The Chinese Mercantilists

Tiffany Tong
November 15^th, 2007

China has been growing in GDP at rates that the world has never seen before. It took China less than 10 years to double its GDP, while it took Britain 58 years, the USA 47 years, and Japan 34 years (Hou & Hou, 2002). Countries that started market reforms at the same time as China have all seen less growth (Remmer, 1998). There are many speculated reasons for this apparent disparity: in this essay, I will argue that a mercantilist approach to the political economy is necessary for a smooth transition into a capitalistic system with free markets. Drawing from the Chinese case study, I will attempt to identify the characteristics of the reform policies and explain why it has been so successful in terms of economic growth. In the process, I will try to answer questions such as “is creating devolution beneficial to rapid growth?” or “is a strongly autonomous government required to push reforms forward?”

Overall, mercantilism focuses on the “needs of the state” over individual freedom or collective equality (O’Neil, 2007: 98), although historically, there was no coherent theory of mercantilism written by one prominent author (Ekelund & Robert, 1982). The domestic economy is an instrument used to generate wealth to back up political power (O’Neil, 2007: 98). Mercantilist theories view international trade as a zero-sum game: no one country can gain without another one losing (Ekelund & Robert, 1982); this is fundamentally different from the theory of capitalism. Thus, the state has to expand its influence in the world while maintaining its own sovereignty, usually by state intervention into the economy on one hand, and expansion of control into other countries on the other. Centuries earlier in Europe, states used violence to expand into other lands (O’Neil, 2007: 98); now, states use foreign investments and “aid” to gain control over other countries’ economies. Policies usually identified as mercantilist are large trade barriers, a large export surplus, and subsidies for local businesses the state deems as beneficial.

Many have argued that because Western countries used to build their politics and economy with mercantilist characteristics, they have become developed nowadays (Remmer, 1998). I believe this is because free market international trade advocated by capitalism leaves a developing country very vulnerable to the volatile international market and thus has a harder chance to initiate and sustain reforms. A transition economy with new institutions and experimental policies are usually not as resilient to economic hardship as stable and established economies. Therefore, mercantilism’s protectionist tendencies work in helping a smooth transition between a non-market economy to a market economy.

In a mercantilist system, high trade barriers means that imported goods cost much more than locally produced goods. The citizens will naturally buy locally produced goods and thus allows time for industries in their infantry stage to build up. There are three effects that contribute to the building up of a country and its industries: the learning curve, the multiplier effect, and the production of products, not commodities.

The experience curve is an explanation for why industries that have a longer history are generally more efficient at producing goods. The theory states that the more experience the worker has with manufacturing a product, the faster the product can be made, especially for those requiring high technological skill (Hax & Majluf, 1982). Therefore, the newly established industries of any one country cannot compete against foreign competitors who are already very efficient because of more experience, unless the state intervenes and puts up barriers so that the local industries have a chance to become competitive.

The multiplier effect happens when money is kept within a community, instead of flowing out to other countries when buying large amounts of imports. When people are forced to buy from local producers, as in a mercantilist country, the money they spend will “multiply” as it flows through the economy (Halweil, 2002). For example, a consumer buys a product, the company of that product will take the profit and either expand the company or raise the wages of the workers, both which will eventually benefit the local economy. However, when large amounts of imports are bought, the money the consumer spends goes into the hands of the company outside of the country and benefits their locals. It was shown in a study in England that $10 spent local generates a $25 value for the community, while only $14 of value if spent on imported products (Halweil, 2002). This means that a mercantilist policy allows local economics to build up almost twice as fast as a free trade market economy.

The multiplier effect is especially true when a country produces and exports commodities, or relatively raw materials, because the country would lose all the money that can be earned with the added value of processing (Shah, 2007). In many countries, which have been forced to enter the international market recently, have found themselves selling certain commodities and then having to purchase them back from richer countries, which have the ability to process the commodities (Shah, 2007). Therefore, mercantilist policies allow a country to build up its own processing industries so that the country does not have to let the money leave the economy in the future. In order for countries to actually gain from free trade, it will have to export mostly products, not commodities (Shah, 2007).

Transition economies have rarely diversified their economy so much that they have unique products to offer on the international market: they usually produce the same basic commodities, such as lumber or food, as all other transition economies. Thus, they have to all compete in the international market by driving down their price and earning fewer profits (Shah, 2007). Mercantilist political economies have the advantage that the government still has monopolistic control over their economy: no price race to the bottom happens.

Moreover, especially in a country where level of education is low and international perspective narrow, good state leaders have a better sense of how international politics and economies will act, and thus can provide good guidance to companies inside their country. In such a system, autonomy is very important because the reforms needed may not have immediate short term benefits, but are necessary to changing the system.

Thus, with all the potential benefits of using mercantilist policies as a transition tool, I want to investigate under what conditions does mercantilism work? In the literature, leadership commitment, technocratic competence, and societal support are repeatedly cited as the most important factors for mercantilism to work (Remmer, 1998). Also, the characteristics repeatedly highlighted, in different countries, as central to successful reform include concentrated executive strength and autonomy, administrative or technocratic capacity, and limited or fragmented political opposition (Remmer, 1998).

