As China’s economy steadily grew in recent decades, its advocates championed the country as an antithesis—and an antidote—to liberal economics and politics. This argument seemed credible as China grew rapidly under an autocratic and economically statist system. At the same time, the United States—that beacon of Western democracy—was suffering from economic and political sclerosis.

This contrast between the Chinese and U.S. systems, and their disparate performances, led to questions regarding the effectiveness of the Western model of free markets and liberal democracy. Perhaps, as some observers have argued—including, most recently, the economist Keyu Jin—the Chinese economic miracle could be evidence of an alternative playbook to that which enabled the West’s success. China has risen, in this view, thanks to the power of statism and the wisdom of Confucianism craftily combined with the efficiency of the private sector. As China’s growth rate consistently averaged nine percent a year, the basic ingredients in standard economics came into doubt. Perhaps market finance, the rule of law, and property rights were unnecessary and, from the perspective of Chinese culture, undesirable and counterproductive contrivances.

These arguments have become less credible lately, as Chinese growth slows and capital flees in search of overseas havens. In August alone, capital outflows amounted to $49 billion. Chinese capitalists are leaving, too, fearful for their safety and the security of their property. At this moment of maximum statism under Chinese President Xi Jinping, the country’s growth is faltering badly, revealing the effect of an increasingly interventionist government. Contrary to the widespread view, China’s economic miracle happened because the government retreated from the commanding heights of central planning and left room for the market economy. Economic statism is not the savior of the Chinese economy—it is an existential threat to it.

STATE OF PLAY

Many have sought to use China as an advertisement for statism, but the country’s economic success actually had little to do with it. Although Confucianism and statism are perennial features of the Chinese system, the economy’s superlative growth only began in 1978, after the Chinese leader Deng Xiaoping launched a program of economic reforms. These reforms were, in many ways, utterly conventional—slowly opening the Chinese market to the world, allowing greater entrepreneurship, reducing government price controls, and privatizing state-owned industries—and their collective effect was a reduction of the power of the state. Rather than China’s growth being a testimony to the expanding power of the state relative to the market, the opposite is true.

This can be seen through a study of the first phase of significant Chinese growth in the 1980s. It was powered by small-scale rural entrepreneurship. Tens of millions of entrepreneurs from humble backgrounds built factories that flooded China with consumer durables, construction materials, food, and labor-intensive goods. This miracle owed nothing to the wisdom of the Chinese Communist Party, as Deng acknowledged in 1987. Hailing the rural economy as “our greatest success,” he declared that it was “one we had by no means anticipated. . . . [These enterprises] were like a new force that just came into being spontaneously. . . . The Central Committee [of the Chinese Communist Party] takes no credit for this.” The Chinese state endorsed—or benignly neglected—the spontaneous, bottom-up explosion of rural entrepreneurship, and the reformist leadership deserved full credit for not stifling it. The virtues of omission, however, should not be confused with those of commission. The Chinese economy took off because the state let go, not because it intervened.

A comparison of Chinese regions also shows this to be the case. The regions that have performed most strongly economically since 1978, including Guangdong and Zhejiang, have been the most market-oriented and have experienced the least state interventionism. On the other hand, those regions in which the state intervenes the most, such as in China’s northeast, are mired in high debt and struggle with lower rates of growth.

SAFETY AND SECURITY

Classic economic theory holds that, in order to create the conditions conducive to economic growth, entrepreneurs need strong property rights. Yet China has never had these. Their absence has fed the myth that China grew because of statist finance and industrial policy.

But a study of the historical record reveals the flaws in this assumption. In 1979, the Chinese government released the capitalists who had been imprisoned during the Cultural Revolution. These businessmen then had their confiscated bank deposits, bonds, gold, and private homes returned to them. This episode shows that—although China has never had a U.S.-style constitution—Beijing moved away from Maoist totalitarianism under Deng, thereby instilling a sense of security and confidence among Chinese entrepreneurs.

