China and the Freedom Advantage

China’s incoming leadership faces a series of tough decisions about future economic growth, social stability and the development of political consensus. China’s leaders to date have managed the country’s economic rise in a successful top-down predominantly directive fashion that has maintained tight social and political control. During its next phase of development China will likely need to address the demands of richer, more educated, interconnected and more assertive citizens. A study of other nations demonstrates that advanced levels of development have gone hand-in-hand with a greater degree of economic and personal freedom than seems on the agenda in China today. However, should China’s leaders not act decisively in this regard, it is possible that the country will forfeit significant material progress and that the gap between citizens’ expectations and freedom delivered may well create critical risks to the development delivered to date.

The Freedom Advantage

Free countries are richer. Comparing GDP/Capita with Freedom House’s Freedom in the World Index ranking for 180 countries shows a clear wealth gap between free and and partially and unfree countries. The table (below) illustrates the magnitude of the gap between countries with different levels of freedom. Also, free countries (as defined by Freedom House) make up over 80% of the top 25 most competitive countries as ranked by the World Economic Forum. Further, there appears to be a strong positive correlation between the level of economic freedom and political and personal freedoms within countries; economic freedom in this definition includes the rule of law, limited government, regulatory efficiency and more open markets. Politically free countries rank much higher on measures of economic freedom such as the Index of Economic Freedom , with politically free countries representing almost 90% of the 25 countries ranked “free” to “mostly free” economically. Conversely, over 80% of the countries ranked “mostly unfree” or “repressed” economically are politically unfree or only partly free. The relationship between freedom and economic growth is less clear, and in fact the majority of countries that have industrialised over the past 50 years have done so with managed development models that stressed economic growth over political and personal freedom. The first wave of industrialising economies in the 1960s included the Asian Tigers, Singapore, South Korea, Taiwan who were able to convert high domestic savings rates into an export-driven growth model backed by large government investments. Not unlike China today, these countries also moved from socialist, closed economies to more market-driven and open economies through the guidance of centrally directed programmes of change. This model was later emulated during the 1980s by a second generation of ‘Tiger Cubs’ – Thailand, Malaysia, Indonesia, and the Philippines - and it was also successfully used in Latin America by Pinochet regime in its transformation of the Chilean economy.

However, the majority of these countries eventually transitioned to more democratic, open, post-industrial societies. The timing of these transitions appears to have been a While state-led, top down and interventionist economic policies are key enablers of initial industrialisation, market driven open economies are required for post-industrial growth and development.function of the country having reached the limits of state-led industrial policies as well as having developed a more highly educated and wealthier population wanting greater participation in government. Looking at the countries that have successfully made this transition and continued to see high rates of economic development (namely, South Korea, Taiwan, Singapore and Chile) one can see that these countries initiated reforms introducing greater personal and political freedom at GDP/Capita levels (PPP adjusted) between approximately US$5,000 and US$10,000 per capita. For these countries, political reforms went hand-in-hand with a transformation of the economy, from export driven industrial growth to more diversified and balanced growth models with stronger domestic consumption and the development of mature services industries, all of which are hallmarks of the post-industrial economy China itself is looking to build. The data on continued economic growth in the absence of increased freedom is even more revealing. Oil producing nations aside, there are no politically unfree countries with per capita GDPs above US$7,500, and among politically partially free countries, only Singapore clears GDP/capita levels of US$10,000. Looking at these and other examples, it becomes clear that while state-led, top down and interventionist economic policies are key enablers of initial industrialisation, market driven open economies are required for post-industrial growth and development.

China’s Current Challenge

China today, with a nominal per capita GDP of US$5,100, remains both politically and economically centrally managed, “unfree” by the criteria that the studies use, yet it is placed among the 30 most competitive countries in the world by the WEF. Is this sustainable? China’s competitive position is largely driven by its macro-economic fundamentals rather than by the maturity and sophistication of its regulatory environment and financial, trade and markets systems with China, for example, ranking 91st out of 183 countries surveyed for the factor which the World Bank refers to as the “ease of doing business”. However, these types of factors re exactly the characteristics China will need to promote and develop if it is to meet it stated development goals. China today is well structured to compete effectively as an industrialising nation, it has not however yet managed to build a strong foundation for more diversified, post-industrial growth or for developing in parallel to industrials the sort of advanced economy that it has stated it intends to in its recent five-year plans.

