The Needham Puzzle and China’s Renaissance: A New Structural Economics Perspective

1. The Needham Puzzle and China’s Renaissance: A New Structural Economics Perspective Justin Yifu Lin Center for New Structural Economics Peking University

2. The Needham Puzzle and the Rise of China • China was the most industrialized and richest country in the world in the pre-modern times • China lost to the West only after the Industrial Revolution in the 18th century. • China’s weight in world economy was 33% in 1820 and reduced to 4.2% and 4.7% in 1949 and 1978 • According to Max Weber, China was on the verge of an Industrial Revolution by the time of 14th century. • The Needham Puzzle • Why had China been so far in advance of other civilisations in pre-modern times? • Why isn't China ahead of the rest of the world in modern times? • After the transition to a market economy in 1978, China has grown dynamically and its economic weight in the world increased to 18.6% in 2016. China is on the path to achieve the dream of regaining its historical position in the world.

3. I will discuss the following 6 topics in the lecture: • Why didn’t Industrial Revolution originate in China? • How could China grow so dynamically after 1978 • Why didn’t China grow as dynamically before 1978 • Why couldn’t other developing countries grow as rapidly as China • What prices did China pay for its dynamic growth? • Could China continue to grow dynamically? • My arguments will base on the New Structural Economics, which uses the neoclassical approach to study the determinants and impact of structure and structural change in the process of economic development, and draw on the analysis in Demystifying the Chinese Economy and Economic Development and Transition (2007 Marshall Lecture)

4. IWHY DIDN’T INDUSTRIAL REVOLUTION ORIGINATE IN CHINA?

5. What Does the industrial revolution mean? • Conventional definition of industrial revolution: Invention and application of steam engine, mechanization of textile industry, and mass production of steel • A more appropriate definition: a sustained high and accelerated rate of technological innovation

6. Lin’s Hypothesis • The Industrial Revolution is the result of shift in the paradigm of technological innovation • Pre-modern time: experience • Modern times: experiment, especially science-based experiment • China had advantage in technological innovations in the pre-modern times because of its large population, supported by favourable weather and fertile land. • After the scientific revolution in the 15th century, Europe had advantages in technological inventions, because of • the use experiments in 18th century • The use of science to break the barrier for technological inventions after the 19th century

7. Why Scientific Revolution Did Not Occur in China? • The scientific revolution refers to the use of mathematic models to form hypotheses about the nature, and the use of controlled experiments or replicable tests to examine the validity of the hypotheses. • Mathematics and controlled experiments are human capital, which require investment. • China was governed by bureaucrats. Civil service was the most honourable and profitable occupation in China, which attracted the gifted. • Confucian classics was the main contents for civil service examination. There was no incentives for Chinese elites to learn mathematics and controlled experiments • European countries were ruled by feudalistic aristocrats, which were hereditary. There was no disincentive for learning mathematics and controlled experiments.

8. Why Confucianism? • The civil service examination based on Confucianism is an institutional innovation, which contributed to China’s political stability and territory integrity • China was locked-in the civil service examination system.

9. Results of Lacking an Industrial Revolution • China changed from the most industrialised and richest nation in pre-modern times to a backward, poor, agrarian nation in modern times • “In the Dark Ages, the West was basically an agrarian society and, compared to China at that time, poorer and backward.” (Carlo M. Cipolla, European Society and Economy before Industrial Revolution: 1000－1700 AD，New York and London: Norton) • For a century after the 1840s China was a quasi-colony of the West, ceding extra-territorial rights in treaty ports to 20 foreign countries, its customs revenue controlled by foreigner powers, surrendering territories to British, Japanese, and Russian.

10. IIHOW COULD CHINA GROW SO DYNAMICALLY AFTER 1978?

11. Growth Performance after 1978 • Performance in 1978-2016 • Average GDP growth rate of 9.6% • Average Trade growth rate of 14.8% • Results of dynamic growth • Overtaking Japan in 2009 to be the world’s 2nd largest economy • Overtaking Germany in 2010 to be the world’s largest exporter • Overtaking U.S. in 2013 to be the world’s largest trading nation • Overtaking U.S. in 2014 to be the world’s largest economy, measured in ppp

12. Latecomer’s Advantage and Dynamic Growth • After the Industrial Revolution, economic growth in a country depends on technological innovation in the existing industries and the emergence of higher value-added new industries • The advanced countries depend on indigenous invention for technological innovation and industrial upgrading and achieve on average 3% growth annually after the mid 19th century. • A developing country has the latecomer’s advantage in technological innovation and industrial upgrading and can potentially grow faster than advanced countries. • After WWII, 13 developing economies realized a growth performance of 7% or more for 25 or years • China became one of the 13 after transition to a market economy in 1978.

