This is the fourth installment of an eight part series on the Patterson School’s Summer Reading List.

Yasheng Huang’s Capitalism with Chinese Characteristics amounts to a complete rethinking of the story of China’s post-Mao economic growth. Huang argues that the story of China’s post-Mao economic expansion told most often in the West (state guided investment, state support for FDI, carefully managed deregulation) is fundamentally wrong. According to Huang, the major shift to economic liberalization came in the early 1980s, in the immediate wake of Deng’s consolidation of power. The most important space for the development of entrepreneurial capitalism was rural China. Relaxation of regulations on individual businesses, combined with a surprisingly sophisticated and robust system of finance, allowed rural entrepreneurship to flourish. In turn, this helped produce very high rates of rural economic growth, which inevitably affected urban areas. Urban areas were strictly secondary to the boom, however. Huang presents a reasonably compelling degree of evidence to argue that Chinese GDP growth in the 1980s stemmed from rural productivity, and moreover that this productivity came from much more than a simple increase in agricultural yields.

Huang argues that earlier scholars have missed out on a significant portion of this explosion of rural entrepreneurship because they have misunderstood the private nature of most TVEs (town and village enterprises), and because some legal restrictions were misinterpreted. Huang argues that TVEs, for example, were overwhelmingly owned by private parties rather than the public sector in the 1980s. TVE refers to a location for a firm, rather than to its ownership status. Similarly, Huang argues that some legal restrictions on the size of firms were either never enforced or have been improperly understood by Westerners. For example, rural firms in the 1980s regularly exceeded seven employees without any state retribution. Key to the success of rural firms was the lifting of regulation, the availability of finance, and a state policy of “directional liberalism.” Huang uses directional liberalism to describe the idea of an economy that lacks many key features of liberal capitalism, but is nevertheless moving in that direction with sufficient speed to reassure investors that they’ll be able to keep their gains. Although the PRC in the early 1980s didn’t resemble a Friedman-esque capitalist wonderland (and lacked rule of law and democratic institutions to protect private property), entrepreneurs were sufficiently convinced by the shift in rhetoric between Mao and Deng that the future would be more, rather than less, economically open. This all changed after Tiananmen.

The second crucial part of Huang’s story is that the 1990s are as misunderstood as the 1980s. Rather than come from rural, domestic entrepreneurship, economic growth in the 1990s came from state investment in urban industry and heavy introduction of FDI (foreign direct investment). China’s economy was restructured to absorb these massive doses of FDI, which primarily benefited urban areas. Rural areas were heavily taxed by the state to support urban investment, and some regulations were re-instated. Without a central commitment to directional liberalism, the local state itself became predatory on rural enterprise. This change came about through the conjunction of ideological conflict and factional politics. Tiananmen resulted in the ouster of Zhao Ziyang, the most reliably pro-reform member of the inner circle of the CCP. Other members of Zhao’s faction were discredited. The older, more rural oriented elite of the CCP had been dying off in any case, and post-Tiananmen were replaced in large part by officials from Shanghai. Shanghai had remained relatively quiet during the Beijing disturbances, which impressed a CCP inner circle shaken by the demonstrations. Jiang Zemin and Zhu Rongji would become the primary elite drivers of PRC economic policy, and steered the PRC in an urban-oriented direction. The big, glittering corporations that emerged during this period legally resided, for the most part, in Hong Kong, where they could rely on both finance and legal protection.

This had two primary effects. In rural areas, growth stagnated, private industry withered, and the social safety net (frayed during the 1980s) in many areas collapsed. Urban areas, particularly Shanghai, saw spectacular growth of a sort. Unfortunately, this growth was not evenly shared, and did not benefit small Chinese entrepreneurs. Shanghai became a “world class city,” but with a hollow core. Huang argues that Shanghai is a Potemkin city; it has been built on a combination of FDI and money looted from rural China. Meanwhile, China’s gini coefficient (measure of inequality) skyrocketed, rural health and literacy declined, and local officials declared open season on rural entrepreneurs. Western economists and analysts missed out on this because of the apparent glittering reality of Shanghai (which, Huang notes, severely underperforms other urban centers on many key metrics), and because of the lack of good statistical evidence on the situation in rural China.

Huang argues that the situation changed again after Hu Jintao replaced Jiang Zemin at the top of the CCP. Without the “Shanghai clique” in power, state investment was directed in a more fair and efficient manner. The state again turned “directionally liberal”, supporting some degree of rural and urban entrepreneurship. Some key indicators on Chinese rural productivity have begun to turn around, although the loss of dip in rural health and literacy will have long term effects. Urban areas also remain productive, although Shanghai lags in many indicators of private industry and innovation. Huang is not given to extreme pessimism about the future of the Chinese economy, although he does believe that India is more likely than China to maintain high growth. India has a robust private sector that does not depend on FDI, and has better developed legal institutions, according to Huang.

This story is not radically different than that presented by Minxin Pei (whom Huang cites), although there are a couple of key distinctions. First, Huang rejects the idea that China adopted a “gradualist” approach to economic change. The reforms of the early 1980s represented a radical and consequential shift in CCP economic policy, a shift that was altered (although not precisely reversed) following Tiananmen. Second, Huang is less certain that the PRC will inevitably become more predatory on the Chinese economy, and that economic stagnation will thus invariably result. Huang takes “directional liberalism” seriously, and it’s possible for the CCP to pursue liberal economic reforms, at least for a period. Moreover, the lower levels of the party and state take cues (if not necessarily orders) from central authority, meaning that predation will be limited given a commitment to economic liberalism in Beijing.

Huang’s argument allows for indefinite continued high growth in China, although this growth is dependent on the quality of central leadership. I wonder, however, whether the Jiang period exposed severe, long term disjunction between the political and economic system. If such an interregnum happened once, it could happen again; Chinese entrepreneurs would be well advised to take care, even if directional liberalism currently prevails. Moreover, increasing political openness doesn’t necessarily require a continued commitment to directional economic liberalism.

Huang hints at, but doesn’t fully develop, an argument that center-left economists have been insufficiently wary of the traditional story of state-led Chinese capitalist development. There may be some truth to this, although I suspect that right wing economists have been too accepting of the idea that FDI was the primary driver in Chinese economic growth. Huang does demonstrate sufficiently that the model of the early 1980s produced less inequality, more economic growth, and altogether greater human welfare than the model adopted in the 1990s.

Capitalism with Chinese Characteristics is valuable both for China specialists and for those more generally interested in economic development. The writing isn’t always crisp, but he presents a truckload of compelling data in support of his thesis. He’s also forthright about the holes in his evidence, which is appropriate given the role that absence of evidence plays in his account.