The country currently is faced with the twin challenges of (i) economic “rebalancing” to internally generated, demand driven growth while (ii) managing an economy seeking to avoid the pitfalls of the “middle income trap”. Freedom, economic and political, has a fundamental role to play in addressing these challenges. “China has identified seven knowledge sectors for rapid development, with investments of up to US$1.5trillion being considered across these industries”China has identified seven knowledge sectors for rapid development, including biotechnology, new energy, electric cars, energy conservation and environmental protection, high-end equipment manufacturing, new materials and next generation IT with investments of up to US$1.5trillion being considered across these industries. China is investing heavily in R&D and education. China, the world’s second largest R&D spender behind the U.S. has set a target of R&D expenditure of 2.2% of GDP by 2015, which would add almost US$100bn in incremental R&D expenditure annually within four years. However, unlike heavy manufacturing which China has focused on to date, knowledge sectors require more human knowledge-related capabilities and assets to develop than capital investment and R&D subsidies. These sectors of course require entrepreneurship, an environment that allows for failures along the road to success and a society in which information is shared freely while sufficiently protecting intellectual property to allow collaboration. Most importantly is the need for talented entrepreneurs and skilled workers to be drawn to the opportunity and the location from across the world. These factors are not the hallmark of closed societies, which have historically failed to attract international talent that has a choice of where to live and work. In addition, building entrepreneurial companies in knowledge sectors requires strong intellectual property rights, clear regulatory frameworks, a flexible labour regime and investment freedom, all of which are lacking in China today.

For continued economic growth, the lessons from other developing and developed economies clearly point to the advantages, if not the necessity, of introducing more freedom. More fundamentally, and beyond economic calculations, the past year has seen the emergence of a global “consciousness phenomenon”, with people all over the world demanding – and often receiving – more personal, economic and political freedom. The most conspicuous examples are in the Middle East, where the Arab Spring has led to regime change in a number of countries and fermented violent unrest in others. China to date has been able to settle or move on from its unrest, whether in physical form, like the ethnic Tibetan and Uighur protests, or in digital form, like the uncontrolled spread of rumours over the internet, through aggressive engagement and widespread media censorship. However, the fundamental, underlying demands continue to remain unaddressed and will likely continue to grow, endangering one of the Chinese Communist Party’s most important objectives, the maintenance of social stability. China’s own history demonstrates that if the protestors are initially silenced, one can win the moment and buy time but the sweep of neighbouring demands finally does reach the ears of the populace.

Freedom, Democracy and Development: Unlocking Potential

It is important to remember that more freedom, political, economic and personal, however, does not necessarily equal democracy. As we already noted, most of the economic success stories of the 20th century that practised economic freedom without effective democracy during their period of rapid development later transitioned to freer and ultimately more democratic societies. We can pick out five distinct phases of development in which different economic and social models have been effectively deployed:

1. Pre-Industrialised Stage: Usually structurally and environmentally challenged countries with closed economic models. GDP/capita levels generally below US$1,500 – Politically free or unfree (Examples include the majority of sub-Saharan African states)
2. Industrialisation Stage: Industrialising and fast growing countries with investment and export led growth models. GDP/capita levels between c.US$1,500 and c.US$7,500 – Political freedom limited by design by effective state intervention (Examples include Thailand today and the Tigers in the late 1970s)
3. Transition Stage:Diversifying and fast growing countries developing services and consumption led economic models with GDPs per capita of US$7,500 to US$20,000 – Increasing levels of political and personal freedom and government accountability (Examples include Central and Eastern Europe today and the Asian Tigers in the 1990s)
4. Diversified State:Mature (and slower growing) economies with high qualities of life and open market economies – GDPs per capita above US$20,000 – Open and politically free democracies (Examples include the United States and Western Europe)
5. Post Industrial Stage: Highly advanced, post-industrial economies driven by services and R&D intensive technology sectors coupled with high competitiveness, extremely high qualities of life, environmental sustainability and robust benefits – GDPs per capita above US$50,000 – Open and politically free democracies (Examples that are developing in that direction include the Nordic countries, Switzerland and Luxembourg)

