To steer growth, trust in free market

One of China's top economic advisers channels wisdom of long-dead Scot

As a visiting professor in Beijing, I spent an evening talking about China's economic development with a group of futures traders at a short executive education course. One thing we all agreed on was that a shrinking workforce and an unbalanced economy are serious obstacles to the chances of China overcoming the middle-income trap that has caught so many promising emerging countries.

How is it possible for China to create enough value to raise the living standards of its huge population, not perhaps to US standards, but at least to an average annual income of $20,000 (17,810 euros), counted in today's money?

The answer can only be found in the thoughts of a Scotsman who died more than 200 years ago. Adam Smith's greatness was that he showed us how society, if left to itself and properly regulated via the rule of law, will find the most efficient and productive way to continuously create wealth for its members. The secret lies in the division of labor, in specialization, in competition, and in the application of new processes and technologies by individuals trading with each other who wish only to benefit themselves and their families.

In Smith's analysis, "enlightened self-interest" produces prosperity. He commented famously that a country with a free, competitive market, which trades widely with other countries, does not need a stock of gold, because it can create the wealth to acquire gold, or anything else it requires.

The truth of Smith's analysis can easily be seen by comparing relatively poor countries that are rich in resources - for example, Zimbabwe and Russia - with countries such as Switzerland and Singapore that are rich but lack natural resources. On their own, natural resources, which deplete and run out, and can be grabbed by powerful elites, do not make a country wealthy. National wealth depends on a competitive, market-driven system, operating within a clear and fair framework of rules and regulations that encourage individuals to trade with each other, with the sole purpose not of trying to help each other, but of improving their own situation.

After many years of trial, error and experimentation, and faced by an advancing reality of falling productivity and a declining workforce, the Chinese government, in the famous decision in November 2013 issued at the Third Plenum of the 18th Congress of the Communist Party of China, has given the market the "decisive" economic role and called for Chinese society to be governed by the rule of law. This appears to be a step away from the Chinese model of "state capitalism", made famous by China's economic resilience after the crash of 2008.

Nicholas Lardy, of the Washington-based Brookings Institution, is one of the world's leading foreign analysts of the Chinese economy. His 2014 book, Markets over Mao, demonstrates that China's small and medium-sized enterprises, some too small to be included in official statistics, have driven the growth in Chinese employment and GDP since the 1990s.

But for many inside China, Lardy's thesis is not convincing. Most bureaucrats and policymakers in Beijing believe the state-owned enterprise is more important to China than the private entrepreneur. For them, Adam Smith came from a country 6,000 miles away, died 225 years ago, and is not relevant to China's situation. However, one of China's most important economic thinkers is a disciple of Smith, and a firm believer in the free market. His ideas have become well-known in China and underpin the Chinese government's new economic direction. His name is Zhang Weiying.

Zhang returned to China from England in 1994 after studying at the University of Oxford with James Mirrlees, an economist who won the Nobel Prize in economics in 1996. He joined the Center for Economic Research established by Justin Yifu Lin at Peking University, and in 1998 was invited by Li Yining, then dean of the Guanghua School of Management, to become deputy dean. Zhang stayed at Guanghua until 2010, becoming dean in 2006 and leading the school to its present high position among the business schools of Asia. In 2011, it was the first Chinese business school to appear in the global business school rankings published each year by London's Financial Times.

When Zhang stepped down as dean he returned to research. In 2012, his book, The Logic of the Market, a collection of his writings about the free market, was published in Beijing. The English edition appeared last year.

Edmund Phelps and Thomas Sargent, both Nobel Prize winners in economics, reviewed Zhang's work. "This remarkable book testifies to the power of economic analysis to isolate basic economic forces that transcend countries and political regimes," Sargent says. Phelps adds: "I advise all students of economic development to read this important book."

The Logic of the Market shows how much Zhang was influenced by Adam Smith in his early thinking as an undergraduate student in economics at Northwestern University in Xi'an. Zhang writes: "Reading The Wealth of Nations by Adam Smith in 1982 started to build my belief in the free market for the first time."

He went on to write two papers in 1983 and 1984, one about the dual-track pricing system later adopted by then premier Zhao Ziyang in the first stage of China's economic reform. The introduction of market forces into Chinese agricultural prices in the 1980s showed how Smith's "invisible hand" could raise output and increase productivity.

As Zhang's thinking developed, he became more convinced that only by introducing market forces could China meet its growth challenges. He writes: "Under the planned economy, we did not pursue happiness by making others happy. Instead, we pursued happiness by making others unhappy. Our energies were spent fighting for power and gain. We were competing ... but we were not creating value. Under the market economy, rights are defined by property. With individual property, as long as people have money, they can also enjoy the majority of services that only people with power could enjoy before. ... The country's future depends on what we believe in and what we do not believe in. From the 1950s to 30 years ago, we believed in the planned economy. The result was a tremendous disaster. ... Only if we move toward the logic of the market will China's future be bright."

As China moves onto the next stage of its development, its senior policymakers and officials need clear thoughts about the economic models they should be using. In the fierce debates that take place between different schools of thought, it's fortunate for them, and for China, that they have a Chinese professor, Zhang, to whom they can turn for inspiration.

That's why the market system is set to play the decisive role in determining a good future for China's economy.

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.