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Imbalance: Institutions and the Chinese Economy, Past and Present

Thursday, July 25, 2013

China was once the world’s leading economic power, but over time it fell behind the West. Why did this happen? Can it return to its earlier greatness?

In their new book Balance: The Economics of Great Powers from Ancient Rome to Modern America, economists Glenn Hubbard and Tim Kane examine history’s Great Powers in an attempt to learn why they rose and fell. They detect a consistent pattern: states rise on the back of strong economies and dynamic cultural and political institutions, but fall into decline when those institutions stagnate and become inflexible. In chapter 5, “Treasure of China”, excerpted here with minor edits, Hubbard and Kane delve into the remarkable rise, fall, stasis, and comeback of the world’s most populous nation, China.

- The Editors

China is a particularly challenging case study for our thesis that institutional stagnation leads to economic imbalance, which in turn is responsible for Great Power decline. Could there be a more obvious example in history of a country that fell to military conquest by foreign barbarians, not once, but multiple times? Unlike Rome, with its long, slow demise, the history of China seems to reinforce military failure as the key factor in imperial decline, or at least a coequal factor alongside economics.

Regardless of these military incursions, we believe economics is the best explanation for China’s decline. China’s dynasties should not be confused with China itself. The “Great Power” of China — its culture and institutions — survived and even thrived despite the shifting identities of sovereign dynasties at the top. Is the succession of China’s rulers so different from Rome’s many emperors? Indeed, this firmness of Chinese culture explains the perseverance of its great power despite different dynastic heads. The firmness also explains China’s later inflexibility and slowness to innovate economically. Confucianism and the Forbidden City swallowed up successive rulers, transforming them, not vice versa. The Chinese empire itself, like the Roman Empire, only fell once. The difference is that Rome fell to its death, whereas China fell into permanent stasis.

The premise of military failure is flawed because it is superficial. Take a closer look at any of the dynastic successions, and each tells a story of military weakness fostered by economic imbalance. Chinese dynasties often fell as a result of self-inflicted economic woes, most often due to the high costs of a centralized bureaucracy. One great advantage of China’s more open internal geography was that a large state could be unified much more easily than Europe, South Asia, the Middle East, or the Americas, as those areas had thick natural barriers, such as the Alps in the heart of Europe. The ease of unification was also China’s weakness. It made progress subject to the whims of a single ruler, with little comparative feedback. “European-style wars between internal political units became rare in China after 960 A.D.,” explains economic historian Joel Mokyr. “The absence of political competition did not mean that technological progress could not take place, but it did mean that one decision maker could deal it a mortal blow.”

Chinese dynasties often fell as a result of self-inflicted economic woes, most often due to the high costs of a centralized bureaucracy.

This ease of unification helps explain why China was the world’s strongest economy for several millennia. It allowed trade and the exchange of ideas across a wide swath of Asia. Indeed, many believe China could have and should have led the industrial revolution, not England. The late Angus Maddison, a British economist and a world scholar on quantitative macroeconomic history, estimated that Chinese GDP per capita was $450 per year from A.D. 400 to 1000 — roughly a third higher than in Western Europe at the time. Because of its economic advantages, incomes rose steadily until A.D. 1300, to an estimated average of $600. After that, Chinese incomes did not rise or fall for the next five hundred years.

Why Did China Not Grow?

An older, orthodox view holds that China was simply backward compared to the West, a view passed down through nineteenth-century colonial prejudices. This view is, of course, incorrect. But its focus on comparing China to the West obscures the more fundamental point articulated by Mokyr: “The question most in need of an answer is not why China differed from Europe, but why China in 1800 differed from China in 1300.” Something happened, something decisive during the early Ming era, that changed China’s destiny.

In order to understand what changed, we must first examine the true “Great Power” of China: its political and cultural institutions. In doing so, we will see that, for better or for worse, their institutions were heavily influenced by Confucian thought. For while Confucianism has timeless wisdom, in practice in dynastic China it created an overly centralized and rigid political order that was especially vulnerable to capture by special interests more concerned with ideological purity than economic success.

The Great Power of China: The “Confucian Party”

Confucianism is not exactly a religion. But what it lacks in supernatural complexity, it more than makes up for in moral guidance and cultural impact. Confucius spoke of “Heaven” without distinguishing its origin in the natural or supernatural, and he was the first to articulate what we know as the golden rule, though in the negative: “Do not do to others what you do not want done to yourself.” Whatever we call it, the influence of Confucian thought was enormous. In the words of Joseph Needham, the famous British historian, China was for two thousand years ruled by one party, the “Confucian party.”

