Three Questions With: Nicholas Lardy

Nicholas Lardy, the Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics and author of the recent book “Markets Over Mao,” challenges the idea that “state capitalism” has been a successful model in China.

Lardy Three Questions
Nicholas Lardy speaks at the Paulson Institute on October 21, 2014.

1-balloonConventional wisdom says that China’s state sector continues to dominate the economy. Is that not true?

When you look at the evidence, private firms have been the driver of China’s economic growth throughout the whole reform period. They’ve created most of the additional output. They have been responsible for most of the growth of employment. Increasingly, they are the major source of China’s exports. And they are also now beginning to be significant drivers of outbound investment. Upstream oil and gas, and certain parts of the service sector—telecommunications, finance—are very, very heavily state dominated. But the state has, in effect, retreated to these enclaves where the state owned enterprises are protected.

2-balloonThe reforms that President Xi Jinping is trying to push through involve opening up at least some of those sectors. Are they making progress?

They have pledged to de-monopolize all but “natural monopolies,” such as electric power or railroads. Nobody thinks financial services are a natural monopoly—so there should be a lot more competition there. How much progress are they making? They’ve already licensed the first five completely private banks. Another area that gets very little notice is the airline industry. A number of start-up airlines have come into existence in recent years, but they had to charge the same fares as incumbent carriers, so it was very difficult for them to gain market share. Now the government has said they can cut their fares. This will add a lot of competition to the existing major players.

3-balloonWhy are your conclusions important? Does challenging the idea that China has a successful “state capitalism” model help drive an internal conversation about what model China will adopt going forward?

Certainly it’s very important domestically, because legitimacy of the regime has depended very much on delivering rapid economic growth. It’s increasingly clear that the sectors dominated by state firms have not been successful in economic terms. Their return on assets is much, much lower than private firms. Their earnings are almost always way below the cost of capital. These firms are a big drag on economic growth. They did make a push in the era of Hu Jintao/Wen Jiabao to have a model of state capitalism, and they adopted a number of industrial policies that favored state firms. But when you look at the outcome, I would say that this effort at state capitalism has failed. I think the top leaders understand that as well, and that’s why they’re talking about de-monopolization. I think if they want to maintain economic growth, more resources need to be going into the private sector.