What China Can Learn From Greece

Sergei Guriev

This is an article from Turning Points, a magazine that explores what critical moments from this year might mean for the year ahead.

Turning Point: China’s stock tumble reverberates in global markets.

As a political economist, I make my living studying the impact of politics on economics. My friends and co-authors who are political scientists focus on how economics affects politics. Which is more relevant in real life? Do countries with bad politics suffer from poor economic outcomes because bad economic policies are driven by bad politics? Or because persistent economic difficulties make reasonable politics hard to sustain?

Every year offers examples of both kinds. The year 2015 was no exception, producing two very important stories: Greece and China. Both are dramatic and multifaceted.

In Greece, the cradle of Western democracy, voters became disappointed with mainstream parties and elected the small leftist Syriza party, which promised deliverance from economic pain. Critics from nondemocratic regimes (or from “illiberal democracies”) interpreted Syriza’s victory as a failure of the democratic system. They argued that it was proof that ordinary voters could not be trusted with important decisions because they prefer simple but incorrect populist solutions. However, the events following Syriza’s victory showed that Greek voters were not shortsighted or irrational.

Yes, as soon became clear, Syriza’s promises were not realistic. As the former U.S. Treasury Secretary Larry Summers once said, “You can’t repeal the laws of economics. Even if they are inconvenient.” However popular Syriza was, it could not conjure up billions of euros out of thin air.

The choice was to continue with painful reforms or to default. Reform would mean an immediate decline in living standards; default would make things even worse. Default always brings turbulence and uncertainty, and the government would automatically switch to austerity policies anyway — not because it wanted to, but because it would have no cash to do anything else. There would simply be no access to financial markets.

I am old enough to remember how the 1998 default in Russia brought to power the only openly leftist government in the country’s post-Soviet history. It initially spouted Communist rhetoric but was forced by lack of cash to implement one of the most austere budgets that Russia has ever had.

Greek voters apparently understood the cost of default and, in a referendum, strongly supported staying in the eurozone. This vote eventually pushed the Syriza government into reaching a deal with the country’s creditors. The deal will not bring prosperity to the Greek voters, but it is certainly the least costly option.

Credit...Tatiana Tcherkezian

The other, even bigger, economic story of the year was China’s stock market crash and slowdown in economic growth. The striking success of China’s economy since 1978, as the government has implemented economic reforms, has puzzled many economists and political scientists. Dictatorships usually suffer from two imminent problems. One, in nondemocracies it is hard to create a genuine rule-of-law, which is crucial for property rights and contract enforcement; these in turn are necessary for investment and growth. Usually dictatorial governments cannot commit to abstain from expropriating investors. Two, without political competition and media freedom it is hard to get proper feedback, which is needed for running a large country.

The Chinese Communist Party addressed these problems to a certain extent by adopting several essential elements of modern democratic politics: meritocracy, checks and balances, and regular elite rotation. The jury is still out on how and why this system emerged. It may well be that the period 1949 to 1978 was just a blip, after which China returned to its Confucian meritocratic institutions, or it may be that the survivors of the Mao era wanted to build safeguards against its return.

This hybrid political system created incentives for pro-growth reforms: liberalization in agriculture and then in other sectors; relaxation of barriers to internal migration; privatization of small firms and then of larger ones; and integration into the global economy. These reforms brought a growth trajectory similar to those in Japan, Taiwan and South Korea 15 to 30 years earlier.

However, those countries already had more open political systems when they reached the income levels that China enjoys today. This openness in turn allowed them to continue with reforms that brought further growth. That is not a coincidence: Economic theory holds that there is a qualitative difference between growth from a poor into a middle-income country and further growth from middle-income to rich. The former involves catching up with advanced countries and adopting their “best practices”; this process may be carried out in a top-down fashion. So a “benevolent” centralized government can do the job.

As for the above-middle-income growth, the economic system needs to encourage innovation, which requires a decentralized, competitive political system. Many countries have not managed to build such pro-innovation institutions and then got stuck in the “middle-income-trap” of growth slowdown. Japan, Taiwan and Korea overcame this trap and became knowledge-based, rich economies.

The turbulence of 2015 indicated that China may be facing this challenge. Multiple economic studies have shown that China still has huge potential for growth that can be unlocked by further reforms in the state-owned enterprises and the financial system, promoting the rule of law and competition policies. But such reforms could undermine the current government’s hold on power because those enterprises and banks are its main economic levers.

In 2012, China’s incoming leaders outlined a reform agenda in an impressive “China 2030” blueprint co-authored by China’s State Council and the World Bank. In the past three years, however, very little of that road map has been implemented. Instead, China’s leaders have opted for greater centralization of political power.

The debate over whether democracy delivers prosperity dates back at least to Aristotle — social scientists have always asked whether democracy promotes economic growth, or high incomes are a prerequisite for a stable democracy. In recent years, economists have used advanced statistical tools to show that the first view is correct: Countries undergoing democratizations on average improve their growth performance by 1 or 2 percent per year for 10 years.

The year 2015 suggests they are probably right. Greek voters chose the lesser evil, however painful. And China’s troubles suggested that the Chinese political system may be somewhat outdated for what its economy needs and deserves. This does not imply that Greece’s economic growth will outperform China’s. It won’t — as there are many things that Greece can learn from China. But this year has also shown that China can also learn from Greece: Voters are not always wrong and top-down rulers are not always benevolent, omniscient and omnipotent.

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