For while Confucianism has timeless wisdom, in practice in dynastic China it created an overly centralized and rigid political order that was especially vulnerable to capture by special interests more concerned with ideological purity than economic success.

Like any ancient wisdom translated across centuries and languages, Confucianism has elements that can be interpreted to suit the times, though some strong themes have been consistent through the ages.

In particular, Confucius recommends the family as the model for the state, with all the former’s positive and negative paternalistic implications. And, like Plato in ancient Greece, Confucius emphasized virtue and righteousness. According to the Stanford Encyclopedia of Philosophy, virtue in Confucianism is “a kind of moral power that allows one to win a following without recourse to physical force.”

The emphasis on righteousness stands, like much of Christian teaching, in sharp contrast with the supposedly greedy behavior of traders, merchants, and bankers. Agriculture was noble, but commerce was not — a moral theme that seems prevalent in all cultures.

Another essential teaching of Confucianism is that leadership expressed through moral example is superior to rule through law. This principle is contrary to today’s conventional wisdom about the importance of rule of law as a foundation for economic growth, but it served the dynasties well and shaped the development of Chinese institutions.

In addition, meritocracy was one potent guiding principle emphasized by Confucius, one that was often a counterweight to the human tendency toward nepotism and corruption. But Confucian meritocracy was rigid and hierarchical: when asked to explain the principles of good governance by the ruler of the state of Qi, Confucius replied: “Good government consists in the ruler being a ruler, the minister being a minister, the father being a father, and the son being a son.” This reply can be heard as a call for competency, as Confucius disdained rulers not fulfilling their primary obligation of loving the people, but it also comes across as a chilling affirmation of a static hierarchy. Everyone should know their place. This reckoning is the antithesis of institutional experimentation, innovation, and evolution.

Confucianism also comes across as a chilling affirmation of a static hierarchy. Everyone should know their place. This reckoning is the antithesis of institutional experimentation, innovation, and evolution.

Due to its benevolent, top-down Mandarin hierarchy, China “never generated a rule of law or mechanisms of political accountability,” Francis Fukuyama, a renowned political scientist and author of The Origins of Political Order, writes. There were no corporate bodies outside of the state, nor independent cities. This point is vital. The institution of the corporation — limiting liability of the individual — was a keystone institution in Western growth. With corporate protection, entrepreneurs were freed to take more economic risks, to pool their resources while protecting their intangible rights to corporate property. That idea is impossible in a system where all property in the kingdom is the king’s. A corporation expands the scope of profit-sharing beyond the family, which is perhaps why the familial strength of Chinese culture is overly appreciated. Moreover, the corporation enables innovation and competition, and it also normalizes failure without personal bankruptcy, another key to entrepreneurship.

Without these elements of commerce enshrined in law, we cannot be surprised that China’s great inventions were not capitalized privately, specifically that production technology did not shift “from the artisan’s shop to the factory,” in the words of economist William Baumol.

The Rise and Fall of Ming China

The story of Zheng He, the famous Chinese admiral who undertook voyages to India and Africa between A.D. 1405 and 1433 in his massive “treasure ships,” appears in almost any popular account of global economics, and that is likely because its parallel with the explorations of Bartolomeu Dias and Christopher Columbus is so tantalizing. There is also the moral of the story of Zheng He, which to modern readers is simple: isolationism is self-defeating. While it is tempting to be contrarians, we tend to agree with this consensus.

As it pertains to the thesis of our book, Zheng He symbolizes rather perfectly China’s economic imbalance and its political stagnation all in one. The admiral, however, isn’t the principal actor in the story of China’s momentous fall. Rather, it has everything to do with China’s excessively centralized and rigid political institutions. Nevertheless, an examination of Zheng He’s story will crystallize how the failure of these institutions led to China’s remarkable decline, for it was during his lifetime that Ming China reached its zenith, and in the decades after his death that its course toward decline became irreversible.

What made Zheng He’s seven voyages to the West noteworthy was not their originality, but their size. (Chinese ships had been trading profitably with India and the Middle East for hundreds of years). A fleet of 317 junks, with an average crew size of ninety sailors, formed his first voyage from Nanjing in 1405. Its six-, seven-, and eight-masted merchant ships carried tons of silk, porcelain, lacquerware, and more. To put their size in perspective, the largest junks were wider than the ships of Columbus were long.

