“Standard economic theory does not offer ready solutions explaining China's path to capitalist economic development.” – Victor Nee and Sonja Opper

As in my previous review articles, the focus is on the theoretical framework of the text upon which the authors’ arguments, and the examples they provide to buttress them, hinge. [1] This approach of engaging with a text’s underlying foundation enables a reviewer to ascertain whether the cases presented – in such big books on economic development with policy implications – are strong evidence, in their own right, when analyzed independently, or examples that are simply tailored or distorted to support a theory.

Even though the authors agree that the state-centered explanation that underscores the key role that the rule-enforcing polity and its politicians play in the performance of the economy “is both substantively undeniable and intuitively appealing” (p. 4), they assert that it is limited in the case of Post-Maoist China. For them, what happened in the context and aftermath of 1978 is “the emergence and self-reinforcing growth of China's robust private enterprise economy” (p. 5), something they assert – aptly, albeit, to the extent that their premise is apt – the former approach cannot explain.

The authors’ conceptual framework – and the model and theory that stems from it – therefore stands or falls with the premise that what happened in China was primarily driven from below through a robust growth of private enterprise. In other words, they shift the center of the story from the reforms that are associated with the political figure of Deng Xiaoping whose name they only mention thrice in the entire book. For them the then political elites whom Deng is their epitome did not plan or envision let alone anticipate the capitalism that would ostensibly come from below. All that they were initially motivated to do, according to the authors, was “to address failures of central planning within the institutional framework of state socialism” (p. 1). To that end the central government did not, in its own accord, create institutions of capitalism to safeguard private property and promote a private enterprise economy in China; rather, “it explicitly sought to restrict private commercial activities to a peripheral role” (p 5) during the first decade of reform (1978-1988). The authors thus conclude:

“To the extent that the government implemented regulations to legitimize private firms, it was in a spirit of tolerance of a necessary concession, allowing marginalized social groups – rural households, the unemployed, laid-off and retired workers – to start up small-scale production, but not providing active support or a level playing field. If the political elite had had their way, the seeds of capitalism, sowed as an unintended consequence of reform policies, would have been contained by state-mandated rules restricting the size of private firms to individual household production, which would have stayed in the traditional mode of making small-scale commodities for the market” (Ibid.)

What ensued out of this necessary concession was an influx of people from below, into the then disadvantaged private sector, that even caught Deng by surprise when he exclaimed that it is “as if a strange army appeared suddenly from nowhere” (p.821) [2] in reference to the “large number of local imitators” who – following their role models i.e. the entrepreneurs who survived the early phase of the reforms – found private firms in the countryside. However, vacillating between the role of the state and the masses in these institutional reforms, the authors point out earlier on that in “implementing the party's reform policies, the central government sought to improve incentives by decentralizing and cutting back on state control of economic activity” (p. 1). They also note that in “agriculture, reformers decentralized production to the peasant household through a land-lease system and promoted the gradual liberalization of rural markets (p. 2) whereas in “industry, reform measures sought to strengthen material incentives for management and workers through retention of profits and more enterprise autonomy” (Ibid.). It also “promoted Foreign Direct Investments (FDIs) to alleviate capital constraints and to speed up the country's technological catching-up process” (Ibid.) Communism was giving way to capitalism.

In this regard it is difficult to understand why the authors thinks the state was not aware it is opening up to capital and capitalism in China that would ultimately lead to the rise of capitalists from below. Yet they go on to introduce a theory and proffer a model that privileges the bottom-up process relative to the top-down process in “explaining China's path to capitalist economic development” (p. 1). The former they call a “theory of endogenous emergence of the institutions of entrepreneurial capitalism” and the latter, “a multilevel causal model of institutional change” (p. 10).

The framework that informs this theory and its model is a synthesis of the new institutionalism in Economics and Sociology that focuses on institutional causality. In this model, “institutional dynamics” are said to “operate in both directions, from institutional mechanisms embedded in macro-structures to micro-level behavior, and from micro-motives and behavior to macro-level institutional change” (p. 10). Thus:

“The bottom-up emergence of capitalism in China rests on the following causal factors. First, shifts in market competition provide incentives for economic actors to come up with bottom-up institutional arrangements to secure gain from emergent opportunity structures. Second, entrepreneurial action generates institutional innovations, and through a process of trial and error, successful solutions diffuse through the regional economy. Third, mutual monitoring and enforcement in crosscutting networks of like-minded actors reinforce novel behavioral strategies and norms. Fourth, through mimicking, swarms of followers pile in, and following tipping points, a self-reinforcing social movement dynamic evolves, which in turn facilitates local collective action to lobby for changes in the formal rules consonant with informal norms. Industry-based associations and lobbyists act as agents representing social interests. Politicians eventually respond to bottom-up innovations by changing formal rules to accommodate and regulate emerging economic realities” (p. 20-21).

The strength of their model is in explaining, with relative success, a particular case – that of post-socialist China. When the same model is applied to other places it falls through. As they point out, probably by way of disclaimer, the trajectory that China took was different from that of Russia and Eastern Europe. The failure of capitalism in the case of the latter to produce a booming economic development, they observe, has a lot to do with its “shock therapy” and “big bang” top-down introduction that the World Bank and the International Monetary Fund (IMF) imposed in collusion with the political elites. Thus, in contrast to China, bottom-up capitalism could not occur.