13. IIIWHY CHINA DID NOT GROWTH DYNAMICALLY BEFORE 1978?

14. Catching up Strategy and Poor Performance • The latecomer advantage has existed after the industrial revolution, why China did not benefit form it before 1978? • After the founding of PRC in 1949, China adopted a catching-up strategy to develop large-scale capital-intensive modern industries, which defied China’s comparative advantages, with the hope to overtake the UK in 10 years and catch-up the US in 15 years. With this strategy, • China gave up the latecomer advantages • The government introduced a whole set of interventions to support nonviable firms in the priority industries , causing misallocation of resources • China switched to a comparative advantage- following strategy after 1978 and started to benefit from the latecomer advantages

15. IVWHY NOT OTHER TRANSITION ECONOMIES PERFORM EQUALLY WELL

16. Transition Strategies and Performance • After WWII, almost all developing countries, both socialist and non-socialist, adopted a similar catching-up strategy, formed a similar interventionist economic system, had a similar poor economic performance, and all started a similar transition to a market system in the 1980s and 1990s. • Most other transition economies encountered economic collapse, stagnation, and frequent crises instead of stability and dynamic growth as in China • Most other transition economies adopted a shock therapy to remove all distortions, causing the bankruptcy of nonviable firms and social/political instability • China adopted a pragmatic dual-track approach • Giving transitory protections and subsidies to nonviable firms in the old priority industries to maintain stability • Liberalizing the entry to labor-intensive industries, which were consistent with China’s comparative advantages and were repressed in the past to achieve dynamic growth

17. VWHAT PRICES DID CHINA PAY FOR THE GROWTH?

18. The Prices and the Way Out • The transitory protection and subsidies created rent and rent-seeking, causing • Wide spread corruption • Income disparities • The transitory protection and subsidies were essential for maintaining stability due to old priority industries defied China’s comparative advantage and firms in those industries were nonviable when China was poor. • The transitory protection and subsidies were not essential anymore because most of those priority industries have become China’s comparative advantages due to the fast accumulation of capital as a result of dynamic growth in the past 4 decades. • The 2013 decision to deepen market reforms will remove the remaining transitory protection and subsidies. After completing the reform, China will have a well-functioning market system and remove the root cause of corruption and disparity in the transition process.

19. VIHOW MUCH LONGER WILL CHINA GROW DYNAMICALLY?

20. Will China Continue to be the Engine of Growth in the World? • How much longer China can maintain the dynamic growth depends on how large the latecomer advantage is. • According to Maddison, China’s per capita GDP in 2008 was 21% of the US, which were similar to Japan in 1951, Singapore in 1967, Taiwan, China in 1975 and South Korea in 1977. • The above East Asian economies realized average 8-9% annual growth for 20 years with the latecomer advantage embedded in the above income gap with the U.S. • Based on the East Asian economies’ experience, China has the potential to grow at 8% for 20 years from 2008. • How much the growth potential can be realized depending on China’s domestic reform and the global economic situation. • As long as China continues to deepen the reform and maintain pragmatism in policy making, China is likely to grow at 6% or more and contribute to 30% or more growth for the world in the coming decade

21. VIICONCLUDING REMARK

22. China had advantages in premodern times when technological innovation drew mainly from experiences due to its large population • China failed to have an indigenous Industrial Revolution due to its inability to shift the paradigm of technological innovation to experiment-cum-science as a result of the civil service examination and Confucianism. China became lagged behind quickly after the Industrial Revolution in the West. • China had the potential to grow dynamically as a latecomer in modern times after the Industrial Revolution. • The way to tap the growth potential is to grow the economy according to the economy’s comparative advantage and manage the transition with a pragmatic dual-track approach if some distortions were created due to inappropriate development strategy in the past • China is likely to maintain a dynamic growth in the coming decade if China deepens the reform and maintain pragmatism in policy making • Other developing countries can also grow dynamically if they follow comparative advantages to develop their economy and adopt a pragmatic transition strategy as argued in my 2007 Marshall Lecture (Economic Development and Transition) and the New Structural Economics.