Is a strong state a prerequisite or an obstacle to economic growth?

Christopher Conway, King's College School, Wimbledon, United Kingdom

Second place for the 2020 History Prize ​| 8 min read 

In 1989, the Cold War victory of the capitalist USA over the communist USSR led Francis Fukuyama to proclaim the ‘End of History’, and the ‘total exhaustion of viable systematic alternatives to Western liberalism [free trade and the “limited state”].’[1] The following decades have not borne this out. Though the realm of historians is the past, that does not preclude them from keeping one eye on the present. Now China, the great repudiator of the ‘Western idea’, has risen as a challenger to the USA’s global power, avoiding the worst of the 2008 recession, and surpassing the USA in PPP-adjusted GDP by 2014.[2] Meanwhile, the strength of Western democracy seems to be at a low ebb: in the UK for example, 69% are inherently dissatisfied with how democracy is functioning.[3] Therefore, the rise of the “Beijing Consensus”

– a state’s political monopoly in return for economic growth – may interest the historian much more than before. Aspects of a “consensually-strong” state – taxation, regulation, state monopoly on violence – are of course necessary for healthy GDP growth.[4] Yet I wish to investigate how far economic growth is fuelled by the accountable, “domineering state”. Three “facets” separate these from consensually-strong states:

  1. Political legitimacy not founded on taxpayers’ votes.

  2. Economy serves politics, not vice versa.

  3. Socially freedoms noticeably restricted.

The historian can isolate the effect of the “domineering state” on economic growth by tracing the parallel transition of Russia and China from communism to capitalism between 1978-91; their divergent political- economic outcomes from 1990-2000; and their recent convergence into domineering states. Though no template “prerequisite” is prescribed, I argue the well-managed domineering state has powerfully challenged the Washington Consensus due to some notable successes in these years.

The Soviet and Chinese states until the 1980s were strong states that would largely satisfy the three facets. In the USSR, the Communist Party (CPSU) had the leading role. Gosplan, a state organ, oversaw the command economy (largely isolated from global markets), and free speech was ultimately restricted by the KGB. Yet, the USSR’s economic growth deteriorated over time: between 1970-80, GDP growth averaged a 1.7% a year, low in comparison to many Western economies.[5] Furthermore, as Miller has argued, the state was strong, but weak enough so that Gosplan lobbying groups began to exert direct power of the running of the economy, instead of the CPSU General Secretary.[6] Business apparently did not serve politics. Gorbachëv, inspired to reform the Soviet state, took steps to reintegrate the Soviet Union into global markets. Perestroika began in 1987-88, involving reduced government control over corporate enterprises. Since no satisfactory socialist market framework was created in such a short time frame, it was estimated that the shadow economy grew to 11% of nominal GDP (i.e., US$150 billion) by 1990, with some earning double their official earnings on the black market.[7] Then in February 1990, Gorbachëv did fatally weaken state control by removing the constitutional article stipulating the “leading role” of the CPSU. This decision effectively rid the USSR of facets I and III; realistically, II was already absent. This positive feedback cycle of political/economic disintegration continued until December 1991, when the USSR itself disintegrated. The USSR, a strong state, failed to deliver the economic growth needed to sustain itself. However, it was the relinquishing of political control that caused it to fall up apart, politically and economically, in a mutually- reinforcing cycle.

In Maoist China, conversely, growth had been similarly mediocre. Between 1953-78, annual real GDP growth was 4.7%, though stability was offset (unlike in the USSR) by the highs of the early Five Year Plans, and the intense lows of the Great Leap Forward (1958-62) and then the Cultural Revolution (1966-76).[8] Between 1952-88, China lagged significantly behind the USSR’s GDP (see Appendix I). However, where China differed was that the Communist Party (CPC) did not resort to political liberalization in order to correct this. The end of the Cultural Revolution in 1976, and the death of Mao and the toppling of the Gang of Four in 1978 strengthened economic reformers in the CPC, notably Deng Xiaoping. They embarked upon a series of reforms mainly increasing financial autonomy of managers in large state-owned enterprises (SOEs). Crucially, these were completed in a much more gradualist manner than Soviet ‘shock therapy’. By 1988, Chinese GDP had exceeded the USSR’s. Yet while the CPC allowed greater autonomy it differed from the CPSU by maintaining supervision of business organs, and absolute control over the Chinese political system. A 1991 party memo gleaned from the fate of the CPSU that ‘the Party must grasp not only the gun but the asset economy as well.’[9] The CPC cemented control by repressing the pro-democracy demonstrations at Tiananmen Square in spring 1989 (while Gorbachëv was visiting Beijing) and all similar movements thereafter. While the CPSU sacrificed political and economic control, the CPC retained political hegemony (I, III), and, despite deregulation, substantial control in economic affairs (II).

