Why China will never overtake the US

In 1961, the most widely used academic textbook in economics, written by Nobel Prize-winner Paul Samuelson, forecast that the Soviet Union…

In 1961, the most widely used academic textbook in economics, written by Nobel Prize-winner Paul Samuelson, forecast that the Soviet Union would overtake the United States by 1984 in terms of GDP. In the 1980 edition, after growth rates had diminished, the overtaking was delayed to 2002. The rest is history: the USSR collapsed in 1991.

Today, analysts give similar projections for China. In 2011, The Economist predicted that China national income would overtake that of the US by 2018. In 2015 they updated their predictions, and delayed overtaking to 2026.

For the same reasons the Soviet Miracle didn’t happen, the Chinese miracle will never happen. Unless major changes occur.

Chinese growth started in the late 70’s. As Nobel Prize-winner Ronald Coase explained, this growth wasn’t initiated by the central government but by “marginal revolutions”. Those revolutions resulted from grassroots initiatives. They were experiments led by entrepreneurs, away from Beijing, such as private farming. Meanwhile, the Communist Party was trying to reform the state sector to save socialism. The Party failed to do so and finally allowed, as a last resort, those marginal revolutions because Chinese leaders saw they were working well.

Those market reforms triggered a huge economic growth. It was a “catch-up growth” due to the reallocation of resources from unproductive agriculture to the industry, the same kind of growth the USSR experienced after World War II.

But as in the USSR, benefits from reallocation will decline after a while. Sustained growth is mainly innovation-driven. And radical innovation, according to Schumpeter, brings “creative destruction”. Creative destruction is the process of innovation that both creates wealth and destroys the established way of doing things. For example after the Industrial Revolution, steam-powered machines replaced human labour in several industries.

The economic and political elites have always been afraid of creative destruction. Indeed, innovation creates both winners and losers, and because of creative destruction the current elites may lose their incomes and privileged positions. As a result, politicians often tempt to block innovation.

For this reason, according to Acemoglu and Robinson, sustained economic growth requires both inclusive economic institutions (property rights, law and order, markets, and state support), and inclusive political institutions (pluralism, checks and balances, and rule of law). Without such an institutional framework, the elites can prevent any innovation from happening.

After the reforms, China did move to more inclusive economic institutions. However, the political institutions remained unchanged. As Ronald Coase brilliantly said:

“China has developed a robust market for goods, but it still lacks a free market for ideas.”

That’s why, Chinese growth will not last without a fundamental political transformation. Without such a change, China will either stagnate or collapse. The slowdown has already started, even if Beijing is making everything possible to hide it: Fathom Consulting estimated the GDP growth rate at 2.4%. The official number is 7.1%…

The Communist Party now faces a dilemma. On the one hand, Chinese authorities know that China’s stability and the Party’s survival rest on growth. On the other hand, they learned from Gorbatchev that “Perestroika + Glasnost = collapse”.

The Party is well aware of this dilemma: all cadres are now asked to watch videos about the fall of the USSR, so that they don’t make Gorbachev’s mistakes. According to Chinese leaders, the Soviet Union collapsed because of oppositions inside the Soviet bureaucracy and corruption. That’s why Xi Jinping’s anti-corruption campaign first focused on his political opponents. However, isn’t corruption the raison d’être of the Communist Party? As a popular Chinese saying goes:

“Not to kill corruption will kill the country, to kill it will kill the Party.”