You are on page 1of 9

China’s Social Capitalism

Benjamin Daniels

The Cold War has often been characterized as a conflict between diametrically opposed,
irreconcilable social systems. The popular manifestation of this outlook assumed that the
socialist economic structure was ideologically inseparable from the communist political system,
and that the capitalist system was similarly paired to the practice of democracy. 1 When the USSR
failed, its two systems – socialism and communism – were thought to have been thoroughly
discredited. However, the binary description gives only an incomplete perspective on the
economic problems that were relevant to the conflict between the Western system and the Soviet
system. The pure Communist approach attempted in the USSR proved to be an unsustainable
construct, but it provided an experiential prototype for the practice of non-capitalist methods
since the Soviet collapse. The most visible and well-researched such system has been that of
“market socialism,” which was attempted in several ex-Soviet Eastern European economies. It
has been noted to combine the worst elements of capitalism and socialism, begetting wide
inequalities while simultaneously providing poor incentives for economic actors. 2 The same
sources have been careful to note that the ostensibly similar system adopted by the People‟s
Republic of China has somehow produced unqualified success.3 A more careful look at the
Chinese approach, however, suggests that it is a different system altogether. Rather than pursuing
“market socialism,” China has adopted a model which provides effective incentives to individual
actors while maintaining a collective power and incentive to tackle the failures of a pure market
economy – what can be called a “social capitalism.”

The historically powerful central government of China has created a drastically different
approach to economic institutions than Western countries have historically taken. The
government has put its weight behind a system of explicitly enumerated institutions, rather than
supporting a broad set of implicit rights and freedoms. Chinese economic institutions have

1
S. M. Amadae, Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice
Liberalism (2003).
2
Joseph Stiglitz, Whither Socialism? (1994) 91.
3
Stiglitz 175-6.
1
emerged via careful statutory development as the state transitions from a totalitarian model to
one which guarantees specific freedoms for its citizens. The trend has allowed more liberal and
Western-compatible institutional structures to develop while maintaining a high level of central
control over the development of the broader Chinese economy. The policy of “groping for stones
to cross the river”4 is suggestive of both the speed and the control with which China‟s
government expects to pursue this process. While the liberalization and integration of
institutional structures has been gradual, it has been deliberate, as exemplified by the
development of specific institutions such as contract enforceability and bankruptcy. The outcome
of the process has been a set of constantly updated institutions: China‟s bankruptcy law, for
example, was introduced in 1986 and revised in 2007;5 its labor contract law was implemented in
1994 and updated for 2008.6 The government has done an excellent job keeping pace with
economic pressures as it balances “[wanting] to stay in power and an international community
that wants access to that mythical market.”7 For example, increased scrutiny over labor
conditions by Western consumers has led to the creation of laws that increase the legal power of
workers against employees; humanitarian concerns have seen the filing of suits against the
government for the 1989 Tiananmen Square massacre.8 The government is actively creating
institutions, rights, and freedoms in response to the perceived need for them. Such a tradition of
positive rights (freedoms-to) rather than Western negative rights (freedoms-from) approaches the
question of economic institutions from a distinctively socialist direction.

The government‟s tight control over the development of these institutions has been a
critical factor in a stable development process for China. The characteristic gradualism of the
transformation has allowed court systems and other government institutions to evolve gradually
with the demands of legal enforcement. This approach comes in marked contrast to the “shock

