Austrian-Style Entrepreneurship Explains Much of China’s Growth.

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Zhang Weiying is a Chinese Professor of Economics who “came across” the Austrian School of Economics. In an article published in Economic Observer on September 4, 2017, he made these points:

· The Austrian School of Economics is the best market theory.

  • It studies the actual market.
  • It gives entrepreneurship central status.
  • It understands economic growth as a continuous process of innovation.

In contrast, neoclassical economics is not a good market theory.

  • It studies an imaginary market contained in the computers of economists.
  • It ignores entrepreneurship.
  • It cannot tell us the true cause of economic growth.

Professor Zhang has pursued an understanding of the true cause of economic growth in China for several years. In 2008, at a Chicago Conference on China’s Economic Transformation organized by Prof. Ronald Coase, he submitted a paper called “The Reallocation Of Entrepreneurial Talent and Economic Development in China.” He presented data that indicated three waves of new entrepreneurship entering the Chinese economy in the 1980’s, 1990’s and 2000’s.

The first wave he called “the rise of the peasant-turned-entrepreneur.” Prior to China’s economic transition, the only channel for any individual with entrepreneurial talent was to work in government. Professor Zhang argues that talented people choose occupations that exhibit increasing returns to ability. That condition holds true in both government and entrepreneurship, so those channels compete for talent. In China before 1980, talent was misallocated to government, because it offered increasing returns to ability, including power, prestige and social status, and there was no private sector where that was the case.

But for many, the government channel was closed off. Specifically, under a strict urban citizenship control system (“Hukou zhidu”) the government and the state sector were closed to rural people. The best the talented people in rural areas could do was to become the leaders of their home villages. With some gradual liberalizing over time, many entrepreneurial village leaders started “township and village enterprises” (TVE’s). They boomed: the number of TVE’s reached 17.5 million in 1990, more than 10 times the number in 1984. Total employees of TVE’s reached 88 million. These enterprises were mainly engaged in manufacturing, transportation and commerce. Zhang says TVE’s “were the major driving force for economic growth” in China in the 1980’s, and helped with “marketization of the whole economy” since they were outside the planning regime.

Zhang calls the second wave of entrepreneurship “officials-turned-entrepreneurs” in the 1990’s. Private firms were legalized in 1998. Some low ranked officials at local levels began to choose private businesses as a better route to returns on their ability. Zhang records two accelerating events for “officials-turned-entrepreneurs”. One was what he calls “the June 4th political event” in 1989. (We call it the Tiananmen Square massacre.) Many officials, sympathetic to the students and possibly even involved in the protest movement, lost their political future. Others, even if they had not made “political mistakes,” lost interest in politics and considered business as an alternative.

The second accelerating event was Deng Xiaoping’s South Visit in 1992, where he argued that a socialist country could also have a market economy. “Building a socialist market economy” became a legitimate goal of reform; registration of private firms became easier; and making a fortune “became a glory for everyone”. Says Zhang,

“…in 1992 alone, there were 120,000 officials quitting from the government and began their own private businesses. In addition, there were about 10 million officials and quasi-officials taking un-paid leave to start up businesses, and thousands of professors, college students and engineers joined them. The success of their businesses induced more and more entrepreneurial bureaucrats into business enterprises.”

These officials-turned-entrepreneurs all were well-educated, with bachelor’s, master’s or even doctorate degrees. They were knowledgeable, well-traveled and well-networked. They created new sectors, such as services, and commercialized the whole economy of China. They capitalized dead assets of urban land and State Owned Enterprises and reallocated them more efficiently. They were the major driving force for the high economic growth of the 1990’s, according to Zhang.

The third wave was what Zhang called “overseas-returned-and engineer-turned entrepreneurs”. This phase was triggered by the internet boom and by China’s joining WTO. Prior to 1998, less than one-third of the Chinese students who went to foreign countries for education returned to China. Since then, the majority of overseas students return, attracted to internet and high-tech industries. In addition, these industries attracted many domestic-made engineer-entrepreneurs. Leading internet and high-tech companies like Baidu, Sina, Sohu, Easenet, Tencent, Shanda, Asiainfo, Dandan, Vimicro and Neusoft were all founded by either overseas-returned or engineer-turned entrepreneurs. The same is true for leading consultancies, venture capitalists and private equity firms. Many of the new high-tech firms were funded by foreign venture capital; their corporate governance is “more transparent” and their property rights are “clearly defined.

In fact, the ascendancy of property rights is the force to which Zhang ascribes China’s economic growth. He states: “….the fast economic development of China has resulted from the gradual introduction of markets and replacing …position-based rights with property-based rights.” Thus, “…China’s miracle has no fundamental difference from that of economic developments in Western developed countries, such as Great Britain during the industrial revolution, and the United States in the late nineteenth and early twentieth centuries.”

Within this phenomenon of economic development, Zhang identifies “entrepreneurial talents” as “one of the most important factors.” These talents have “existed since the birth of the human being.” Before the industrial revolution, they were diverted to “military wars, political struggles and government services, rather than in productive activities.” There was no other option for talented people. “For economic development”, says Zhang, “the allocation of entrepreneurial talents between different uses” is most important. And in China, the most important change is “the reallocation of entrepreneurial talents from government and the agriculture sector to business and industrial sectors”.

“Most entrepreneurial people now create value instead of distributing income and rent-seeking.”

It is the change in property rights that lies behind the rise of entrepreneurship. Property rights are an incentive and accountability system to link one’s action to one’s expected return. When property rights are not well-defined, both price and incentive would be distorted, and entrepreneurs would be induced to do something unproductive.

Importantly, Zhang makes a point that he says is crucial for understanding the growth of the Chinese economy over the three decades he described in 2008: there is no economy in existence today where property rights are completely well-defined. Instead , there is a continuum from complete vagueness to complete clarity. Prices and incentives converge continuously in the right direction as clarity of property rights increases.

“An economy can start to grow as long as the vagueness of property rights is decreasing in the right direction, not necessarily after a completely well-defined property rights system is implemented.”

“China has been moving increasingly to a private property-based economy from a position-based rights economy.”

Zhang contrasts property-based rights with position-based rights. Position-based rights, such as those pertaining to government officials, are “loosely and non-exclusively defined and often subject to frequent administrative changes.” The holders often have discretionary power to change the boundaries of the rights, and only an administrative process (rather than a legal process) can resolve disputes. Rent-seeking activities are “inborn” with position-based rights.

Position-based rights are term-limited and non-marketable. Sounding like Hans-Hermann Hoppe, Zhang points out the implication that “the incumbent holder has only a short horizon of using the position-based rights” and therefore seeks to maximize their personal value during the term in office, “not the discounted present value of long return flows.” In China, the rights attached to a position determine not only authority, but also personal income, perks (such as using a car, and of what type), control benefits and prestige.

Therefore, concludes Zhang, competition for positions is value-destructive. In contrast, competition for property-based rights among entrepreneurs is value-creative.

It is the move “in the right direction,” away from the total dominance of position-based rights to a more favorable view of property-based rights, and the entrepreneurial value-creation associated with them, that has been significantly responsible for Chinese economic growth.

It is reasonable to wonder whether, if Zhang were to conduct a similar study of the US, he would determine whether the balance is shifting, and in which direction.

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