached the international technology frontier there is no one left to imitate. You have to become creative yourself. And creativity is a concept that is inherently bottom-up. You have to empower your people such that they can become the entrepreneurs of the future.

China has a few success stories in this realm (Huawei, Alibaba). But investing into R&D is a risky business–much riskier than investing into physical capital. You will only do this in an environment where you can trust on the rule of law and that nobody will expropriate you should you lose the favor of political rulers. Otherwise, too much creative capacity is wasted on political lobbying.

The CPC itself reacts to the new normal. The new five-years plan has a strong focus on science, technology and education. Officials have realized that they need to develop a more inclusive administrative system to push China further. Other public concerns such as environmental pollution and health also play an important role.

I don’t believe in a distinct “Chinese way” of sustained growth under tight autocratic rule. The new caste of innovative entrepreneurs that China currently seeks for will finally demand political representation to secure the profits from their investments and maintain a stable business environment. This is not to say that China will necessarily become a western-style democracy. Maybe this political representation will happen within the CPC, which already today some see as a “intra-party democracy”. However, the tradeoff is clear: either the Communist Party continues the path of empowering its people and thereby constraining its political power, or innovation-led growth will remain wishful thinking.