4
Ran Tao and Zhigang Xu, “Groping for Stones to Cross the River versus Coordinated Policy Reforms:
The Case of Two Reforms in China,” Journal of Policy Reform (Sep 2006).
5
Dan Harris and Travis Hodgkins, “China's New Bankruptcy Law -- First Report From The Ground,”
China Law Blog (12 Jun 2007).
6
“Labor Contract Law of the People‟s Republic of China,” Beijing Review (4 Oct 2007).
7
Doug Guthrie, China and Globalization (2009) 216.
8
Guthrie 66.
2
therapy”9 reforms that were attempted in many of the former Soviet states; the rapid transition
approach promoted by the economic orthodoxy of the time was founded in the Cold War
ideological conflict and sought total institutional reform, considering the socialist political
structure incompatible with the development of a liberal economic regime. China, however, has
utilized its socialist tradition to ease the transition phase. It has gradually unraveled Mao‟s
totalitarianism without throwing the economy into a period of disorganization.10 In doing so,
however, China views the “market as the servant … not the master”11 of its economic
development process, and the manner by which it has implemented its institutional reforms
shows a serious policy of refusing to let market forces overcome social goals. This careful
execution of transition has been evident in the measured pace of the legal changes as well as by
the manner in which they have been instituted. As noted earlier, the socialist influence on the
mode of government – leading to creation of institutions by fiat rather than the presupposition of
their existence – provided a legitimacy to them that stems from their immediate need. However,
it also lent an extra level of stability to them. In particular, courts are limited to settling legal
disputes in light of the law rather than having the power to redefine existing rights and
institutions in respect of implicit higher principles. Reforms are inherently more credible under
such a rule of law, especially since the government has proved willing to continue driving reform
agendas and successively updating its catalogue of enumerated protections as social and
economic demands for legal improvement continue.

Property rights have been constituted in a nonstandard fashion by way of this gradual
process. The transition from total state ownership to a market-oriented structure required a new
allocation of property rights so as to provide appropriate incentives to resource managers. The
socialist aspect of the Chinese development path, however, has entailed a divergence from the
Western understanding of property as a binary term: either something is owned by an individual
or it is not. China has instead developed a property-rights regime which traditional analyses
viewed as “ill-defined”12 due to its unusual mix of state ownership and private control. Without

9
Peter Nolan, China’s Rise, Russia’s Fall (1995) 58.
10
Peter Nolan, China at the Crossroads (2004) 27.
11
Nolan (2004) 175.
12
Stiglitz 176.
3
the Western binary understanding of property, critical tools for examining those institutions, such
as Coase‟s theories, could not be applied. More recent examinations have adapted to the Chinese
system; they have considered property not as a singular institution, but as a “„bundle of rights,‟
where questions of managerial control, the ability to extract revenue, and the ability to transfer
ownership must all be addressed.”13 Within that framework, questions of property in Chinese
society are more easily understood with traditional economic analyses. Managerial control, along
with marginal revenue extraction, has been devolved to local governments and managers
throughout China‟s industries. The incentives of managers and local administrators for
increasing profitability and productivity have been improved at the enterprises they manage.14
The same version of partial property rights has been applied at the margin for domestic
agricultural production; in particular, once households have supplied the specified quota of
output to the government, the remainder can be sold at local market prices.15 Both of these
changes move Chinese economics toward a system that replicates the ideal marginal incentives
of a privatized regime without changing the “ownership” of the assets. The adaptation is “the
gradual receding of the state from control over the economy, a process that brought about a shift
in economic control without privatization.”16 That balance is the defining characteristic of
China‟s social capitalism. It has recognized that liberal markets and complementary marginal
incentives can be developed within an economy without reassigning the full plethora of property
rights. The regime privatizes control over flows rather than stocks of commodities, allowing
market pricing to occur in such a way that determines socially beneficial exchanges without
instigating disputes over resource distribution.

China‟s system of social capitalism has maintained the institution of state ownership as a
tool to address the market failures of a laissez-faire system. A rapid move to a Western model of
property rights and the ensuing privatization of large swaths of industry would have pushed
China‟s economy into a period of “primitive capitalist accumulation”17 such as those that were

