What Hayek can teach Shanghai

By Peter Zhang
web posted December 27, 1999

Bad habits die hard. It is an old saying and one that applies to the Chinese as much as anyone else. Even though Chinese officials are prepared to publicly admit the errors of the past (condemnation is usually quite strident in private) not all the lessons have been learnt. Dazzled by the apparent success of industry policies in South Korea, Taiwan and Singapore, despite the ensuing economic crisis, many officials are drawing the wrong conclusions.

It is true, they opine in private, that Mao's economic schemes were an unmitigated disaster. It is equally true, they willingly concede, that central planning has failed elsewhere and would never succeed anyway. But South Korea and Singpore have demonstrated that there is a role for intelligent state guidance. The crisis is largely dismissed by many offficials as being caused by monetary mismanagement. Though there is considerable truth in this view, it completely misses the point about bureaucratic intervention in economic decision-making.

It is easy to brush aside many Chinese officials enthusiasm for interventionism on the grounds that it is motivated by nostalgia or a desire to justify their function or even strengthen their position in the bureaucracy. Such views overlook the natural attractions of industry policy also holds for many Westerners. The Chinese are no different from anyone else in wishing order in their affairs. One might say that order has been central to making China the world's oldest existing civilisation. But I learnt from the writings of Hayek, as have many Russians and Poles with whom I have spoken, that there is spontaneous order and there is order brought about by conscious design. (Oddly enough, all of the Western journalists I have met have been completely ignorant of Friedrich Hayek's work). The market is a brilliant example of spontaneous order. Unfortunately most Chinese officials and academics are as ignorant of Hayek's brilliant insights as are most Western journalists.

What has brought this to mind has been the worrying emergence of think-big schemes. It is now believed that conglomerates have the strength and flexibility to resist "big tides and waves," what the rest of us call crises, while small companies are simply washed away. They just do not believe that an economy based on small and medium-sized enterprises can support 21st-century economy. That South Korea saw eight giant conglomerates go to the wall during the crisis does not deter these Chinese officials. To them, as to many others elsewhere, it is just a matter of using appropriate guidelines and learning from the mistakes of others.

So entrenched is this view becoming that Shanghai supported efforts by more than 100 large industrial enterprises to become conglomerates by absorbing smaller companies. This process, hopes Hu Xiongfei of the Municipal Economic Commission, will enable these companies to join the world's top 500 companies. For fear of ounding insolent — so what! Hu Xiongfei and like-minded officials have not grasped that size in the market place does not determine success. It's success that determines size. The English economist Ronald Coase revealed that companies expand to the point where the costs of additional transactions exceed their benefits. In granting 'cheap' credit, tax breaks and other favours to privileged companies and hence their directors Hu Xiongfei is making the same terrible mistake South Korea made.

By all means, allow companies to grow and expand their output and range of products by acquiring other companies. But he should learn that size through competition is what really ccounts and not size through favouritism. The huge successful companies that officials like Hu Xiongfei evidently admire started as companies competing in the market place against other companies, many of which were bigger and better established. Nevertheless, by exercising superior entrepreneurship the smaller companies eventually triumphed. This is something we Chinese are famous for. Where ever we go we take risks, set up businesses and become noted for our diligence and entrepreneurial flair. This is our talent. It is inexhaustible, costless and yet priceless.

By giving favours to established businesses in the misguided belief that it is size that matters, that small is an insurmountable obstacle to growth is to misconstrue the nature of economic growth and fall into the economic errors that now rack South Korea. Shanghai is the last place on Earth that needs economic guidance. It is a city with an endless supply of entrepreneurial talent. Encourage and reward that and China will get all the big companies it can be proud of. And they will be companies that have earned their positions and pay their way.

Reprinted with the kind permission of The New Australian.

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