China Economy: Government Policy For Mixed Economy

China’s economy is the second-largest in the world and growing at 6 % GDP per annum. Soon it will be the world’s largest. But who are the economic agents behind this change? Who are the true drivers affecting the economy? Are their social, market or government?

In any economy, production, consumption and exchange are economic aspects; carried out by three basic economic units. These units are: the firm, the household, and the government.

Firms make production decisions. These include three key decisions: what goods to produce, how these goods are to be produced and what prices to charge? But in the case of China these firms may be both private or public, or even a mixture of both. So market as well as state policy can have influence. So who is behind the change?

In any economy consumers are a force in their own right. But in China are they driven by policies of the government or by the firms who produce and promote their goods? Or are the consumers actually the magnate that production is responding to? Maybe all have equal influence in their own way making China’s economy unique and the role of its agents a bit different from other economies. We will examine this question of economic agency in China from three perspectives: production via the state or private firm; consumption of households representing the largest population in the world; economic exchange with the state setting policy through planning.

China’s Production – State-owned or Private Firm as Economic Agent?

The role of the firm as economic agent on production in China is more complex than other countries. This is because there are private and state-owned enterprises, and some that are a mixture of both. Which is better and which has a better impact? It is hard to judge. There are competing arguments on both sides. Either way the China situation is unique because the ownership of the firm is not only private but also state.

There is a strong argument that the state-owned firm is a powerful economic agent benefitting the Chinese economy. In a study by the economic think tank Research Gate on the good effect of state-owned enterprises upon China’s economy they wrote, “State-owned enterprises are playing a pro-growth role in China in three ways: first, they stabilize growth in economic downturns by carrying out massive investments; second, they promote technical progress by investing in riskier areas of technology; third, they establish an efficiency-wage mechanism by providing workers a living wage (1).” According to this argument, larger numbers of state-owned enterprises will be better for the Chinese economy in the long run. Why? Because they can absorb more risk than the private enterprises. Based on the three points of the study quoted above, they will balance the private enterprise and as economic agents reduce risks. This will benefit long-term stable economic growth.

There is also a counterargument that state-owned enterprises are not such important economic agents as the private enterprises. World Economic Forum expressed a somewhat different opinion as reported by the pro-business magazine Forbes: “China’s private sector – which has been revving up since the global financial crisis – is now serving as the main driver of China’s economic growth…Private wealth is also responsible for 70% of investment and 90% of exports. Today, China’s private sector contributes nearly two-thirds of the country’s growth and nine-tenths of new jobs, according to the All-China Federation of Industry and Commerce, an official business group (2).” The arguments reported by Forbes during its coverage of the World Economic Forum claim that the private sector as economic agent contributes to more than half of China’s GDP and the majority of employment and innovation.

The truth tends to lie in a middle way between different opinions. A more objective way to look at this might be to say that state-owned enterprises as economic agents have impacted the Chinese economy in a positive way. They have absorbed risk. They can invest more in technology. They can invest in areas that require longer periods of return and carry more risk. Private enterprises cannot always take such a long-term view as they need to make money faster and quicker otherwise they will go bankrupt. Because the state supports the state owned enterprises, as economic agents, they can serve to stabilize the economy.

The private enterprise as economic agents may be seeking profits, which of course is good for immediate growth. However, sometimes these are really short term, which is not good for long-term growth. That is when we need stabilizing economic agents. As Research Gate observes, “If the profits of private enterprises are invested, the result is growth—but profits of private enterprises also go to dividends and non-productive uses such as speculative purchase of existing assets (3).”

While the private firm is a driver of the Chinese economy as economic agent, the public firm is a longer-term driver of research and development as well as core infrastructure necessary for the private firm to flourish. Moreover, according to Research Gate, the state maintains control over key pillar industries such as: “defense, electricity, oil and gas, telecom, coal, shipping, aviation, and rail, which have strategic linkage to national economic development, and maintain the necessary influence in normal industries (4).”

Both are important economic agents playing according to China Briefing, “decisive role for markets in resource allocation”. China Briefing’s economic analysis noted that, “Following China’s 2015 stock market turmoil, the leadership in Beijing was reluctant to withdraw the ‘visible hand’ of the state (5).” This further supports Research Gate’s arguments that the state turns more to the state-owned enterprises at times of economic instability to act as stabilizer.

According to pro-business magazine Forbes, “China has openly acknowledged its mixed economy and the role that state and private firms both have as economic agents on the economy (6).” The reality is that China is a mixed economic system that combines both planning and market, balancing the role of both state and private firms as economic agents affecting productivity. This combination seems to be what has made China’s economy successful and strong.

China Consumption Conundrum – The Household Buying Power of 1.4 billion

Are the consumers the agents driving China’s economy or the producers and state? What is the power of the consumer as agent in affecting China’s economy? To what extent does China’s population of 1.4 billion really drive consumption or to what extent does the production and exchange agency factors? China’s consumers are viewed as increasingly sophisticated. That is changing the nature of consumption from the days when they were not exposed to either business or luxury. Now everything changes so fast in China.