13
Guthrie 47.
14
Nolan (1995) 202.
15
Guthrie 42.
16
Guthrie 38.
17
Nolan (2004) 63.
4
frequently experienced during the early stages of free-market economic development, especially
in countries which adopted the shock-therapy transition model. The widespread looting of assets
that occurs throughout such an “Age of Plunder”18 would have deteriorated China‟s capital base
and left it in a squalid, vulnerable position similar to that of post-Soviet Russia. Instead, the
Chinese state has retained control of an enormous proportion of the country‟s capital assets. State
ownership of corporations is so pervasive that while “state-owned firms officially only account
for 2 percent of firms … shareholding corporations … are firms in which the state controls up to
70 percent of the shares.”19 The refusal of the government to privatize the majority of capital has
prevented an asset grab by managers at the administrative level. Simultaneously, the sale of
significant portions of corporate stock to institutional and private investors has outsourced
valuation and scrutiny responsibilities to the international investors who have taken stakes in the
enterprises. As it did in the local agricultural markets throughout the 1980s, the state has layered
a liberal market economy on top of a publicly-owned institution. The partial privatization creates
appropriate incentives for free exchange and demands efficiency gains from all enterprises, even
government-owned ones, because of the impacts on share price and market capitalization that
would result from mismanagement. The dual-track system of marginal privatization is utilized in
this context to create a robust market without eroding the core tenet of socialist public
ownership. This capture of market incentives and distributed decision making is combined with
the strong central government, high level of public ownership, and social objectives of Chinese
central management. The blend cuts to the core of the social capitalist model as it attempts to
reap the benefits of both structural models without sacrificing core social or institutional tenets.
Instead, the government has taken a vested financial interest in the country‟s economic
performance and pursued a capital structure for business that incorporates a “third way” tradition
of balancing economic interest with socially-conscious governance.20

The Communist Party of China has effectively bound its legitimacy to the
accomplishment of economic goals, creating a strong incentive to pursue socially optimal

18
Ibid.
19
Guthrie 129.
20
Nolan (2004) 174.
5
policies. The collective ownership represented by large government stakes in corporations
provides a strong incentive to the government to manage policy in a way that maximizes the total
value of Chinese enterprises. This is particularly useful when questions of industrial or social
policy questions demand cooperative outcomes. For example, China‟s energy needs, which have
in the past been met only at high environmental cost, are now being approached by the
government in a manner that reflects the need for sustainable, independent energy production by
Chinese firms. The long-term, government-directed program is coordinated by the newly-formed
National Energy Commission to provide an efficient, socially-minded utilization of resources.21
The program contrasts starkly with stalled efforts in the United States to promote renewable
energy development, where a laissez-faire mindset has prevented the federal government from
coordinating the collective action needed to drive large-scale change. For China, the collective
incentives provided by the government‟s vested interest in economic performance have created a
remarkably robust system. During the Asian financial crisis, China‟s government discovered that
its banking system had amassed an inordinate volume of nonperforming loans. In 1997, “the
World Bank said the net value of the banking system was already negative.” 22 The government
was able to mitigate the crisis, however, by pursuing a policy with a positive social outcome:
“„cutting the trees to save the forest‟ (i.e. to make GITIC go through bankruptcy proceedings in
order to save the rest of the financial system) … provided a breathing space for the central
government to attempt to undertake deep structural reform in the financial system.” 23 Those
reforms appear to have been successfully executed since that time. In 2002 Moodys commented,
“China‟s banks walk on a tightrope,”24 but in the wake of the global financial crisis of 2008,
China‟s banking system and broader economy stood strong, beating expectations to grow by
8.7% in 2009.25

The need for such sustained growth to ensure social stability has forced China‟s
government to assimilate into the world economy. Party officials recognized the need to reduce

21
James Murray, “China to unveil multibillion-dollar renewable energy plan,” BusinessGreen.com (5 Mar
2010).
22
Philippe Riès, Asian Storm: The Economic Crisis Examined, trans. Peter Starr (1998) 175.
23
Nolan (2004) 57.
24
Ibid.
25
Leo Lewis, “China‟s GDP soars as it shrugs off global crisis,” The Times (22 Jan 2010).
6
barriers to foreign markets so that China could exploit its comparative advantages in unskilled
labor and reverse the trade deficit which it had run until the early 1990s. 26 Additionally, capital
markets needed to be synchronized with Western institutions in order to attract outside funds to
Chinese investment opportunities. The necessity for integration and openness sparked a series of
reforms throughout the 1980s and 1990s, including recognition of and equal legal status for
foreign firms, joint ventures and foreign direct investments.27 Similarly, the creation of special
economic zones for export-led growth encouraged foreign investment even as it spurred
domestic development: “of the top forty exporters from China, ten are U.S. companies.”28 The
technology transfer and capital inflow had immense effects on the structure of government and
business. To continue reaping the benefits of the investments, laws and corporate practices have
developed “institutional accommodations that support rational-legal accountability and the rule
of law within the firm.”29 In essence, Chinese economic actors had their hands tied by the liberal
expectations of massive multinationals. To seek the wealth of the world, China was forced to
play by its rules; it had to be a good global citizen and domestic master in order to continue
receiving the rewards of economic success. China‟s desire to continue to hold that place in the
world‟s view is reflected clearly, for example, in its efforts to exceed its WTO commitments.
Maintaining its attractiveness as an investment destination is critical to Chinese efforts to keep
the economic tide rising, for “if the „bubble‟ of foreign direct investment in China were to burst,
it would have serious consequences for the whole growth path and for China‟s stability.”30 In
order to keep drawing foreign funds and driving domestic development, China will have to
continue converging its corporate institutions to world norms. These pressures are almost certain
to have developmental effects on Chinese society; increasing Western scrutiny over labor
conditions and workers‟ rights have already led to internal labor reforms as well as a rise in the

