China’s achievements over the past 30 years have been impressive. The changes that the country has enjoyed, and the resulting increases in prosperity, have no historical reference of similar magnitude.
Between 1990 and 2016, the number of people living under the poverty line of $1.90 per day fell from 750 million to 7.2 million (only 0.5% of the population). Today, 14 of the 100 largest companies in the world by market capitalisation, and 23 out of the 100 largest unicorns, are Chinese.
However, there is still a long way to go. This year China ranks 16 out of 64 economies in the IMD World Competitiveness Rankings, up four points from last year. Our rankings combine statistical data in areas of economic performance, government and business efficiency, and infrastructure (two-thirds) and survey data (one third) to evaluate the performance of these 64 economies across the globe.
China’s ranking often raises questions because it is not obvious why the second largest economy in the world cannot yet be considered very competitive. At our centre, we also rank Hong Kong and Taiwan. These economies with Chinese roots, but operating in different political and social environments, rank higher.
Indeed, this year Hong Kong is ranked seven and Taiwan eight. One success factor is their small size, which allows them to implement effective policies, find the required social consensus, and specialise in technology and human capital. Another reason they are in the top 10 is that both Hong Kong and Taiwan have exploited the capitalist model of free enterprise, private property and little intervention by the state in business. The Chinese model is quite different.
State-market relations in China
Indeed, the Chinese business ecosystem is unique, with a much more proactive intervention of the state in the economy, but with a promotion of entrepreneurship and competition that is not characteristic of a typical socialist state. This design is attributed to Deng Xiaoping’s modernisation strategy, but it is also the result of emergent decisions and changes implemented since the early 1980s when he allegedly declared: “To get rich is glorious”.
What China has achieved is a system in which the public sector is a relevant actor in the economy. The most striking aspect of the Chinese Third Way is its acceptance by society. In capitalist societies, the government is seen as providing support to businesses and passing regulation that promotes innovation and competition, at least in the most competitive ones, such as Switzerland and the US. However, in many free-market societies the government is seen as the enemy. For example, in our rankings we usually ask survey respondents to assess which (out of a list of 15) are the key attractiveness indicators of their economy. In the 2021 rankings, only 2.9% of Hong Kong respondents, and 7.3% of Taiwanese mention the “competency of the government”. By contrast, respondents in China rank this at 32.6%, the highest-chosen indicator being the dynamism of the economy (selected by 62% of survey respondents).
What China has achieved is a system in which the public sector is a relevant actor in the economy.
Adam Smith’s capitalist model rests on three pillars: perfect competition in which monopolies are viewed as bad; passive governments whose regulation provides guidelines only and whose main objective is to facilitate business; and shareholder value maximisation, in which social objectives are not a goal but simply a means. This is not the case with the ecosystem in China. Rather than allowing businesses to freely operate within the parameters of its regulations, the Chinese government, instead, grants monopoly power to companies within an industry. That way, the government dominates a number of industries—such as banking and technology—through state-owned enterprises. Only later on, once the industry is well-established, is competition allowed. By then, market dominance rests already in the hands of a few companies.
The state dominance is formal, as in the case of the banking system, or implicit, as the recent IPO of Alibaba shows. Very often the state is also the largest customer, so corporate interests come second to the policy objectives of the government.
In this peculiar economic model, there is a triangle between the state, companies and the public. The state provides businesses with monopoly power, license to operate, financial resources, and subsidies; businesses provide services to customers; and customers, finally, support the state. The strength of the connection between the government and businesses is, therefore, very strong in China, although the share of state-owned enterprises in industrial output has been dropping as the country has steadily allowed for more and more private enterprise.
State-directed capitalism is closely related to a quasi-monopoly market structure that focuses on social monopolies and that some advanced Western economies have been moving toward. In such a model, governments assume a greater economic role by intervening in business. This involvement creates social pressure on corporations and, as a consequence, the public, corporations and the government develop “shared value” objectives. In turn, companies expand their boundaries—thus maximising business sustainability and social welfare—and maintain their competitive position.
The banking example
A good illustration of such an ecosystem is the Chinese banking system. At the end of 2015, China was home to 12 joint-stock commercial banks, 133 city commercial banks, 5 private banks, 859 rural commercial banks, 71 rural cooperative banks and 1,373 rural credit cooperatives. The number and size of players hide the fact that, originally, the Chinese financial system was created as a state monopoly. Only recently, the rapid rise of small- and medium-sized banks has broken such monopoly of large state-owned banks under the planned economy.
State-directed capitalism is closely related to a quasi-monopoly market structure that focuses on social monopolies.
From China’s only bank (the People’s Bank of China), the state transformed the banking industry, as part of China’s reform and opening-up agenda, in the late 1970s. The four major specialised banks, known as the Big Four—Agricultural Bank of China (ABC), Bank of China (BOC), Construction Bank of China (CCB), and Industrial and Commercial Bank of China (ICBC)—were either spun off from the monolithic Central Bank or were newly incorporated. Until recently, these four banks operated as monopolies in their customer segments. And even today, they retain advantages with respect to other commercial banks (size, interest rate subsides and loss-ratio guarantees) that make full, Western-style competition in the industry still unthinkable.
An alternative model?
The Chinese model should be examined carefully by other countries: the traditional competitiveness model that we have used for decades has found a successful alternative. Traditionally, we have seen the private sector pulling (innovation, entrepreneurship, investment in technology and talent), with the public sector following (providing support through education and health systems, investment in infrastructure, passing of business-friendly regulation).
In Switzerland, the most competitive economy in this year’s rankings, the efficiency of the government is ranked higher than the efficiency of the private sector (number two and five respectively). In China, we see the opposite, with the government ranked 27 and the private sector 17. This is not what we would expect from a traditional socialist economy, but it may well be the model for many in the future.
Of course, there are problems in China, notably the deficient rule of law and significant corruption in the public sector. There are significant inequalities in income and access to education; lack of democracy hinders quality of life, pollution and environmental issues; furthermore, there is a lack of access to technology in remote areas.
But China’s rapid rise means that it is destined to sit among the top-10 most competitive economies in the years to come.
Arturo Bris is professor of finance at IMD. Since January 2014 he is also leading the world-renowned IMD World Competitiveness Center. Prior to joining IMD, Professor Bris was the Robert B & Candice J. Haas Associate Professor of Corporate Finance at the Yale School of Management. His research and consulting activities focus on the international aspects of financial regulation, and in particular on the effects of bankruptcy, short sales, insider trading and merger laws.