How Chinese communists hacked western capitalism

The prevailing narrative, corroborated by a “large body of research”, suggests that the rise of China was a consequence of natural comparative advantages that China always had, but that were suppressed by Mao’s regime and eventually released by the post-Mao’s CCP approach. As the story usually goes, you are supposed to attribute the success to a simple reason: Capitalism works, Communism doesn’t work.

This story isn’t wrong, but to assume it tells you everything you need to know about what happened it is misleading. Yes, capitalism indeed is a better system for wealth production than communism. And yes, China indeed had a large population that could become very productive once their supreme leaders allowed them to participate in the global markets. But that alone doesn’t explain why in 30 years their GDP grew at double digit rates and allowed their per capta income to quickly leap frog other developing world candidates like India, Brazil, Pakistan, Indonesia, post-soviet Russia, and to eventually catch up and overtake the US in total GDP. Very few people would predict that was possible in 1985 or even in 1995. But by 2005 it was clearly a possibility and by 2015 it was a foregone conclusion.

God did not create China as the quintessential manufacturing hub for the world, and up until the late 70s they were struggling to even feed their population. So if it is true that today China has more to offer capital in terms of comparatives advantages than a simply regulatory and tax spread, that wasn’t the case since the inception, and through out much of its recent past – and China was still industrializing very fast (even faster than now) regardless of its lacking infrastructure and human capital quality.

Here is something that should be completely obvious but somehow gets denied by the “body of research” – comparative advantages that come from the geographical concentration of capital (e.g. energy and transport infrastructure, skilled labor / human capital, and localized supply chain network effects) can only appear after a lot of capital has been deployed in that area, not before.

After chairman Mao died, Den Xiaoping and the CCP upper echelon didn’t have any of that to offer. What they had was (i) a large pool of unskilled labor barely surviving, (ii) a consolidated single-party regime that ruled with an iron fist, and (iii) the US State Department willingness to make China an ally and prevent them from realigning with the soviets.

They developed a strategy to attract capital that levered what they had available at the time – i.e. cheap labor, and nearly zero tax and regulatory burden vis-a-vis worker safety, worker rights, or environment. That strategy created a large structural advantage (i.e. arbitrage) to those manufacturing segments that could use unskilled labor, or that were very dirty, or both. They attracted this kind of capital first.

That should lead to some gains in prosperity for the population, which under a floating currency regime and relatively free trade, would increase their purchase power of foreign goods and increase consumer imports in China. But that wasn’t the case – the CCP instead ignored intellectual property protections and legalized the counterfeit domestic industry to simply run amok, with the party controlling the USD reserves and foreign exchange rates. That was possible because chinese workers were happy that they now could afford a better living standard (even if their consumer goods were poor quality counterfeit or knockoff brands), which allowed the party elites to use their foreign reserves to (i) import capital assets (i.e. raw commodities and industrial assets), (ii) to buy equity control of companies, as well as land and financial assets in western nations, (iii) fund higher education scholarships for chinese students (whose families were kept as hostages in order to force them to return) and (iv) lobby and bribe politicians world wide (to enable their intellectual property theft, and to create regulatory and tax conditions in their own countries that made China comparative advantages irresistible).

The CCP totalitarian system turned to be a great advantage – despite some inevitable losses from corrupt members, they were largely capable to reinvest most of their own party gains into increasing the party power to produce these capital inflow advantages, which included: (i) creating support infrastructure for industry (i.e. power plants, transportation), (ii) increasing the skill level of their workers (largely boosted by the foreign student program), and (iii) also by bribing and lobbying corrupt politicians in the west to adopt more regulations and to increase taxes, and to keep tariffs low or zero, and manipulating their exchange rate, in order to maintain the capital arbitrage spread that resulted in a massive flow of US and western investments to China.

(Side note: the soviets did something similar in the 1920s, and rapidly industrialized using foreign capital. But that ended with the Great Depression, and with Stalin’s shiftting gears from NEP to a fully centralized economy, after seizing the industrial capacity needed to operate in a more autarkic capacity).

They basically found a way to hack capitalism, and I respect that. The CCP leadership is smart, pragmatic, disciplined and ruthless. You cannot underestimate their long term thinking.

But if you think that China’s rise was just a feel good rags to riches story, where they lifted themselves from their bootstraps by just adopting capitalism and globalization (particularly “free trade”), without being helped by a massive wealth transfer that was facilitated by western politicians and large capitalists, and that ultimately served to squeeze the middle and working class of these countries, you are being naive.

They colluded with the corrupt elites in the West to create an arbitrage that would benefit both the CCP and their elite partners, at the expense of everyone else (i.e. the poor people inside and outside of China). However the poor people inside of China were already pretty screwed by maoism, so this new deal ended up being largely an improvement for most of them. They were oppressed and starving, and now they are oppresed and fat, with a much better living standard overall. The biggest losers were the US and European middle and working classes, who were forced to pay more rent for those who became arbitrageurs of this structural scam.

Libertarians are used to underestimate the economic sophistication of the communist regimes, and to overestimate the wisdom of western free markets to not be captured by their schemes. The Chinese just exploited the greed and corruption of western elites, by creating them a “free profits” opportunity that they couldn’t refuse. And in doing so they convinced all the smart people to deploy their assets there, and now they have options that they didn’t have before.