Deng Xiaoping’s economic playbook has been ripped up

Had Deng Xiaoping not sought and received advice from Tokyo and Singapore in his creation of “socialism with Japanese and Singaporean characteristics,” China’s economic miracle would have been less miraculous. 

Its current economic woes stem largely from President Xi Jinping’s abandonment of this paradigm.

When Mao Zedong died in 1976, China was the second poorest among 140 countries. Deng proclaimed a remedy of “reform and opening up” to foreign countries, drawing from previous Asian success stories.

During a 1978 trip to Japan, he met with business leaders, toured a Nissan auto plant, and saw China’s future. “We are a backward country, and we need to learn from Japan,” he told a media conference in Tokyo. 

His first official foreign economic advisor was Saburo Okita, one of the legendary architects of Japan’s economic miracle. Over the years, 22,000 advisors from Singapore came to China.

Command economy

Instead of Mao’s command economy dominated by state-owned enterprises or SOEs, Beijing adopted a Japan-style industrial policy. 

Deng combined various governmental measures to direct resources to modern industry, leveraging the efficiency of private firms.

To avoid the pitfalls associated with economies favoring a single ‘national champion’ across assorted industries, it became imperative for private companies to engage in healthy competition. 

By 2018, SOEs dwindled to 12% of urban employment and exports, and one-third of business investment. SOEs never could have created the economic miracle. Nearly half of them regularly run losses, causing the economy to shrink every time they make a product. 

Even profitable SOEs create less growth than private companies for every yuan invested.

In a reversal of that record, Xi is resurrecting SOE dominance. In 2012, before he came to power, only 32% of bank loans went to SOEs. 

By 2016, they received 83%, but these loans took a while to translate into a stronger presence in investment and employment. This policy reversal stemmed from the Chinese Communist Party’s concerns that private companies could become a separate focus of power. 

In addition, Xi has compelled many private firms to accept interference from Party branches in their management decisions, resulting in declining efficiency, as measured by return on assets.

Equally indispensable to growth are the foreign companies that transfer technology and drive exports. 

Strategic solution

As in Japan, exports facilitated industrialization because, when Deng began, China’s people were still too poor to buy modern factory goods and could not yet produce them in a highly competitive global market.

Singapore proposed to Beijing its strategic solution by bringing foreign companies to China to make and export products. By 2000, according to the International Monetary Fund, foreign multinationals produced half of China’s exports, especially high-tech items. 

Foreign companies exported 100% of computer products, compared to 40% of clothing. This process transferred knowledge to all new private companies that supplied 80% of the content of these exports and even to unrelated firms.

While Xi does not want to isolate China, he believes the country would be more secure if it became less dependent on foreign technology and firms. 

He asserts that Beijing no longer needs foreign technology as much as before.

He is miscalculating. In 2015, he launched the ‘Made in China 2025’ program, which was aimed at becoming self-sufficient, as well as achieving global supremacy in several pivotal technologies and products.

The program has fallen short. 

For example, China’s tax breaks for companies issuing lots of patents caused them to shift from high-quality to lower-quality ones. That has reduced innovation, according to a study by Chinese academics. 

While China has made tremendous strides in some technologies and created world-class companies like Huawei, driving away foreign firms hurts innovation and growth.

Dubious charges

Before Xi’s rise, foreign firms suffered procurement discrimination and intellectual property theft, but the situation has escalated in frequency and severity. 

It now includes arrests of foreign personnel on dubious charges of espionage, along with demands that foreign firms involve CCP branches in business decisions. As sales in China decrease, companies are less willing to tolerate such impositions. 

Foreign direct investment into China plunged 8% in the first eight months of 2023.

The clampdown on private and foreign companies couldn’t come at a worse time. With the labor force shrinking and private investment decelerating, China cannot boost growth unless it increases total factor productivity or TFP. 

During 1980–2010, TFP accounted for about 40% of the growth in GDP per worker. But under Xi, the TFP growth rate has plunged by two-thirds.

It is one of the biggest drivers for China’s per capita GDP growth halving from 9% in the decade before Xi ascended to a forecasted 4% or less in the coming five years.

Rather than correct this productivity drop, Beijing has tried to boost growth by building a surplus of “apartments for no one,” financed by excessive debt. 

This has resulted in financial turmoil and demonstrations from buyers still waiting for their homes.

Political goals

Xi is either deceiving himself about the causes of China’s economic headwinds or demonstrating his willingness to sacrifice growth to pursue political goals at home and abroad. The effect of weaker growth on political stability is yet to be determined.

Richard Katz is a Senior Fellow at the Carnegie Council for Ethics in International Affairs.

A version of this article was first published here in Japan Economy Watch.

This edited version of that article is republished from the East Asia Forum under a Creative Commons license. Read the article here.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of China Factor.