Cat and Maoist: Chinese officials debate China's economic development with a Nobel Laureate

Europe and the U.S., which had been clamoring for a free-floating Chinese currency in the hopes of addressing growing trade deficits, got their wish this summer when China announced a limited float for the Yuan. While the announcement should please many free-market economists – among them Edward C. Prescott, 2004 Nobel Laureate and professor at the W. P. Carey School of Business — Chinese national leaders have made it clear that when it comes to its economy, they do not welcome external "advice."

China took an important step toward liberalizing its currency regime this summer by revaluing the yuan and scrapping its peg to the U. S. dollar – an action welcomed in the United States and Europe as a move toward addressing growing trade deficits. Last week, China’s central bank further developed the nation’s capital markets by expanding the foreign exchange forwards business and launching a swaps business.

As China was making these moves to become a level-field player globally, one of its largest companies took a step back. Offshore oil producer Cnooc Ltd. withdrew from the bidding for California-based Unocal Corp. in the face of opposition in Congress. Coverage of the Cnooc news in China hinted at official concern about a nationalistic backlash against perceived outside pressure.

China’s stance at the juncture between a managed economy and a free market system was clear at the Shanghai National Accounting Institute Executive Forum earlier this summer. There, Chinese representatives maintained support for a carefully planned economic development, despite the free-market appeals of Edward C. Prescott, 2004 Nobel Laureate in Economics.

In contrast to the various Chinese speakers' call for scientifically planned and controlled development, Prescott, who shared the 2004 Nobel Prize in Economics with Finn Kydland for his work on business cycle theory, advocated the establishment of a free Chinese market to ensure the country's continued sustainable economic development.

Using historical data to establish a correlation between a country's standard of living and its stock of usable knowledge, he sought to demonstrate that the principal factor contributing to a country or society's economic development is its economic efficiency. "My thesis," he said, "is that some countries are poor because they're good at it. They're able to erect huge barriers to efficient production." Why? To protect vested interests, according to Prescott. His solution: "Become a member of a free trade club."

Fundamentally, this means not levying tariffs or otherwise restricting imports from the club's other members while guaranteeing that you will never expropriate their investments in your country. According to Prescott, China is moving in this direction, though the threat of centralization looms large. "I think it would be a lot easier for China if it were 30 countries rather than one huge one," he said, "but I hope and expect that it is going to become one of the rich industrial countries."

Prescott's remarks were greeted by polite applause. The Chinese, in fact, have become adept at nodding politely when receiving unsolicited advice. If Shanghai is any indication of the country's economic potential, as Han Zheng, the city's mayor, suggested in his address to the Executive Forum, it certainly appears the Chinese are doing just fine.

Though he agreed with Prescott on the need for openness, market-driven competition and economic integration, Mayor Han cited the growth of the city's GDP from RMB 76 billion (US $9.1 billion) a little over a decade ago to more than RMB 740 billion (US $89 billion) today as evidence of the astounding success of careful economic planning. He described the gradual privatization of Shanghai's economy and the city's transformation into a bustling, market-driven world financial center as a paradigm of China's new openness.

In contrast to a free market, Han called for a more scientific approach to development in order to sustain the city's growth. The need for a culture of independent innovation, funded primarily by the corporate sector but supported also by academia and the government, is the single most important factor influencing Shanghai's future development, he said. Han expects this approach to result in a continuation of the staggering growth of the last ten years. In addition to assessing and streamlining the city's industrial efficiency, the Shanghai government will press on with improvements to the city's infrastructure.

Five new subway lines will be running in time for the 2010 Expo and construction efforts are underway to establish Shanghai as both an international shipping port and a pan-Asian airline hub. But many of the factors that contributed to Shanghai's transformation over the last 15 years are absent and/or unthinkable in the kind of free-market society Prescott has in mind. Take the development of Shanghai's transportation infrastructure, for instance.

In the last decade, the city has constructed and opened three subway lines, created a vast public bus network and torn down great swathes of urban real estate to make room for a series of elevated highways — projects that by 2010 will have cost RMB 100 billion (US $12 billion). Over 1 million households had to be relocated, sometimes forcefully. This has all been possible primarily because the Shanghai government retains ownership of all land, using the proceeds from its lease to fund much of its development. But even if it is carefully planned, is this breakneck pace of development sustainable?

"The main challenge to continued development," said Han, "is our limited resources."

Land in particular is becoming scarce, though reclamation projects along the Yangtze have helped to stall the problem. Shanghai's power consumption and continued population growth are also sources of considerable worry. The government, however, is confident that continued reform and improvements in social services, education, environmental controls, air and water quality and the eventual complete liberalization of the market will allow the city and its denizens to overcome these obstacles.

"Competition brings progress to the companies and benefits to the market," said Han, though the time for that competition to take over the city's development has not yet arrived. Given the sheer size of the Chinese economy, Han and his colleagues' cautiousness makes sense. Before they remove all obstacles to free trade as Prescott urged, they want to be sure that the economy will be able to withstand unrestrained market forces. Indeed, the re-evaluation of the Chinese currency is expected to proceed as a slow, deliberate pace.

While the formerly fixed currency may have hurt China, said Lou Jiwei, China's Vice Minister of Finance, in his address to the Executive Forum, the U.S. and Europe do not fully understand the complexities of China's situation, and cannot therefore appreciate the delicacy with which currency revaluation must proceed. The RMB must first be allowed to fluctuate between set limits before the training wheels come off entirely, he said. Lou cited China's lack of reliable mechanisms to offset the risk of a free-floating currency, and pointed to recent legislation authorizing Chinese banks to buy futures and foreign stocks as evidence of a step in the right direction.

"We need to learn from foreign countries," he said, "and investing in foreign capital markets is a way for us to learn about our own financial markets." After stressing the importance of bolstering the Chinese stock market's competitiveness, Lou appealed to Chinese manufacturers to help accelerate Chinese economic development. "To compete with Hong Kong and Tokyo's stock markets we need to offer good products," he said amid enthusiastic applause.

Regardless of whether China ultimately decides to let international market forces shape its economic development or keeps its faith in the guiding hand of government officials, it plans to do so on its own terms. Prescott finished his address to the Executive Forum by recommending that the overseers of the country's development steel themselves to criticism. "Don't let the mosquitoes bother you," he said. This is one piece of advice they obviously plan to take.