Institutional Design for China's
New Economic Growth Model
Joseph E. Stiglitz
Beijing
March 2007
Key Elements of New Model
• Increasing concern about inequality
– Including rural urban divide
• Increasing concern about environment
• Innovation
• Away from export orientation towards
domestic consumption and investment
Objectives
• Not just an increase in GDP
– But sustainable increases in living standards
• Environmentally sustainable
• Socially sustainable
– Better measures (still imperfect)
• Measurement affects behavior
• Green GDP, median income, HDI
• Towards a more “harmonious society”
– Between different parts of society
– Between economy and environment
New Realities
• Growth has not benefited all
– Trickle down economics doesn’t work
• Even high growth does not ensure jobs
– Productivity growth can exceed demand growth
• Current trajectory is not environmentally
sustainable
• Rate of growth of exports not sustainable
– Saturation of markets
– Political backlash
• China has accumulated sufficient reserves to
protect itself against fluctuations
Why Export led growth worked
• Basis of technological advance
– What separates developed from less developed countries is not
just disparity in resources but disparity in ideas
– Transmission of ideas/knowledge better in industrial sectors
(Greenwald-Stiglitz 2006)
• Export industries help create standards
• Strong competition
• Productive capacities expanded more rapidly than
capacities to allocate resources domestically
– Requiring financial system to make loans and get repayment
Today, China is at a new stage…
• Exports are still important
• But broad based financial system is rapidly developing
• And China has made big strides in technological
development
– Technological gap reduced, but still there
– It has been learning to learn
– And is creating the foundations of its own innovation system
• China has shown that it can create vibrant competition
domestically
– But will need to adopt and enforce strong competition laws
– Pressure from some vested interests to look other way, allow
some monopolies, oligopolies (“big players required to compete
in global market”)
Old system was like vendor finance
• Selling goods to advanced industrial
countries, and in effect lending them
money to finance those goods
• But why finance richest country in world to
consume beyond its means, when there
are so many greater needs at home?
• Need to promote domestic consumption
and investment
Promoting Consumption
• excessive savings” as a result of excessively weak social
safety net
• Providing stronger social safety net would thus be a
double benefit
– Especially important in health
• Improved financial system could also strengthen
consumption
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Problem is not lending money, but getting it back
That requires strong financial system
Need to continue strengthening
Warning: exploitive financial institutions, combined with bad
bankruptcy laws, undermining social harmony
Promoting Investment
• Problem today is not so much the level of
investment but its efficient allocation
• Can be perverse incentives
– Short term speculative gains
• Or even incentives that may lead to bad
investment decisions
– Additional revenues for local governments
– Additional jobs
Western Technological Developments May Not
be Consistent with China’s Social Goals
• Pays to much attention to reducing demand for
labor
– Labor viewed mainly as a cost of production
• Implying much effort directed at reducing demand for labor
• If productivity grows at say 5%, then output must grow at
more than 5% if there is to be any employment growth
• From perspective of industrials, higher unemployment has
another benefit—downward pressure on wages
– Jobs are essential for a harmonious society
• Especially when redistributive mechanisms are limited
• Reducing demand for labor lowers wages, benefit to firms,
but with the consequence of growing inequality
• Pays too little attention to reducing the
demands on the environment
– Market based incentives would help
– Carbon tax—makes more sense to tax “bads”
than goods (like savings and work)
• Could provide needed impetus for a global
agreement—around a common tax
• Distortions between market incentives and social returns
– Market prices don’t reflect social costs (environment, jobs)
– Social return of an innovation is its arrival faster than it otherwise
would have occurred; private return is monopoly rents that
accrue to whoever is first
• Innovation is endogenous
– Both level and direction
– Policies can affect both level and direction
– Can have “equality-enhancing” (or even job-inducing)
innovations that are at the technological frontier
• Trade-offs: reducing environmental inputs and increasing other
inputs
• Example: retail innovation in U.S. has been land/resource using
and labor saving
Examples of implications
• Livable cities
• Design of innovation system
• Design of information system
Livable Cities
• Design of cities (urban transportation
systems, parks, etc) has major effect on
quality of life
– Not captured in GDP
• Time spent community
– Including congestion
• Greenhouse gas emissions and other
environmental costs
– Can have immense effect on “environmental footprint”
• Urban amenities
Livable Cities
• Decisions today will have long-lived effects
• Require government planning (zoning)
– Markets by themselves will ignore
externalities
– And there may even be perverse incentives
on the part of markets and some government
officials
– And cannot solve immense coordination
problems
Innovation System
• One of central elements in 11th five year plan is
the design of institutions for China’s distinctive
market economy
• Western system has been highly productive
– Based on strong government support of basic
research
– But also highly distorted
• Expenditures on marketing/advertising vs. research; direction
of research (me-too drugs and life style drugs vs. life-saving
drugs; life-saving drugs for rich vs. life-saving drugs for poor)
• Monopoly system associated with patents means knowledge
is not used efficiently
– And in some cases has actually retarded innovation
– What is needed is a development oriented
intellectual property regime, designed for
China’s stage of development
• As in other areas, one size fits all policies don’t
work
• America’s IP system is not good for America
• And is even more poorly suited for China
– Part of broader institutional infrastructure for
the innovation system
Innovation System
• Portfolio of instruments—patents, prizes, and
government support
• With greater incentives for innovation towards social
needs (reducing environmental impact, creating
employment opportunities)
• With greater incentives for using knowledge (using
competition)
• With greater awareness of the imperfections in the
prevalent intellectual property regime
– The bias towards patenting rather than keeping ideas in the
public domain (it is a public good to challenge a patent)
– The adverse effects of monopolization on innovation
– The change in the system towards a liability system
Innovation system illustrates
several general themes
• Institutional structures that are appropriate for one
country may not be the best for another
– One size fits all doesn’t work
– Differences in circumstances, history
– Differences in objectives
• This is true of property rights system (including
intellectual property rights)
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Even formulation needs to be changed
Responsibilities as well as rights
Key role of restrictions
These are social constructions that need to be adapted to the
circumstances, history, and objectives of each country
Information System
• Good information is essential for the running of
an economy
– Requiring good accounting systems
– Appropriate incentives for information revelation
• Systems of compensation with stock options provides
distorted incentives
• Modern economy is highly complex
– Governments often don’t have requisite information to
make good decisions
– Incentives to provide distorted, partial information
– Need to develop variety of information channels
Information System
• Vibrant, responsible media can play an
important role
– Needs access to information
• Important role of freedom of information acts
– Incentives to act responsibly
• Balanced libel laws
“Crossing the river by feeling the
stones”
• Reflects pragmatic spirit that has guided
China’s transition
• And is partly responsible for the success
of that transition
• Now that China has gone more than half way across the
river, what is on the other side is clearer
– There are many forms of a market economy
• Japan, Continental Europe, Scandinavia, American, U.K.
• And the form of market economy that is sometimes argued for by
“free market” advocates is more extreme than that embraced by any
market economy
– U.S. rejected notion of privatizing social security
– Every country has a large variety of restrictions on property rights and
imposes large responsibilities on property owners
• China can now see that it can make a great deal of
difference the directions which it takes
– What kind of market economy it chooses will affect what kind of
society it will create
• Even as China crosses the river by feeling the
stones, Creating a Market Economy with
Chinese Characteristics that is consistent with
China’s distinct circumstances and values will
require a New Economic Model
– China’s 11th five year plan reflected this New
Economic Model
– I have tried to lay out some of the economic
foundations underlying this New Economic Model