26
C. Fred Bergsten, Charles Freeman, Nicholas R. Lardy, and Derek J. Mitchell, China’s Rise: Challenges
and Opportunities (2008) 109.
27
Guthrie 118.
28
Guthrie 116.
29
Guthrie 136.
30
Nolan (2004) 24.
7
volume of successful litigation brought by workers against corporations.31 Development in that
direction only seems set to continue.

The mechanisms of privatization and institutional development have been utilized by the
Chinese Communist Party to provide a foundation for sustained growth in the country. The
national leadership, however, avoided the errors of the post-Soviet economies, which were
generally subjected to „big-bang‟ reforms by Western-trained economists following the collapse
of the Soviet system. In China, by contrast, fundamental economic institutions have been steadily
created since the death of Chairman Mao. Economic freedoms and market institutions now exist
where once there were none, yet the government has maintained tight control over the process of
liberalization. It has integrated Western institutions and standards only where they benefit the
economy as a whole, and held onto socialist ideas in key areas to institute a “social capitalist”
model. Rather than create a fully privatized, free-market system, the Chinese government has
been able to develop a dual-track system of marginal privatization and marketization. This
regime, which separated property rights into the distinct institutions of control and ownership,
created high levels of social cohesion, appropriate private incentives, and a large government
stake in the performance of the Chinese economy. Thanks to those characteristics, the
government‟s vested interests have driven it to solve coordination problems and pursue high-
benefit policies and reforms throughout the country. At the same time, the reforms have enabled
Chinese managers and entrepreneurs to create increasingly valuable corporations and
partnerships with existing multinational firms. The result has been an extraordinarily successful
development process that defies traditional classification, yet one that solves key distributional
and institutional challenges facing post-Communist and primitive-capitalist countries.

31
Guthrie 210, 215.
8
Works Cited
“Labor Contract Law of the People‟s Republic of China.” Beijing Review. 4 Oct 2007.
Amadae, S. M. Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice
Liberalism. 2003.
Bergsten, C. Fred, Charles Freeman, Nicholas R. Lardy, and Derek J. Mitchell. China’s Rise:
Challenges and Opportunities. 2008.
Guthrie, Doug. China and Globalization. 2009.
Harris, Dan and Travis Hodgkins. “China's New Bankruptcy Law -- First Report From The
Ground.” China Law Blog. 12 Jun 2007.
Lewis, Leo. “China‟s GDP soars as it shrugs off global crisis.” The Times. 22 Jan 2010.
Murray, James. “China to unveil multibillion-dollar renewable energy plan.”
BusinessGreen.com. 5 Mar 2010.
Nolan, Peter. China at the Crossroads. 2004.
Nolan, Peter. China’s Rise, Russia’s Fall. 1995.
Riès, Philippe. Asian Storm: The Economic Crisis Examined. Trans. Peter Starr. 1998.
Stiglitz, Joseph. Whither Socialism? 1994.
Tao, Ran and Zhigang Xu. “Groping for Stones to Cross the River versus Coordinated Policy
Reforms: The Case of Two Reforms in China.” Journal of Policy Reform. Sep 2006.