Step in, then step back

China needs a new Southern Tour to promote entrepreneurship over state-driven growth, says Tsinghua’s Patrick Chovanec

Step in, then step back

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In the spring of 1992, China stood at a crossroads. Ever since the Tiananmen massacre in June 1989, the economy had been in state of lockdown.

Afraid that market reforms had gone too far, too fast, and had helped to fuel political unrest, Communist Party leaders had moved to reassert state control. Deng Xiaoping, officially retired but still China's paramount leader, faced fierce internal criticism from hardliners who blamed his reform and opening policies for weakening the Party's hold on power. Many observers wondered whether the country's brief experiment with markets had come to an end.

Deng's response was bold. On a surprise visit to Shenzhen, the special economic zone (SEZ) in which the reforms of the 1980s had begun, Deng declared that "to get rich is glorious." He lauded the anything-goes spirit that had transformed this sleepy fishing village into a thriving city in barely a decade.

The rousing endorsement of market forces that characterized Deng's Southern Tour, as it came to be known, set the stage for a renewed burst of reform and entrepreneurship, and the creation of the China we know today. The 1990s saw the emergence of private companies, the rapid development of stock markets, the privatization of many smaller state-owned enterprises (SOEs) and the reorganization and public listing of dozens of larger ones. There was also a massive transfer in home ownership from the state to individuals, and an end to the cradle-to-grave power of work units.

Today, however, China stands at a similar crossroads. The global financial crisis, and the consequent fall-off in demand for Chinese exports, rattled Beijing and reawakened deep fears of social unrest.

In order to meet its minimum target of 8% GDP growth, China embarked upon a massive government-engineered stimulus. The apparent success of that strategy - although in my view, it's far too early to judge - has convinced officials of their superior ability to steer the economy. The painful corrections faced by Western nations have also made them more skeptical of the free market.

Rise of the state

These days, the buzz-phrase in Chinese business circles is guo jin, min tui - the state advances, the private sector retreats. There's a feeling among foreign investors and local entrepreneurs that the playing field is increasingly tilted in favor of SOEs, at everyone else's expense.

To some degree, this trend is the unintentional outcome of stimulus money being channeled primarily to SOEs. At the same time, it's a natural protective response to economic uncertainty. But it is also the product of a shift in philosophy, from the dynamic turmoil of competition to the security of state control. A new revisionist history has emerged, in which China's economic "miracle" was the product of a series of wise and coordinated five-year plans, in which entrepreneurs played a helpful but always subordinate role.

The obvious beneficiaries of this new climate are the large SOEs, but it also distorts how even private companies operate. A recent survey conducted by YouGov and London's Legatum Institute found that while 81% of Indian entrepreneurs believe the key to success is jugaad - innovation in getting around restrictive policies and bureaucratic obstacles, 93% of Chinese entrepreneurs see guanxi - relationships, particularly within the state - as critical to success.

No wonder many Chinese enterprises that were once wholly private, like Mengniu Dairy (2319.HK), have sold controlling stakes to the state shareholders. In an environment where the government serves dual and conflicting roles - regulator and competitor - connections count as much or more than actual value creation. The result is an emphasis on rent-seeking behavior rather than real competitiveness.

Embrace the future

What China needs is a new Southern Tour. Like Deng Xiaoping did in the spring of 1992, the leaders of today should set the record straight, and recommit the nation to tackling the critical reforms that lie ahead.

After 1989 and 2008, China needed a period to retrench - fine. But the future won't wait. The country must resume efforts to create a banking system that allocates capital based on returns, not assets or connections. It must move toward a convertible currency. It must prepare Chinese firms to go abroad and compete effectively. The key to all these challenges is the acceptance and recognition of market prices as essential signals for the allocation of resources. That can't happen when the state builds a wall around the economy and favors its own.

Whether the will or desire to communicate this message exists is another matter. In September, Shenzhen celebrated 30 years as an SEZ. President Hu Jintao and Premier Wen Jiabao both came and gave speeches. But Hu merely invoked the standard platitudes about opening and reform, while Wen sketched an inspiring but rather vague vision of turning Shenzhen into a laboratory for future political reform.

Neither seized the moment, as Deng did, to drive home the key lesson of Shenzhen: that China's miracle wasn't the product of omniscient state planning; it was the spontaneous response to a farsighted decision by China's leaders to get out of the way and let the people take their own initiative to build better lives for themselves.

When the state advances and the people retreat - guo jin, min tui - China loses sight of that lesson, and risks losing its way. If it does take those lessons to heart, however, years from now we might talk of how a new Southern Tour once again heralded a spectacular new chapter in China's development.