Chinese poliitical reform

[Marvin Gandall <marvgandall@xxxxxxxxxxxx>]

Below, an interesting effort to illustrate how political reform is driven by
economic necessity, in this case corresponding to China's need to make the
transition from an industrial to a service economy.

Zhiwu Chen, who teaches at Yale's School of Management, argues that China
has so far not much had the economic requirement for an independent media or
other liberal democratic institutions because it is primarily an industrial
economy, where goods are "tangible" and more easily evaluated. Buyers have
relatively less need for information than they do in service economies where
products are "intangible" and their perfomance characteristics less
apparent.

But Chinese manufacturing has peaked, the writer claims, and future growth
will have to come from services. At this level of development, state control
of the internet and other media, the legal system, and large corporations
are fetters depriving the market of the independent information and legal
safeguards it needs for secure and efficient decision-making - especially
where it counts most, in financial services - so China's economic progress
will inevitably require that these constraints be lifted.

Politics does largely follow economics, but the appearance of these
institutions preceding and during the industrialization phase of Western
capitalism would seem to weaken Zhiwu's thesis that these reforms are
primarily a response to what Stiglitz and others have described as
"information disadvantages" in modern economies.

MG
--------------------------
A free press could help China's economy
By Zhiwu Chen
Financial Times
September 20 2005

China has recently stepped up efforts to control the press and cyberspace.
What does this mean for China's economy, and is press freedom really
relevant at a time of surging economic growth? For centuries, press freedom
has been viewed as a fundamental political institution, providing checks and
balances on authorities. But the media's role in facilitating economic
development is often overlooked.

China's growth has been impressive in many ways. Since reforms began in
1978, gross domestic product has grown an average 9 per cent a year, raising
per-capita GDP from $338 to about $5,000 in 2003. While the global economy
has slowed recently, China's has not only maintained its momentum but
spurred growth in many countries. China is not known for having
market-friendly institutions and yet its growth challenges the conventional
view that "institutions matter for development". What is going on?

The answer lies in the industrial structure. The main drivers of China's
growth have been export-oriented manufacturing and construction. The economy
depends heavily on the industrial sector. China's service sector, meanwhile,
is one of the least developed in the world, comprising only 33.5 per cent of
GDP in 2004 (compared with a service sector share of 79.4 per cent in
the US). This structure has enabled China to grow even without a free press
or reliable institutions.

Market development in manufactured goods is much less demanding than
in ­services, especially financial services. The physical tangibility of a
product leaves ­little room for cheating, giving such a market a natural
informational advantage. In contrast, the intangible nature of "services"
presents the buyer with severe informational disadvantage. In this case,
both legal institutions and free media are critical.

Markets in tangible goods therefore depend much less on legal and
informational institutions than markets in intangible services. Countries
with undesirable institutions can develop only by focusing on "hard"
industries, whereas countries with a free press and reliable institutions
can focus on industry or the service sector, whichever offers higher
value-added. Indeed, if we divide 106 countries into three groups according
to their 1990 press freedom ratings by Freedom House, the average
service-sector share in 2002 is 62.4 per cent for free-press countries, 57.1
per cent for countries in the middle and 48.5 per cent for countries that
censor their media. Thus, the freer the press, the better developed a
country's service sector. Press freedom facilitates service ­development
by reducing information asymmetries among transacting parties, bringing
confidence to the marketplace. Unbiased information enhances trust, which is
fundamental to the deepening of a service market.

China's growth story does not reject the "institutions matter" thesis. With
its vast, cheap labour force, China has been able to take advantage of
manufacturing's low dependence on institutions and grow without adopting
political reforms. However, this "hardware" approach is already being
challenged.

First, being the "world's factory" has taken its toll on China's
environment.

Second, China faces tough hurdles to further expanding its world market
share in manufactured goods. Finally, manufacturing can no longer create new
jobs. While manufacturing output has grown annually, manufacturing
employment peaked at 98m jobs in 1995 and declined to 83m jobs by 2002. With
200m jobless peasants in China, manufacturing cannot solve the problem.

China must develop its service sector for job creation. With 1.3bn people to
­service, this sector offers the greatest potential. But, it also
requires reliable law enforcement, judicial independence and freedom of the
press. Institutional reform is clearly the way to go. China has resisted
political reforms so far. But, in a largely state-run economy where
regulations are intrusive, it is difficult to separate business from
politics. For example, with the governors of commercial banks being
minister-rank political appointees, investigative reporting on their conduct
is often subject to political censorship.

Corporate governance has received much attention in China. But, again, with
most of the 1,400 public corporations majority-owned by the state, top
management is often government-appointed. If journalists dare to report on
these corporations in a negative light, they can jeopardise their careers.
Censorship limits the supply of useful information and distorts the
information available in the marketplace, thereby hindering the development
of markets - especially financial markets.

Extensive road, rail and air networks have truly integrated China's regions
into one national market. Like goods and services, financial products
are sold beyond geographical boundaries. In this environment, no government
can employ enough regulators to monitor and correct wrongdoings in the
marketplace. Neither can the government do enough to provide sufficient
information for the market.

A free press can not only provide independent information, but also act as a
corrective mechanism for the economy in a way that the government cannot.
Thus, media freedom is not only politically necessary, but also good for
growth and job creation.

The writer is professor of finance at Yale School of Management