Plausible as it seems, this contrast does not explain why the swarms of small-scale entrepreneurs who also burst into the scene in socialists countries in Africa and Latin America during the transition towards the universal fall of socialism, as epitomized by the fall of the Berlin Wall and the end of the Cold War, did not bring about the so-called capitalism from below. This also highlights the tension between the model as an explanatory framework and as a policy framework. The authors attempt to make it both. In the case of the latter, they try to show that other societies can also – ostensibly – develop capitalism from below the way China – presumably – did. All they need is to acquire a “critical mass” and thus attain the corresponding “threshold”:

“The collective action of economic actors imposes pressure on the state to respond initially by enforcing the existing legal and regulatory structures. Once a critical mass is reached, however, and collective action becomes self-reinforcing, the state can no longer effectively enforce compliance. Opposition norms may eventually spur changes in the formal rules, if a certain threshold level of noncompliance with state-mandated rules is reached and state actors see a need to adjust formal rules accordingly. In this way, social norms and group behavior are no longer relegated to a passive role of cultural filters, but comprise active forces of endogenous institutional change” (p. 20).

However, their historicization implies that the model is exclusive to Post-Mao China:

“In the Maoist era, private entrepreneurship would not have reached a critical threshold level triggering a self-reinforcing growth of private firms, even with the support of some local governments. Moreover, even if political actors responded in a lenient way to deviators, allowing opposition norms to arise at the margins of society, the state could still have continued to deny adjustments of formal rules, prolonging the marginalization of private entrepreneurial activities” (p. 4293).

Yet they thus indicate that the model is open-ended implying a universal applicability:

“Whether or not political actors accommodate endogenous institutional change is determined by the nature and direction of changing incentives. China’s policy of fiscal decentralization played a key role in explaining their responsiveness to entrepreneurial activity. That policy required lower-level governments to submit a fixed proportion of fiscal revenues to
governments to submit a fixed proportion of fiscal revenues to their superior government unit, but they could retain the residual for their own budget. The aim was to make local levels of government rely increasingly on self-financing to meet growing responsibility for funding local public goods” (p. 4293-4294).

But even in the case of China they acknowledge that initially “this was not a broad-based national movement”; rather, “entrepreneurial development was spatially concentrated and grew through protracted bursts of entrepreneurial activity, similar to the ‘waves of creative destruction’ that Joseph Schumpeter observed in other such dynamic periods” (p. 338). Ironically they single out the Yangzi delta as a region that particularly “emerged as a center of entrepreneurial capitalism, and thus it lends itself as a natural laboratory to study the formation of capitalist economic institutions” (Ibid.) “Through a bottom-up dynamics of cumulative causation”, they conclude, “a fledgling private enterprise economy diffused and grew in the Yangzi delta and in other coastal regions (Ibid.) The history of capitalism in port cities is thus truncated.

A closely related problem with their theory and model is that they pay little attention to the long history of capitalism in China. This stretches across dynasties with some – such as the Song, Ming and Qing dynasties – leaning more towards capitalist entrepreneurial ventures compared to others, at least in certain periods and places. In the Republic era at the turn of the 20th century such accumulation of experiences were being consolidated, for instance in the case of the introduction of the Company Act of 1904 and Chambers of Commerce that were established in 1905 to cater for the merchant class of overseas as well as inland Chinese. Like layers of sediments, these waves and sprouts of capitalism left an imprint in the Chinese social and economic landscape that communist China could not simply erase in its entirety within a space of a generation or two. In a way even the authors thus note that not all was forgotten:

“By the end of the Maoist era of state socialism, private firms had become virtually extinct, and market exchange survived only in black-market trading and semilegal and illegal household production of agricultural goods and handicrafts for a constricted rural informal economy” (p. 1738).

In fact they also note that in “the early years of economic reform, market transactions could build on the revival of prerevolutionary commercial practices and institutions, embedded in living memories and local commercial tradition” (p. 1763). However, underplaying the role and impact of modern capitalist institutions established prior to the cultural revolution, they thus view these practices in terms of culture: “The cultural factors underlying this tradition derive from Neo-Confucian ethics, the common cultural basis of East Asian economic development” (Ibid.). Even the long history of capitalism in Yangzi is reduced to a culture: “Historically, a commercial culture had flourished in the Yangzi delta since the fourteenth century. This had been interrupted by the people’s commune system for a brief two decades (Ibid.) This makes them assert that a “straight-line restoration of traditional commercial practices and institutions did not address adequately the problems faced by private commercial and manufacturing firms” (Ibid.) during the transition economy in Post-Maoist China.

The book indeed makes an optimistic reading for those who want to see the promised fruits of capitalism in post-socialist countries. However, in trying so hard to explain the arguably dramatic success story of China, it ironically ends up proving that it is an exceptional case. Hence it provides a sociological explanation that is fairly plausible but an economic model that is hardly replicable. History, after all, is context-specific.

END NOTES

[1] Exclusive Institutional Theory of Market Inclusivity: A Review of Why Nations Fail
[2] Pages that are numbered in hundreds and thousands are from the kindle edition of the book.

* Chambi Chachage is a PhD student in history at Harvard University.