Panel 1:
Economic Development, Economic Growth and International Trade

Investment vs. Institutional Transformation
to Promote Growth: Perspectives from China

Terry Sicular

April 16, 1999

It is a pleasure to be back in New Haven and to see so many familiar faces in the audience. As many of those familiar faces know, I have spent much of my life studying China’s economic development. Not surprisingly, then, I have been thinking about the theme of today’s panel – capital formation vs. institutional transformation for growth – from the perspective of China.

This seems to me a useful perspective for several reasons. First, China is a large and important developing country. It has the largest population in the world, and it now has the second largest economy in the world (in PPP terms) after the U.S. Second, China has been relatively successful in promoting growth and development. Third, China is known for its substantial and extensive experience of institutional transformation.

That said, as I think about investment and institutional transformation in China, I find China’s experiences poses questions rather than provides answers. Let me discuss one such question, in part to provide fodder for our later collective discussion.

Historically China has experienced two periods of rapid growth. One is the recent reform period from the early 1980s to the present. The other, perhaps less known, is the First Five Year Plan (FFYP) period, from 1952 through 1957. (See Table 1.) These two periods were both characterized by growth in national product of more than 8%. Per capita growth during the FFYP period was lower than that during the reform period due to higher population growth in the 1950s, but estimates of growth in total factor productivity show higher productivity growth in the FFYP era than during the Reform period. Admittedly, high productivity growth is difficult to sustain for long periods, and at the start of the Reform period it was higher than on average since the late 1970s. Even so, productivity growth during the Reform period peaked in the early 1980s at about 3.8%, and so even at its highest did not surpass that during the FFYP.

Table 1:  GROWTH AND INVESTMENT

The Reform and FFYP periods share in common the fact that they both were characterized by high rates of investment. During the FFYP the aggregate rate of investment in China increased from historical levels of well below 10% to the then high rate of 24% (Table 1). During the Reform period investment rates have been even higher, but in this case show a continuation or slight increase in the high investment rates China already enjoyed during the 1970s.

Both periods are also characterized by major institutional transformation, but the institutional changes taking place went more or less in opposite directions (Table 2). During the FFYP agriculture was collectivized; during the Reform period it was decollectivized. During the FFYP planning was introduced and expanded; during the Reform period planning has been nearly eliminated and markets revived. During the FFYP period industry was nationalized; during the Reform period state industry has been subject to reforms and decentralization, and there has been a substantial expansion of industrial production outside of the formal state sector. During the FFYP China imposed controls on foreign trade and prohibited direct foreign investment; during the Reform period China has decentralized trade, encouraged foreign direct investment, and moved in the direction of a convertible currency.

Table 2: INSTITUTIONAL TRANSFORMATION

These contrasts pose a paradox. Why did agricultural output respond positively to both collectivization and decollectivization? Why did China grow rapidly both when it closed its borders and when it reopened them? Why did China develop successfully both when introducing planning and when dismantling it?

I do not have definitive answers to these questions, but let me raise some hypotheses. One possibility is that high investment is a sufficient condition for rapid growth regardless of the direction of institutional change (within limits – those limits were exceeded during the Great Leap Forward). Alternatively, one could argue that, within limits, institutional change in and of itself promotes growth, as it sweeps away vested interests that constrain growth.

Finally, one could propose a more complex story that recognizes the importance of initial conditions. The initial conditions in 1952 and 1978 were very different. The initial conditions in 1952 were characterized by low savings and investment rates, which at that time posed a constraint on growth and development. The institutional changes that took place during the FFYP – collectivization, the introduction of planning, and so on – were instrumental in raising rates of savings and investment. So this institutional change at that time promoted rapid growth.

In contrast, at the start of the Reform investment was already high. The returns to that investment, however, were low. In this context, the institutional changes that took place in agriculture and other sectors raised the returns not just to current investment, but also allowed China to reap greater benefits from existing capital stock that had been built up during the prior decades.

This last way of explaining the paradox, which I favor, suggests that the roles of capital formation and institutional transformation depend very much on initial conditions. In other words, no single prescription will apply to all countries at all times.