After the collapse of the Soviet Union, many western and Chinese analysts came to the conclusion that China was spared the same fate in 1989 because it did not liberalise its political system. This is a flawed reading of history. The reason why China did not collapse in 1989 has very little to do with lack of political reforms (China experimented with meaningful political reforms in the 1980s). The real reason China did not collapse was that its rural population was reasonably content.
As usual, the most astute observation of Chinese politics came from Deng Xiaoping. At the height of the Tiananmen turmoil, Deng reportedly made the following remarks to other Chinese leaders: “The economy is still the base; if we didn’t have that economic base, the farmers would have risen in rebellion after only 10 days of student protests – never mind a whole month.”
This is a lesson worth remembering as China is confronted with some of the most difficult economic circumstances during this global downturn. Millions of export manufacturing jobs have been lost and a multitude of rural migrants are either unemployed or are being forced to take a substantial pay cut. The key to getting China out of its export-dependent growth is to ensure that the rural sector repeats its miracle of the 1980s, when the personal income of the rural population grew by around 9% every year. In contrast, the growth slowed down to less than 4% in the 1990s and it was about 5%-6% immediately before the global financial crisis.
China’s rural miracle is the reason why the Chinese Communist party is still in power today. It was the result of substantial policy liberalisation in the countryside during the 1980s. The government began to direct financial resources to the burgeoning private sector and to nascent rural entrepreneurship. The rural financial system also became flexible, permitting non-state providers of capital to compete with state-owned financial institutions in drawing deposits and making loans. The government systematically dismantled many regulatory barriers that had prevented rural traders from buying and selling in urban areas.
Never covered by the cradle-to-grave socialist welfare system, rural entrepreneurs quickly seized the opportunities created by reforms. They took advantage of the high urban income and low efficiency of urban state-owned enterprises. The fastest-growing component of rural income in the 1980s was the business income – the profits made by rural households in operating small-scale businesses.
All of that changed in the 1990s when the country embarked upon a massive, urban-centric investment programme that succeeded in remaking China’s landscape – new airports and skyscrapers seemingly emerging overnight – but failed to deliver on rural income growth. The personal income growth of China’s rural population slowed to less than half of its level in the 1980s. My examination of detailed household survey data also reveals that rural finance collapsed in the 1990s. In the 1980s, about 30% of rural households surveyed were able to access some form of credit capital; in the 1990s, the figure went down to 10%. During this time, rural households also had to pay ever higher taxes, school fees and medical service charges.
The majority of the Chinese population slowed down so much in its income growth that the country would have to cut down on its personal consumption. One of the most remarkable developments in the Chinese economy in the last 20 years has been a massive shrinking of household consumption relative to GDP. In 2007, household consumption as a ratio to GDP stood at a paltry 33%, a decline of more than 10% from the early 1990s. No other major economies come remotely close to this low level of consumption. India’s consumption is 20 percentage points higher; Brazil, 25 percentage points higher. And there is nothing east Asian about China’s low consumption level. Korea and Japan, two other quintessentially east Asian countries, consume more than 55% of their GDP.
Many analysts have urged China to cut down on its exports as a way of correcting the current global imbalances. But the right way to frame the issue is not to ask why China exports so much, but why it consumes so little. To get Chinese consumption to drive GDP growth, it is critical to recreate the business and finance environments that rural China enjoyed in the 1980s.
The good news is that the current Chinese leadership has a far keener recognition of China’s rural issue than its predecessors. Before the economic crisis, they made agricultural reforms and the welfare of the rural population a priority on the policy agenda. A number of their policy initiatives have been very productive, such as reducing rural taxation and school fees. But they need to do more and follow the example of the 1980s, when the country embarked upon not just economic liberalisation but political reforms as well.
China should adopt bold institutional reforms such as financial support for small and medium businesses, abolishing the hukou regulations (a system that restricted rural migrants from accessing urban public services and from acquiring full urban residency), granting full trading rights of land to rural residents, and above all improving village governance by strengthening village elections – another product of the 1980s.
During a crisis, the worst thing a government can do is to waste the opportunity it presents. The global downturn throws up many thorny policy challenges, but it is also a chance for China to move on to a firmer economic footing and to create a more sustainable growth trajectory.