Divergent strategies produced divergent economic results between 1978-1999. Post-CPSU Russian politics tobogganed into the economic anarchy unleashed by perestroika. In 1989, crime rates increased by 32% across the Union, a clear indicator of decaying state control.[10] Disintegrating political control led to the August 1991 failed coup, which also placed Gorbachëv – the president – under house arrest. During the Novo-Ogarëvo talks in December 1991 to dissolve the USSR, Gorbachëv was not invited. The comparative weakness of the new Russian Federation spawned geographical disintegration: a number of states declared autonomy (e.g. Chechnya and Tatarstan), and in 1998, the Kaliningrad authorities declared they would no longer remit taxes to Moscow.[11] Moscow was unable to enforce Federation-wide taxation, anti-corruption measures, or efficiency standards in loss-making corporations. These especially had the leverage of providing employment, key to winning votes for Yeltsin, and by 1996 had accumulated arrears of 13.7 trillion roubles.[12] This power of the ex-SOEs in turn constrained Moscow in reducing their share in the economy, increasing liability to recession when energy prices dropped (as in 1997-98). To reduce the huge Soviet consumer subsidies now hindering the Russian economy, Yeltsin was forced to shell the Russian parliament building in 1993. Consequently, the disintegration of political control, and associated fall-out, caused GDP to drop 35% during the 1990s.[13]

In China, by comparison, similar problems failed to appear. Geographical integration was preserved. Suppression of the pro-democracy movements cemented the political domination of the CPC. This allowed the leadership to carry out economically-intense reform to improve efficiency of China’s SOEs (now, not so untouchable as in Russia). Zhu Rongji , for example, laid off as many as 40 million workers from loss-making SOEs between 1997-2003, and reduced their number by 37%.[14] Often, these were later privatised. These sweeping powers, combined with deregulation to increase efficiency, allowed for striking economic growth not possible in Russia largely due to the constraints placed upon its leadership (alongside material and demographic constraints). While the Russian and Chinese economies were almost identical in size in 1993, by 2003, China’s was three times as large.[15] The stronger state cultivated by the CPC, it would seem, has been able to pursue specific reforms while ignoring the disaffected, whereas in Russia’s weaker state, any leader pursuing this might have been voted out.

Perhaps Vladimir Putin recognised these weaknesses. Miller’s ‘three pillars of Putinomics’ are:

  1. Strengthen central authority.

  2. Prevent popular discontent.

  3. Increase business efficiency, solely to serve I and II.[16]

This seems to emulate CPC policies and rejected CPSU ones. While Yeltsin struggled to deal with wealthy rival power blocs, Putin used his links to the security services firstly to discipline rival blocs, and then co- opt them to achieve his political and economic objectives. An example of this was the cashiering of Mikhail Khodorkovskii, previously Russia’s richest man. Owner of the giant energy conglomerate Yukos, he had tried to avoid punitive tax measures in the aftermath of the 1997-98 crisis. Putin’s response was to order his arrest in 2003 and imprison him for eight years. Taxes were raised on the Russian ultra-rich, allowing the budget to re-balance in the early 2000s, and government saving eventually allowed more insulation from the financial crisis of 2007-8. This was mainly achieved by Beijing-style policies which allowed the Russian government to utilise high oil prices in the early 2000s to strengthen state finances.[17] The Russian state currently represents about 35% of GDP, though large increases have been observed in energy and banking, also key strategic areas for Beijing.[18] In Russia, ‘indirect’ state involvement in the economy has enlarged the state’s presence, a more nuanced approach which appears a third way between Soviet over- regulation and Yeltsinite under-regulation. However, it has not automatically produced growth: demographic and diplomatic constraints have limited GDP growth, such that between 2013-18, disposal incomes fell annually.[19] Thus it remains to be seen whether Putin’s new strategies will enhance the economic growth of a stronger Russian state.