According to progressive film-maker Guo Jingqing quoted in an Economist Magazine article, “Materialism is neutral, neither positive nor negative.” He claims that, “China’s cosmopolitans know at any given moment what movies are playing in New York and what fashions are on the Paris runways.” Meanwhile, the official Chinese media criticizes his films that depict youth luxury consumption as “hedonism (7).” So what is the truth? The truth always lies somewhere in between the opinions.

Chinese consumers have caught global attention. They shop around the world. In the 1980s and 1990s they were busy just buying electrical appliances and trying to catch up with everyone else. In the decade following the Millennium, they have become known for their luxury tastes. According to a study of Chinese luxury consumption in the Nielson Report, “Clothing and dining out are among the top five consumption areas for all major consumer segments. Many young girls tend to choose clothing as their main consumption when it comes to products. The study found that 51% of girls and 38% of young married women are more than willing to purchase clothing using their income. When looking at the older and more wealthy generations and groups of people the main way they find leisure is by eating out (24%). Many older people are less keen to spend money as the young but also want to enjoy life, the majority (33%) use their holiday time to travel and vacation (8).”

However, patterns are changing. Chinese consumers are becoming more sophisticated due to the fact that when material life is unprecedentedly developed, consumers are becoming more mature. Today more Chinese people rationally consider their purchases rather than blindly buying things. According to data from the National Bureau of Statistics, the national wide per capita disposable income of residents in the beginning three quarters of 2018 was 21,035RMB (9).” This means that people are becoming more sensitive toward their own spending patterns.

Compared with 2017, change began to occur. Households began to spend less frivolously. According to industry studies they reduced unnecessary consumption in areas like alcohol, tobacco, clothing, and even housing. Instead they spent more money on medical expenses, education, culture, entertainment, transportation and travel. This showed a marked shift from mundane luxury expenses toward investment in services and experiences. One industry study noted that, “Due to the emergence of more consumer goods, consumers are becoming more cautious when choosing fast consumer necessities. Rational consumption can thus be divided into two categories: cautious product selection and multi-channel price comparison (10).” So how is the government responding in its own role as economic agent to affect consumption?

But was this due to market and patterns of household consumptions driving the productivity of firms and exchange of government? Or was the government’s own crackdown on corruption, call for frugality, and encouragement of long-term non-luxury investments the real reason? One study noted that the government as the economic agent had already begun to, “Encourage additional spending in areas such as education, with expenditure on children’s education and further education having become eligible for tax deduction (11).” This is also consistent with the more mature spending patterns of China’s consumers as economic agents.

China Economic Exchange – Government Policy for Mixed Economy

So how does the government play a role as an exchange driver through economic policy, balancing the role of both firms and consumers as economic agents? In a mixed economy with both private and public forces driving the economy, how does the government serve as an economic agent by maintaining a mixed set of policies encouraging private sector while driving state investments?

“Chinese consumption is not driven by the government but by entrepreneurship, and the market,” Jack Ma of Alibaba said as reported by the Guardian in September 2015. The Guardian quoted him as saying, “In the past 20 years, the government was so strong. Now, they are getting weak. It’s our opportunity; it’s our show time, to see how the market economy, entrepreneurship, can develop real consumption (12).”

According to this article private firms were responsible for about 50% of all investment in China and about 75% of economic output. But also quoted in the same article was a different view expressed by Nicholas Lardy, a US economist who has long studied the Chinese economy. Lardy concluded, “Since 2012, private, market-driven growth has given way to a resurgence of the role of the state (13).” Does this mean that the state is the real economic agent affecting both firm as producer and the household as consumer?

China adopts a policy of managed market. It is called the “macro-control system.” For the past thirty years, much of China’s growth has been driven by massive government infrastructure investment. Such fiscal spending has driven production. Such state spending stimulating production, in turn stimulates consumption. As one study observes “Government control over major companies and the yuan’s exchange rate have generated large improvements in the Chinese economy (14).” So from this perspective, we can see the government as the main economic agent. However it is not the only one.

Conclusion: China’s Economic Agents – Firm, Consumer, State

While the government as economic agent is the main force of exchange in determining macro-policies for the economy as a whole, other agents play a key role. The firm as producer has a bifurcated aspect to its role. Half is state and half private. So both are functioning under the overall guidance of the stage in fixing parameters for market, and its control over currency and other factors. The household as consumer is also a key economic agent, however, working at the lower rungs of the economic order.

This arrangement has been explained clearly by Britannica in an article on the role of the state versus the other economic agents: “Overall, therefore, the Chinese industrial system contains a complex mixture of relationships. In general, the State Council exercises relatively tight control over resources deemed to be of core importance for the performance of the entire economy. Less-important aspects of the system are devolved to lower levels for detailed decisions and management (15).”

China’s model is unique in that it combines market with planning. Its firms include pure state, pure private and a cross-section and mixture of both. The government promotes the market yet plans and drives the economy with many leverages and mechanisms. So the traditional economic agents of firm as producer, household as consumer and government as medium of exchange are affected by this unique mixture of private and state ownership that work in coordination that have been driving