The late Ronald Coase (1910-2013) was one of the most influential economists of the post-World War II era thanks to his insights on how defining property rights tightly and creating high quality legal institutions for monitoring & enforcing those rights could transform economic outcomes for the better. He was awarded the Nobel Prize in Economics in 1991 and 30 years later he co-authored a remarkable book on China titled ‘How China Became Capitalist’ which anyone who is interested in understanding the unravelling of that great country would do well to read.

Coase says that China suffered until the 1970s because Mao concentrated economic power at the Centre (just as Xi appears to be doing now): “As early as 1956, even before China’s first Five-Year Plan (1953–1957) ended, Mao realized centralization of power in the Chinese economy had dampened the incentives of local officials as well as those of the state enterprises in cities and communes and production teams in rural areas. Mao pushed decentralization in 1958, but it was quickly absorbed into the “Great Leap Forward,” when more than 30 million Chinese peasants perished in Mao’s great famine. In the eyes of Chinese economic planners, decentralization was the culprit. Afterward, centralization was restored.

By 1978, the Chinese government came back to Mao’s diagnosis, though its prescription went one step further than Mao’s, since it knew that Mao’s did not work. Mao devolved economic authorities only to provincial and sub-provincial local governments. Now, state enterprises were given some autonomy in their operation.”

Coase then credit China’s economic revival in the 1980s & 90s to Deng Xiaoping’s ‘four marginal revolutions’ all of which basically took power away from the Centre. Alberto Mingardi summarises these in his review of Coase & Wang’s book: “During the 1980s, the Chinese economy was transformed by “four marginal forces: private farming, township and village enterprises, individual entrepreneurship and the Special Economic Zones.” These played a pivotal role in opening up China to the global market economy. Shenzen, in the southeast corner of the Guangdong province, was a poor town before becoming the frontline of China’s economic integration. “China would probably have stayed on the intended path to socialism were it not for the marginal revolutions that reintroduced private entrepreneurship to the economy.”

The change was as much institutional as cultural. On the institutional side, private ownership was restored. On the cultural side, the Chinese political discourse rediscovered the role of thrift, self-reliance and experimentation. Entrepreneurship requires risk-taking. The future is uncertain, therefore, the entrepreneur bets on his forecasts and intuitions.”

However, Coase explains that not everything that Deng tried worked. Specifically, wherever Deng tried to Soviet-style top down dictat driven planning, the results were not impressive. Whilst the starving peasants when allowed to start private farms made a success of it and so did unemployed city residents when allowed to start private enterprises, what didn’t work was state owned enterprises (or PSUs as we call them in India): “China’s reforms of state enterprises as the “central link” of the whole reform program lasted for more than two decades, from the very beginning to 2003. Before the mid-1990s, privatization of state enterprises was strictly prohibited, and reform mainly consisted of delegating some economic rights to state enterprises and giving them some incentives. Even though the state enterprises gained more autonomy and better incentive structures, they were never subject to market discipline. For example, poor-performing state enterprises were not allowed to go bankrupt. Not surprisingly, state enterprises were quickly outperformed by private enterprises, which were poorly equipped in terms of financial and human capital but had to face strict market selection.

In the 1990s, increasing competition from the private sector made more and more state enterprises insolvent, adding financial burden to local governments. This led many local authorities to let go of the state enterprises under their jurisdiction. Since the mid-1990s, the Chinese government started to privatize state enterprises, and the number of remaining state enterprises was reduced dramatically.

Today, the central government controls less than 120 state-owned enterprises, but many of them are state monopolies, still not subject to market discipline. As a special interest group, the remaining state enterprises pose a serious challenge to market order.”

Coase notes that private enterprises with less human and physical capital than the state-owned enterprises did better because they knew that if they did not deliver there was no sugar-daddy waiting to bail them out.

Coase explains that Deng internalised this insight and let competition rip between the different regions in China: “Identified with repetitive investment, regional competition is often faulted for distorting comparative advantage and hindering economies of scale. A more nuanced pictured emerged in our account. What regional competition did was to translate China’s advantage in space as a continental country into the high speed of industrialization. How this happened can best be seen from a Hayekian perspective, which stresses the growth of knowledge as the ultimate force driving economic change. In Maos time, education was under attack and knowledge became a political liability; China isolated itself from the West and cut itself off from its own traditions. Maos radical ideology impoverished the Chinese economy and, worse, closed Chinese minds.

After Mao died, China re​embraced pragmatism. “Seeking truth from facts” became the Party’s new guideline; getting rich became glorious. Then the most restrictive constraint for economic growth was the lack of knowledge. This included technical knowledge, knowledge about institutions — how various market​supporting institutions work, and local knowledge — what Hayek called “knowledge of the particular circumstances of time and place.” The solution to this problem was found in regional competition. When China’s 32 provinces, 282 municipalities, 2,862 counties, 19,522 towns and 14,677 villages threw themselves into an open competition for investment and for good ideas of developing the local economy, China became a gigantic laboratory where many different economic experiments were tried simultaneously. Knowledge of all kinds was created, discovered, and diffused fast. Through the growth of knowledge, the enormous scale of Chinese industrialization made its rapid speed possible.”

As far back as 2011, Coase identifies the issue which in the years to come has become China’s Achilles heel: “The combination of rapid economic liberalization and seemingly unchanged politics has led many to characterize China’s market economy as state​led, authoritarian capitalism, which many people have rightly recognized as fragile and unsustainable. When and how China will embrace democracy, and whether the Party will survive democratization, are the main questions asked about China’s political future. In our book, a different perspective is offered. It provides a different diagnosis of the main flaw of the Chinese market economy: China has developed a robust market for goods, but it still lacks a free market for ideas….

“Seeking truth from facts” is a traditional Chinese teaching, which Deng Xiaoping mistakenly called the “essence of Marxism.” But many facts are still covered in China because a free market for ideas does not exist yet. We are cautiously optimistic that China may well embrace a market for ideas in the decades to come, just like the way it embraced the market for goods in the recent past. As our modern economy becomes more and more knowledge driven, the gains from free exchange of ideas are too great; the costs of suppressing it are too high.”

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