Under Xi, this has changed. Chinese capitalists have once again been marginalized, harassed, sidelined, and arrested. An extreme instance of this treatment occurred in July 2021. Sun Dawu, an agriculture billionaire, was sentenced to 18 years in prison, ostensibly for violating land regulations but, in reality, for his outspokenness. China is moving backward, toward the Cultural Revolution, and away from Deng’s reforms, a development not lost on Chinese entrepreneurs. They have become reluctant to invest and are trying to move their capital abroad. Far from reaping a reward, Beijing is paying a price for its lack of the rule of law.

THE ISLAND ENGINE

Hong Kong has always been an outlier. From the end of British rule in 1997 to the enactment of the National Security Law in 2020, the city preserved property rights, a free press, and the rule of law. Many high-tech Chinese firms, recognizing the desirability of this business environment, established Hong Kong domiciles. The territory has always been the largest investor in China, though many Hong Kong investors are Chinese firms. These companies established themselves in Hong Kong to acquire its legal protections and enjoy asset security. They then plowed their capital into China. This kind of institutional laundering was legally ambiguous, but for many years the pragmatic reformist leaders chose to look away, allowing Chinese entrepreneurs to enjoy Hong Kong’s rule of law and market finance while building their businesses in China.

Hong Kong’s advanced capital market—and access to global capital in general—funded the early rounds of Chinese high-tech startups that began in the 1990s. Before the rise of China’s own venture capital industry, foreign capital was needed to fund Alibaba, Baidu, Tencent, and many other high-tech startups. Much of the money came through Hong Kong. This was a globalization story par excellence credited to China’s open-door policy; to the knowledge and expertise of foreign capital; and to the hard work, ingenuity, and vision of Chinese entrepreneurs.

The forces that created China’s high-tech economy were the same as those responsible for the rural miracle of the 1980s. Both low- and high-tech Chinese entrepreneurship were caused by liberalization—globalization for the high-tech sector and financial reforms for the rural sector. Statist finance, eviscerating the autonomy of Hong Kong, and a retreat from globalization can only undermine the vitality of Chinese entrepreneurship and China’s growth engine.

THE INFRASTRUCTURE MYTH

Statism has been crucial in building China’s impressive infrastructure. But there is an inconvenient truth: the Chinese economy took off well before the gargantuan expansion of infrastructure in the country. The large-scale building of Chinese highways, for example, happened in two waves—one in the late 1990s and the other after 2008. In other words, China built its infrastructure after more than two decades of rapid growth. Growth enabled savings and raised government revenues as well as land values, and it funded state projects. Statism did not give rise to growth; growth gave rise to statism.

Infrastructure is beneficial to growth. But the Chinese infatuation with it poses a threat to future economic prospects. Continually building roads, railways, and ports has plunged China into precarious indebtedness, and because of this infatuation, Beijing has chosen to invest in physical infrastructure at the expense of education and health in rural China. This prioritization has already had damaging effects. For example, the poor state of China’s primitive rural health-care system in part justified the draconian COVID-19 measures in 2022, inflicting severe and possibly permanent damage to the Chinese economy.

China has also underinvested in its human capital relative to the size of its population. Among middle-income countries, China has the lowest proportion of high school graduates in its labor force, according to research done by Stanford University. There is the increasing possibility that the Chinese economy may stagnate, as growth stalls. Should this poor economic performance become prolonged, the Chinese brand of statism will be to blame.

VANISHED PRAGMATISM

Chinese success is not a story of laissez-faire capitalism but one of gradual and pragmatic liberalization. That spirit of pragmatism has largely vanished from China. Since 2013, the Chinese government has adopted a statist view of economic growth. At the same time, an obsession with national security matters has weaponized the state at the expense of the private sector. Beijing has betrayed and rejected its own success formula, and the economy is paying the price. Ultimately, it is the Chinese people who will suffer for as long as their government gets wrong these basic economic decisions.