The CPC views control of business as crucial to its survival. Although between 1978-2017, SOE employment/population dropped by 80%, and share of output by two-thirds, Xi Jinping has committed to improving both the efficiency and wealth of SOEs. Incidentally, the private sector’s share of profits have declined steadily since 2015, and in 2018 – the first time since 2011 – SOEs surpassed private enterprises in gross profits.[20] SOEs constitute 50% of the 500 largest manufacturing companies in China. Meanwhile, 14/16 largest Chinese companies operating outside China are SOEs.[21] Subjecting them to CPC political prerogatives – enriching China, increasing FDI stocks, and thus China’s global power – has often been a mutually-beneficial arrangement. The CPC has also extended political control into the private sector, creating monopolies or leverage for Chinese companies: e.g. bankcard company UnionPay, whose monopolisation of the Chinese bankcard sector the CPC sponsored against American rivals until 2014. 68% of Chinese private enterprises had party bodies in 2016, and 70% of foreign enterprises; meanwhile, corporations such as L’Oréal, Disney and Dow Chemicals all have party committees, and display the hammer and sickle in their Chinese offices.[22] Furthermore, degree of CPC affiliation has affected the ability of private enterprises to accumulate bank loans (see Appendix V). The deregulation of the 1980s-2000s undoubtedly produced astonishing economic growth, averaging 9.5% GDP growth p.a. 1979-2018.[23] However, amidst forecast of declining growth rates past 2020 (see Appendix VI), the CPC seems to be strengthening its involvement in the economy to preserve its power, and direct these assets abroad to build power globally: the key example is the risk-laden Belt and Road Initiative (BRI), a potential $8 trillion investment.[24] It is thus hard to deny that the CPC is the ‘silent partner’ of business, an economically as well as politically strong state, but in a much more subtle form than the communist states of the previous century. Corruption and inefficiency are not rare, and have hindered economic growth to some extent. However, Russia has noticed China’s successes: just recently, United Russia delegates have begun visiting China to learn how it opened up its economy without sacrificing political control.[25]

Ultimately, I would not prescribe a strong state as a “prerequisite” for economic growth because, as seen in the USSR and Maoist China for decades, political strength hindered growth. Furthermore, the laissez-faire approach of the USA, and neoliberal policies in the UK, have aided growth in those countries. Yet, a strong state is not necessarily an obstacle. Maintaining political control, while cultivating a more nuanced and decentralized approach to political ownership of business has hitherto benefited the CPC. Domineering states in today’s world are increasingly challenging the idea that Western liberal ideas will herald the ‘End of History’. Naturally, corruption and party interest groups undermine growth, as was seen in the late USSR when it economically diverged from China, despite reform.[26] However, under Xi Jinping, the CPC has taken a hard-line attitude to corruption.[27] Regardless, should China’s BRI[28] succeed in establishing the global influence the CPC seeks from it, Washington might find that its political and economic prescriptions will begin to be successfully challenged worldwide by power blocs with very different values.

Footnotes

 

1 F. Fukuyama, ‘The End of History?’, The National Interest, no. 16 (1989), pp. 3-18: 1.

2 W.M. Morrison, ‘China’s Economic Rise’, Congressional Research Service (2019), p. 10.

3 R. Wike & S. Schumacher, ‘Satisfaction with democracy’, Pew Research Centre, 27 February 2020. Available at: https://www.pewresearch.org/global/2020/02/27/satisfaction-with-democracy/.

4 See D. Acemoglu, ‘Politics and Economics in Strong and Weak States’, NBER Working Paper 11275 (2005), pp. 19-25. Acemoglu gives as examples the United Kingdom (with its NHS and welfare system), and Sweden.

5 P. Hanson, The Rise and Fall of the Soviet Economy: Economic History of the USSR 1945-1991, Routledge (Abingdon, 2003), p. 131.

6 C. Miller, The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, North Carolina U.P. (Chapel Hill, NC, 2016), p. 57: ‘In theory, the CPSU controlled the economy, but in reality the industries controlled the party.’

7 R. Parker, ‘Inside the Collapsing Soviet Economy’, The Atlantic, June 1990.

8 A. Maddison, Chinese Economic Performance in the Long Run, 960-2030, OECD Development Centre (2007), p. 150.

9 Quoted in R. McGregor, ‘How the state runs business in China’, The Guardian, 25 July 2019.

10 A. Ogushi, ‘The disintegration of the Communist Party of the Soviet Union’, PhD thesis (University of Glasgow, 2005), p. 231. See also Appendix II.

11 M. Gilman, No Precedent, No Plan: Inside Russia’s 1998 Default, M.I.T. Press (Cambridge, MA, 2010), pp. 192-3.

12 Miller, Putinomics: Power and Money in Resurgent Russia, North Carolina U.P. (Chapel Hill, NC, 2018), p. 15.

13 A. Aslund, Building Capitalism: The Transformation of the Former Soviet Bloc, Cambridge U.P. (Cambridge, 2002), pp. 118, 308. Russian male life expectancy dropped nearly 10%, and suicides rose 60%, showing the extent of economic stress.

