Opening the Door to Economic Freedom

January 8, 2004 • Commentary
This article originally appeared in The South China Morning Post on January 8, 2004.

The gradual relaxation of state controls has increased economic freedom in mainland China. In 1980, it rated very low on the Fraser Institute’s economic freedom of the world index, achieving only 3.9 out of 10, compared with Hong Kong, which scored 8.6 and was ranked top. By 2001, however, the mainland’s score had increased to 5.5, but that understates the true degree of economic freedom today. Indeed, if the focus was on the coastal areas alone, one would find a significant amount of economic freedom.

Provinces with fewer restrictions have grown considerably faster than other areas, as indicated by the size of the state sector. For example, Fujian, Guangdong and Zhejiang provinces — where the non‐​state sector is dominant — have vastly outperformed Qinghai, Heilongjiang, and the Ningxia Autonomous Region, where state‐​owned enterprises rule.

Major changes have occurred in the foreign trade sector. In 1978, only 12 state‐​owned enterprises had exclusive trading rights. This year, all firms will have complete freedom to import and export as the result of China’s accession to the World Trade Organisation.

The growth of foreign trade and the expansion of the non‐​state sector have been accompanied by substantial price liberalisation. Nicholas Lardy, of the Institute for International Economics, points out that even as recently as 1999, “market prices prevailed in more than nine‐​tenths of all retail transactions, more than four‐​fifths of sales of farm products, and almost nine‐​tenths of all producer goods sales”. Today, the European Union recognises China as a market economy.

Nevertheless, capital controls still exist, and interest rates are set by government fiat. The interest rate on savings deposits is set artificially low, and state‐​owned banks allocate most of their funds to state‐​owned enterprises at below‐​market interest rates. In such a system, investment decisions are politicised and capital is wasted — non‐​performing loans of the big four state‐​owned banks may be as high as 40 per cent of outstanding loans.

Private firms have been discriminated against, even though they are profitable. That very profitability, however, has given rise to informal capital markets that entrepreneurs in the non‐​state sector can tap. A wide variety of mutually beneficial arrangements have emerged to circumvent state controls. The informal financial network includes trade credit, private brokers, money lenders, credit associations, private money houses, co‐​operative savings associations and so‐​called red hat enterprises (private firms posing as collectives). There is no question that non‐​state enterprises have learned how to work around the rules to acquire capital and expand.

An important step towards strengthening economic freedom in China was taken in August 2002 when the Standing Committee of the National People’s Congress passed the Rural Land Contracting Law. It strengthens farmers’ land‐​tenure rights by prohibiting so‐​called administrative readjustments to land‐​tenure contracts. Local officials will not be able to arbitrarily take contracted land and redistribute it, as they have in the past. Markets in land‐​use rights can now develop more fully, giving individuals the opportunity to increase the value of their land by putting it to more productive use.

As individuals have acquired greater economic freedom in China, they have used it to increase their standard of living and demand greater protection for newly acquired wealth. Extending the range of the market, by limiting the scope of government, will increase freedom and depoliticise economic life. In a market‐​liberal order, where politics is limited to its proper role, people will be free to choose and develop civil society.

Governments that have used laws and regulations to violate individual rights to life, liberty and property have hindered the development of free markets and impoverished millions. The challenge for China is to create a constitutional order of freedom that reflects the consent of the governed and limits the power of government to the protection of persons and property. Expanding economic freedom is an important first step.

In March, the National People’s Congress is expected to amend the constitution to give individuals more secure rights to their legally acquired assets. The proposed amendment states “citizens’ lawful private assets are inviolable”. That change signals greater tolerance for the private sector and is a positive step towards political reform.

About the Author
James A. Dorn

Vice President for Monetary Studies, Senior Fellow, and Editor of Cato Journal