Within this framework China today appears to be reaching the limits of the Industrialisation Stage with some of China’s leadership increasingly aware that, as China transitions toward a more diversified economy, this will result in demands from the people for freer and more democratic forms of government. In this regard, the Singapore model much studied by China’s policy makers despite being far less complicated due Singapore being a city-state, has demonstrated that a gradual and partial democratisation appears to be a sustainable option as long as government is seen to be delivering. “Singapore has demonstrated that a gradual and partial democratisation appears to be a sustainable option as long as the government keeps delivering” Similarly, it is also important to note that, in practise, democratisation does not necessarily drive a dramatic change in the status quo of a country’s institutions, which is an important consideration for a ruling party whose primary priority (along with stability) is the maintenance of its own leadership of the country. India, for example, the world’s largest democracy, performs more poorly than China on Transparency International’s Corruption Perceptions Index, despite the fact that its politicians are directly answerable to their constituencies. India has also seen strong government continuity almost at the level of the Chinese Communist Party, with the Indian Congress Party having ruled the country for all but a dozen of the now 65 years since independence. For China the lesson is no doubt that freedom or democratisation may well not threaten the political rule of what is clearly recognized as one of the smartest set of politicians in the world at delivering economic performance. The converse is that not delivering freedom and partial democratisation may well threaten continuity of leadership since freedom and democratisation are essential ingredients in sustaining economic performance.

Over the long term, it is important to recognise that China today is in transition between the second and third phase of a longer development arc. Any managed transition introducing an increased level of personal, political and economic freedom will be only the first step of an on-going process, one that China’s leaders will almost certainly lose control of over the medium term. Evolutions have the tendency to turn into revolutions if the pressure for change is greater than the rate of change. Along with any opening also come individuals who are self-appointed news reporters, broadcasters, environmentalists, political analysts, critics and social agitators. The seeds for China’s leaders’ loss of control are in place already and the pressure will continue to build even if China initiates gradual reform today. Fundamentally though, increasing levels of freedom and openness are necessary for continued development. “History has shown that successful democratisation and wealth are positively correlated”To move forwards to the next level of development as is China’s stated goal, a necessary pre-condition is an open society that leverages the full network of people, at home and abroad, to solve complex problems and innovate. Without this societies are stuck in a phase of development. Even democratic and politically free societies can stumble over this block, as the lesson from Japan’s electronics industry shows. Japan led the world in a number of industries in what was touted as the model of top-down industrial strategy. This enabled Japan in scaling, exporting and achieving market leadership across a host of industries including consumer electronics in the 1980s and 1990s.The focus in consumer electronics was on process, technology, efficient design and generally in incremental innovation with occasional breakthroughs that won over the global customer. However, the inability to cross sector boundaries meant that the industry did not foster entrepreneurs to lead in the next generation of personal mobile communications, internet media and technologies, software and personal computing electronics that emerged in the past decades. The innovators in these areas created whole new unimagined multi-billion dollar industries and leap-frogged Japan Inc. Japan had not created the culture of entrepreneurship, cross-industry fertilisation of ideas and the trial and error approach to innovation that are key characteristics of post-industrial economies. The lesson from Japan shows that China’s path is a long one, and that government will may not be the only stumbling block it will need to overcome. Freedom is more than the vote and more than a bill or rights, it needs to be personal and cultural. Clearly, freedom also has high costs in terms of creating uncertainty and swings from boom to bust.

Regarding China’s current dilemma, history has shown that successful democratisation and wealth are positively correlated, with richer countries being more successful than poorer countries in managing the transition from autocratic to democratic societies. This is undoubtedly due to the interplay of a number of related factors, including the existence of an educated middle class, strong government institutions, well-enforced property rights, rule of law, and the liberal economic policies that enable growth and development. Looking at examples from the other economic success stories that had managed the transition to democracy implies that broadly, China has the wealth required to successfully democratise today should it wish to do so and one could argue that it is a reasonable basis of the underlying institutions mentioned above that enable democratic government.

In conclusion, given the confluence of economic necessity, the growing political demands from its citizens, the maturity of its economy and the availability of successful role models upon which to base its transition, China should seize the opportunity to begin effecting a well-managed and orderly transition to greater freedom. Recent history has demonstrated the spiralling human costs and loss of political credibility of maintaining unfree societies (for example Syria, Bahrain) and the speed at which unrest can topple previously stable governments (for example Tunisia, Egypt, Libya). Recent history has demonstrated the spiralling human costs and loss of political credibility of maintaining unfree societies” China today has the luxury of choice to give its people freedom, rather than having its people take it themselves – this is an opportunity it should not miss. Premier Wen Jiabao’s calls for political reform, democratisation and the paving of the way for a reassessment of the Tiananmen protests are all steps in the right direction. However, these have been tempered by a significant increase in recent media censorship, particularly around the dismissal of Politburo member Bo Xilai and the subsequent arrest of his wife under suspicion of corruption and involvement in the death of a British national. China is strategic and long term and one of the most effective of governors so we are hopeful that Premier Wen’s calls are harbingers of China’s leaders’ intentions to implement changes gradually, the costs of not doing so are too great.