Firstly, an exceptionally strong and visionary leadership is required since “[al]though significant benefits may accrue to society as a whole, policy adjustment involves significant startup costs and the reduction of rents to particular groups,” large opposition may rise in the general population (Remmer, 1998). Especially in the short run, “reforms are likely to cause inflation, unemployment, and resource misallocation as well as generate volatile changes in relative incomes (Remmer, 1998).” In China’s case, a central authoritarian government proved to be beneficial for setting large goals and making sweeping reforms. The government had the capacity to move forward with its policies without listening to dissent from the population, even though the gradual opening of the market meant many people lost their jobs from state owned industries. China is also particular in that the leaders, such as Deng Xiaoping, of the economic reform were severely oppressed during the Cultural Revolution (Y. Li, personal communications, November 8, 2007). These unpleasant experiences probably left the elites with a strong will to plough forward and completely change the market. Also, it is suggested that “weak presidents are likely to see economic reform as a way of enhancing their political position, while strong presidents anticipate fewer gains and/or greater risks from policy innovation (Remmer, 1998).” Since Deng was not the official General Secretary of the party, he may have seen market reforms as a way to consolidate his power as well as bring the country out of an economic crisis.

Also, unlike Mao, the new government led by Deng were mostly university educated technocrats who were willing to look at what China had done wrong during the past years (Y. Li, personal communications, November 8, 2007). They had administrative and technocratic capacity to plan policies that would gradually lead the Chinese economy to be compatible with the international market. The gradualism approach the government undertook required much planning to balance societal tensions from the increasing gap between the rich and poor and market mechanisms. It also helped that China had many previous examples of changes from mercantilism to capitalism, such as the U.S.A and Japan, to learn from, enabling China to avoid major economic crises from problems such as inflexibility in the market.

Furthermore, there was a societal consensus that the reforms the Cultural Revolution brought were not sustainable in the long run. The stagnation of the economy, the increasing scarcity of resources created a common sense of need for change in the people (Y. Li, personal communications, November 8, 2007). Normally, the “logic of collective action biases policy in favor of the status quo and thereby impedes economic reform (Remmer, 1998),” but in China’s case, the status quo was in such horrible shape that everyone believed change can only be better. The dire economic circumstances weakened organized groups, shattered other political coalitions, removed “potential sources of resistance by undermining or destroying rent[-seeking],” thus creating room for “political innovation” and enhanced the autonomy of the political leaders (Remmer, 1998). Although rent-seeking and corruption practices are still prevalent in China today, they have been largely curbed by pressure from the people and power from the state. With the society and the government working with the same vision, China paved a relatively, compared to other states without the historical background of country wide hardship, easy road for market reforms.

After almost 30 years of market reforms that have remained similar to those Deng initiated, China’s economy is booming and will probably continue to do so in the foreseeable future. There are many political strategies China is currently using to continue to protect its market before becoming fully stable. Firstly, many say the pegging of the Yuan to the U.S. Dollar at a constant rate has devaluated of the Yuan and thus make China’s exports artificially cheap. Critics say this provides an unfair competitive edge to goods produced in China and has lured many investors to pour money and technology into China (Hanke, 2005). Technology helps produce products, and as mentioned earlier, products are much more valuable than commodities in an export-oriented market. Secondly, since development is state-led, “China can entice countries with packages of corporate investment, cheap loans and other aid goodies” (Hanke, 2005); an advantage more democratic countries may lack. Thirdly, the Chinese government has invested much money into higher education, especially in the sciences and engineering (Hou & Hou, 2002). These value adding industries will provide a smoother transition from a commodity production based economy to a high technological products producing economy. Lastly, China actually devolved many powers to the provincial and city level governments while maintaining an iron grip on the overall political decisions (Montinola et al, 1996). Some suggest that devolution was in China’s favour because it encouraged competition between regions and thus increased efficiency in making suitable policies (Montinola et al, 1996). Overall, from historical trends, it seems like mercantilism is only a transition phase; it will be interesting, in the future, to see if China, indeed, moves towards a market based economy.

Works Cited

Ekelund, R., & Robert, D. (1982). Mercantilism as a Rent-Seeking Society. Texas: Texas a & M Univ Pr.

Halweil, B. (2002). Home Grown: The Case for Local Food in a Global Market. WorldWatch Institute.

Hanke, S. H. (2005). Stop The Mercantilists. Forbes , 175 (13).

Hax, A., & Majluf, N. (1982). Competitive cost dynamics: the experience curve. Interfaces , 12, 50-61.

Hou, C., & Hou, J. W. (2002). Evolution of economic institutions and China’s economic reform. The Social Science Journal , 39, 363-379.

Montinola, G., Qian, Y., & Weingast, B. (1996). Federalism, Chinese Style: The Political Basis for Economic Success. World Politics , 48 (1), 50-81.

O’Neil, P. (2007). Essentials of Comparative Politics (2nd Edition ed.). New York: W.W.Norton & Company, Inc.

Remmer, K. L. (1998). The politics of neoliberal economic reform in South America, 0-1994. Studies in Comparative International Development , 33 (2), 3-27.

Shah, A. (2007, July 2). Structural Adjustment—a Major Cause of Poverty. Retrieved November 15, 2007, from Global Issues: http://www.globalissues.org/TradeRelated/SAP.asp