This question may be a bit premature at this point in the course but it’s important for various reasons. Therefore I will address it here for the benefit of those who wish to understand it now.
This is prompted by a question that Nithya asked:
In our 2nd live session, it was concluded that if Government gets into production then that country’s economy may not perform well. But, China is having a communist economy where most of the decisions and production is under government control. Still, they are the 2nd largest economy in the world. Why is it like that?
The short answer is that China is a capitalist economy, not a communist or socialist economy. India, by contrast, is a socialist economy. That distinction briefly explains why China’s economy is around 6 times larger than the Indian economy. And which is why China is poised to become the largest economy in the world in a few years, and why India will continue to be unfortunately a very poor country.
Here’s a bit from a blog post of mine from June 2020:
The story of modern China is at once frightening and encouraging. It’s hard to comprehend something that involved hundreds of millions of people. It’s impossible to imagine what is is like to lift hundreds of millions of people out of extreme poverty. China did it. I don’t excuse the human rights abuses that China routinely indulges in but I celebrate the reduction in human suffering that it achieved. I have special contempt for the Chinese Communist Party leadership. They are evil but at least they did one thing right: they relieved the suffering of their people.
I would fall to my knees in deep gratitude to those who were responsible for sparing me the torture of a life of grinding poverty. Conversely, if I had been condemned to a life to unrelenting poverty — as is the fate of hundreds of millions of Indians even today — I would curse those responsible to be tortured in hell for eternity. That includes those of every political party that has ruled India since 1947.
You can go read the rest of that piece titled 70 Years of China in One Image. Here are some important sources that address the question.
A must read: The Jan/Feb 2013 Policy Report by the Cato Institute: How China Became Capitalist by Ronald Coase and Ning Wang. The report is based on the book of the same name by Coase and Wang. Coase was a “Nobel” prize economist, and I just love the man. When the book was published in March 2012, Coase was only 102 years old.
That brief report is quite good to get a sense of what happened. Another good book on the topic Branko Milanovic’s “Capitalism, Alone: The Future of the System that Rules the World.” (published 2019.) I am sure that no one here is that interested in reading a whole book on the subject. But wait — there’s an easy way to get most of what it’s about. Just listen to a podcast.
Branko has appeared on EconTalk. Go download and listen to that episode which was published in May 2020 (although it was recorded in February.) Russ Roberts’ EconTalk is my favorite economics podcast. Here’s a bit that will give you a sense of what Branko’s point is:
Russ Roberts: Now, your book talks about two different kinds of capitalism. On the one hand, liberal and meritocratic, and the other is, you call, political capitalism. Talk about the difference between those two systems and which countries embody them that you focus on in the book.
Branko Milanovic: Yeah. The countries that embody them and actually the data that I use to illustrate the two systems come, first I’m going to say, for meritocratic and liberal capitalism from the United States, where we actually have probably, in the area that I work on, which is inequality, probably the best data or most detailed data.
And, the country which illustrates political capitalism is China, where of course I use quite a lot of Chinese data, and I make sort of the structure of the two chapters that deal with the United States on the one hand and China on the other hand, relatively similar. Because, the objective of the two chapters is to look at the forces of inequality–be it inequality in wealth, or opportunity, or income–which might lead to the creation of a self-sustained upper class in both systems. So, that’s the structure of the book.
Now, the two systems differ–I mean, first, they are similar in the sense they are both capitalist. That’s my argument. And, actually, as you said, even the title of the book is kind of makes this obvious because it says Capitalism, Alone, meaning that capitalism is the only economic system which exists today.
But, they are also different, obviously, in the political space because the political space of a liberal or meritocratic capitalism as essentially democratic. The political space of Chinese-type or political capitalism is not democratic. It’s a one party system where the state has much more of a preponderant political role, and, to a large extent also, more preponderant economic role.
Russ Roberts: And, your description of capitalism, I’ll try to remember it first. You can correct me and then add to it. It’s decentralized, in terms of economic decisions. Labor is hired at wage rates in a somewhat open market. Prices are somewhat free to adjust and steer resources. Investment is made privately. And, so, if I left anything out, tell me. And, how do you reconcile that with China, where a lot of investment is clearly not private? And, I also wonder about how decentralized economic decision-making is there. I simply don’t know. Something I think about a lot.
Branko Milanovic: Yeah. Actually the way that you define it is, I think, almost fully correct. But, let me say first that the definition is not mine. It’s actually the definition is sort of a standard definition that was used by Marx. It was used by Max Weber afterwards.
And, I think it’s a very economical definition of capitalism. It includes, as you said, first, decentralized coordination. Secondly, legally free labor. That’s very important because, in the past, labor was not legally free very often. But, that labor is hired labor. Now, the term ‘hired labor’ is also important because it means that labor is not exercising entrepreneurial function–which, in other words, it’s not workers who decide we are going to produce this and that gadget. It is–and that’s the third sort of definitional part–it is capitalists who decide on that, who have entrepreneurial function. And, economic life is conducted using privately-owned capital and profit principle. So, this is the definition.
Now, you ask and many people ask: Now, how does it apply to China? It’s more or less clear it applies to the United States because actually all the three elements are, I think, very clear in the case of liberal capitalism.
My argument–and it’s based on facts, so it’s not really what I think China does or what I don’t think–but they simply look, first, what percentage of labor force is working as self-employed, because in agriculture in China is mostly self-employed, and in the private sector. And, there you actually find that in 1978 for example, when you had still the commune system in China, in agriculture, you had about 85% I think of labor that was state–I mean, working the state-owned or commune system in agriculture.
Well, that percentage now is less than 10%. So, you really have had a tremendous change of first, privatization, be it privatization in the sense that there are large private companies, or middle-sized private companies, or finally private individuals, mostly peasants, farmers producing on their own land.
Finally, I have written a few blog posts on that matter. They are —