Zheng He symbolizes rather perfectly China’s economic imbalance and its political stagnation all in one. The admiral, however, isn’t the principal actor in the story of China’s momentous fall. Rather, it has everything to do with China’s excessively centralized and rigid political institutions.

Many historians characterize these voyages as a show of force by an emperor, indeed an empire, with a superiority complex. But this characterization defies common sense as well as archeological facts. These were trading missions.

Zheng He cemented trade relations with Calicut and western India, which was Zheng He’s destination. But he also opened trade with Japan (which had twice resisted massive invasions by the Yuan Dynasty). He cleared the seas of pirates. As a result, China became the economic hegemon of Asia.

Is this imperial overstretch? Some historians contend that the voyages of Zheng He were so expensive that they created a fiscal burden.

Our assessment is that trade is, in the economists’ parlance, the handmaiden of growth. Making the seas safe for trade entails costly public investment, while the gains from trade go much more to the private sector. However, contemporary critics of Zhu Di, the ambitious young emperor responsible for Zheng He’s voyages, focus on imperial politics rather than public finances. The Confucian mandarins distrusted the emperor, and vice versa. Zhu Di forced the mandarins to open the administrative examinations to the public rather than just their own elite families. His most trusted allies were eunuchs like Zheng He. The mandarins schemed against Zhu Di patiently, laying the groundwork for their ascendancy with his successor.

Consider the fragility of the political institution in play after Zhu Di’s death. As scholar Louise Levathes says in her book When China Ruled the Seas: The Treasure Fleet of the Dragon Throne:

Upon becoming emperor, [Zhu] Gaozhi . . . surrounded himself with a group of traditional Confucians, including Qian Yi, his tutor who stressed the importance of benevolent rule, and Yang Rong, another tutor, who believed in curbing the power of the eunuchs and withdrawing from [Southeast Asia]. . . . On September 7, 1424, the day he formally ascended the throne, the emperor issued his first edict, which clearly reflected the philosophy of his tutors and advisers: “All voyages of the treasure ships are to be stopped.”

Gaozhi’s son ascended to the throne less than a year later and reversed that last decision. While also surrounded by the same Confucian advisers, Zhu Zhanji struck a balance between the eunuch faction, which oversaw trade and the military, and the scholar-bureaucrat faction, which administered the state. Zhanji favored trade and openness, but not wars of conquest. Zheng He’s voyages continued for another decade under Zhanji, until 1433, when he died and was buried at sea. Unfortunately, the emperor died three years later, and his successor fell sway to the mandarins. The final termination of exploration and trade was not a fit of pique by an emperor, or a fiscal necessity. It was the consequence of an internal power struggle in an excessively centralized government.

The political institution of Chinese emperorship, designed to serve the greater good, in reality produced a zero-sum struggle for influence among interest groups.

What happened next is fascinating, and a case study in how imbalance leads to decline. A near civil war between the eunuchs and mandarins burned for decades. The tribute trade collapsed. The unrivaled Ming fleet rotted away in port. Meanwhile, people in coastal towns continued to profit from foreign trade for decades, but their prosperity was seen as offensive and threatening by the Ming court. The mandarins did what any myopic, economically ignorant bureaucracy would do: they undercut their potential rivals. So much for benevolence. Levathes describes the situation:

By 1500, it was a capital offense to build boats of more than two masts, and in 1525 an imperial edict authorized coastal authorities to destroy all oceangoing ships and to arrest the merchants who sailed them. By 1551 . . . it was a crime to go to sea in a multimasted ship, even for purposes of trade. In less than a hundred years, the greatest navy the world had ever known had ordered itself into extinction. Why? . . . Seafaring and overseas trade were the traditional domain of the eunuchs, and in striking down those enterprises, the Confucians were eliminating a primary source of their rivals’ power and income.

Luckily, China was blessed with weak neighbors, which insulated it from external threats in the short-term. However, by the late 16th century, the Chinese court realized that external threats came from beyond the neighborhood, even from half a world away. By then, China’s imbalanced and rigid institutions left it incapable of confronting the challenges posed by these foreigners.