14 Economist Intelligence Unit, ‘Are state-owned enterprises reformable?’, 18 December 2018.

15 World Bank, Sodruzhestya nezavisimykh gosudartsv v 2005g (Moscow, 2006).

16 Miller, Putinomics, p. xiii.

17 It can also go the other way: the political subjection of the Venezuelan state oil company, PDVSA, means that its workers are hired on a basis of political allegiance to the United Socialist Party of Venezuela. In 2002, when PDVSA employees went on strike to protest the policies of Chávez, 19,000 were fired, and Intevep, the research and development arm of PDVSA lost 80%, reducing its ability to innovate and compete globally. 1976-92, 29% of PDVSA revenues went towards costs, and 71% to the government. Because of this, Chávez and his successor Nicolás Maduro have been accused of treating it like a ‘piggybank’.

18 See G. Di Bella, O. Dynnikova, S. Slavov, ‘The Russian State’s Size and its Footprint: Have They Increased?’, IMF WP 19/53 (2019). See also Appendix III.

19 Miller, ‘Russians Lower Their Standards’, Foreign Policy, 11 February 2019.

20 EIU, 2018. See also Appendix IV.

21 ‘Chinese Multinationals Gain Further Momentum’, Vale Columbia Centre and Fudan University survey, 9 December 2010. Available at: https://emgp.org/wpcontent/uploads/2018/07/China_2010.pdf.

22 McGregor, ‘How the state runs business’.

23 Morrison, ‘China’s Economic Rise’, summary.

24 A. Bruce-Lockhart, ‘China’s $900 billion New Silk Road. What you need to know’, World Economic Forum, 26 June 2017. Available at: https://www.weforum.org/agenda/2017/06/china-new-silk-road-explainer/. It is estimated that 80% of funds invested in Pakistan, 50% in Myanmar, and 33% in Central Asia will be lost (J. Kynge, ‘How the Silk Road plans will be financed’, Financial Times, 9 May 2016). However, the trade off for this is an increase in Chinese hard power: land collaterals for debt in Kyrgyzstan (where per capita debt was $703 in 2018) or the entire Hambanthota Port in Sri Lanka (See M. Abi-Habib, ‘How China Got Sri Lanka to Cough Up a Port’, New York Times, 25 June 2018. Available at: https://www.nytimes.com/2018/06/25/world/asia/china-sri-lanka-port.html). In addition, it may prove to be a boon for the Chinese workforce, since 89% of BRI contracts will go to Chinese corporations.

25 J. Kurlantzick, State Capitalism: How the Return of Statism is Transforming the World, O.U.P. USA (New York, NY, 2016), p. 111.

26 Miller, The Struggle to Save the Soviet Economy, p, 178: ‘Where the Soviet Union diverged from China, it was because powerful interest groups obstructed Gorbachëv’s policies’. Elsewhere, a school of thought argues that the new “interest group” in Russian politics is not economic, but military-political: the old guard of the KGB, the new FSB and SVR security services. For the best piece on this, see C. Belton, Putin’s People: How the KGB Took Back Russia and then Took on the West, William Collins (London, 2020).

27 In 2016, Xi Jinping released a statement saying that ‘one million’ Chinese officials had been punished for corruption between 2013- 16 (https://www.bbc.co.uk/news/world-asia-china-37748241).

28 For an interesting and suggestive investigation of the Belt and Road Initiative, refer to P. Frankopan, ‘The Roads to Beijing’, in The New Silk Roads: The Present and Future of the World, Bloomsbury (London, 2019), pp. 87-151.

Graphs

29 Maddison, Chinese Economic Performance, p. 61.

30 V. Popov, ‘China’s rise, Russia’s fall: Medium term perspective’, TIGER Working Paper Series No. 99 (2007), p. 10.

31 A. Abramov, A. Radygin & M. Chernova, ‘State-owned enterprises in the Russian market: Ownership structure and their role in the

economy’, Russian Journal of Economics, vol. 3, no. 1 (2017), pp. 1-23, fig. 6.

32 EIU, 2018.

33 N.R. Lardy, ‘State Sector Support in China Is Accelerating’, PIIE, 28 October 2019.

34 V. Nee & S. Opper, ‘On politicized capitalism’ (2006), p. 41, table 7.

35 Morrison, ‘China’s Economic Rise’, p. 9; EIU database.

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