The Arrival of Europeans and Chinese Attempts at Reform

The appearance of Jesuits with their mechanical clocks shocked a court that considered its emperor the supreme authority on time and the heavens. The Manchu Dynasty likely felt threatened by superior foreign technology. Confucianism held that foreign barbarians were inferior, but these Europeans brought cannons, kerosene, manufactures, and ideas — astronomy, mathematics, engineering. Manchus reconciled this dilemma by often pretending publicly that there was nothing new or useful in the toys of the Europeans. Internally, however, a battle raged. Some members of the imperial court advocated reforms, but losing these battles often meant personal loss as well.

The mandarin order with all of its well-defined interest groups locked the Manchu institutions into inflexibility. Call it loss aversion on a national scale, or a dynastic collective action problem, but it led to weakness and then exploitation at the hands of imperial Europeans who carved up the Middle Kingdom.

“The would-be modernizers were thwarted, moreover, not only by brittle insecurities but also by the intrigue of a palace milieu where innovations were judged by their consequences for the pecking order,” explains the historian David Landes. “No proposal that did not incite resistance; no novelty that did not frighten vested interests. At all levels, moreover, fear of reprimand (or worse) outweighed the prospect of reward.” In the judgment of political economy, this scenario is prototypical institutional stagnation. The mandarin order with all of its well-defined interest groups locked the Manchu institutions into inflexibility. Call it loss aversion on a national scale, or a dynastic collective action problem, but it led to weakness and then exploitation at the hands of imperial Europeans who carved up the Middle Kingdom.
As it turns out, Zheng He is not the story. Manchu conservatism is not the story. Overstretch is not the story. Rather, the underlying politics explain why decline happened. Emperor Zhu Di’s policies explain China’s economic rise, and his erratic progeny explain China’s fall.

We believe the Ming empire would have continued to expand its power if its political institutions had been stable, perhaps with less centralization.

The thing that truly doomed Ming China was institutional fragility. The Chinese call this the “bad emperor” problem, but even that term doesn’t do justice to the underlying danger of centralization. Bad emperors happen (as do bad U.S. presidents). But like Roman history, China’s history is marked by eras where the checks on imperial power were absent. The political institution of Chinese emperorship, designed to serve the greater good, in reality produced a zero-sum struggle for influence among interest groups.

One of these interest groups, the mandarin scholars who worked to turn the Ming emperors inward, won the short-term game. And they surely believed their policy of autarky was wise. What we see in hindsight is their cultish devotion to heuristics — farmers are noble; merchants are not. We also see that sea trade was creating prosperity for the people in 1436, but mandarins’ benevolence was blind to commerce as a source of wealth.

The rise and fall of Ming China happened quickly. Zhu Di reigned for just two decades, and his grandson for one more. These emperors were followed by instability, which was destructive to Smithian commerce, indifferent to Schumpeterian learning, and chilling to Solovian investment.

Modern China: Correcting the Mistakes of the Past?

China’s economy today has shrugged off many of the habits and institutions of its imperial past, many of which were discarded by Mao Zedong and the much wiser Deng Xiaoping. The modern one-party state cherishes stability, perhaps to a fault, but with great effect. There is administrative balance in Beijing, absent in the fifteenth century, which diminishes the vulnerability to abrupt and doctrinaire policy swings. And yet the Chinese economy remains centrally organized rather than federally, a feature that makes institutional progress less likely. The nation is primed to grow further in the twenty-first century, but there are questions about how high that growth can go without a more open political system. Only time will answer those questions, not history.

Glenn Hubbard is a Visiting Scholar at the American Enterprise Institute and dean of the Columbia Business School. Tim Kane is the chief economist at Hudson Institute and founder of the social networking firm StoryPoint. Henrik Temp, acting managing editor of American.com, excerpted this essay from Balance: The Economics of Great Powers from Ancient Rome to Modern America, published by Simon & Schuster in May 2013. It is reprinted here with permission.

For a look at the book as a whole, check out this video produced by AEI's Anthony Johnson:

FURTHER READING: Dan Blumental writes “Why Isn’t China Democratizing? Because It’s Not Really Capitalist.” Michael Mazza takes “A Look at China’s ‘Political Meritocracy.’” Mark J. Perry explains “Why We Should Thank the Chinese Currency Manipulators.” James Pethokoukis blogs “Has China Been Snared by the Middle-Income Trap? If so, Here’s How It Can Escape” while Claude Barfield asks “Is China Bending on the Pacific Trade Pact?” Phillip Swagel considers “China’s Transition: Three Scenarios,” Michael Auslin writes “Planning for China’s ‘Fall,’” and John H. Makin considers “Is China Slowing Down?

Image by Dianna Ingram/Bergman Group

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