Institutions, Economic Development, and China’s Development Policy for Escaping Poverty

I recently have had opportunities to reread the works of Professors Erik Reinert and Peer Vries and to reflect on my previous work on the relationship between institutions, economic development, and China’s development policy for escaping poverty. Professors Reinert and Vries have studied, along with a few other distinguished economists and economic historians, ‘poverty traps’ at national and transnational levels for decades (eg, Serra 1613; Landes 1998; Reinert 2007; Reinert 2009; Vries 2013). Both argued that innovation and structural change are the keys to escaping poverty.

Professors Reinert’s and Vries’s work on economic development has brought the work of Joseph Schumpeter (1883-1950) to light. In this blog post, I will review how the work of Schumpeter, Reinert, and Vries helps us explore three key questions: First, what kind of development does a country need to escape poverty? Second, what kind of institutions can promote development? Third, how to develop? These three questions are crucial to understand China’s escape from poverty.

Professors Reinert’s and Vries’s arguments can be well supported by China’s national development policy. Below are a few highlights of rich empirical evidence. In 1984 the Chinese government proposed a development-oriented poverty reduction policy to replace the previous aid reliance policy (Central Committee of the Communist Party of China and the State Council 1984; for critiques of relying on massive foreign aid to escape poverty, see e.g. Moyo 2009; Hubbard and Duggan 2009; Banerjee and Duflo 2011). On 18 January 1992, Deng Xiaoping (1904-1997, leader of the PRC from 1978 to 1989) made a famous speech in his Southern Tour, emphasising that ‘development is the absolute principle’ (fazhan cai shi ying daoli). Since then, China’s economic development has entered a new stage. In 1994 the Chinese government fully adopted the development-oriented poverty reduction policy as a national policy.

Schumpeter made a fundamental distinction between economic development and economic growth. This distinction helps answer the first question. Mere quantitative growth does not amount to economic development: as Schumpeter (1934/2012: 64) argued, ‘add successively as many mail coaches as you please, you will never get a railway thereby’. GDP growth, for example, does not equal Schumpeterian economic development. Economic development ‘comes from within the economic system and is not merely an adaptation to changes in external data; it occurs discontinuously, rather than smoothly; it brings qualitative changes or “revolutions,” which fundamentally displace old equilibria and create radically new conditions’ (Elliott 2012: xix). A country needs this kind of economic development to escape poverty (Reinert 2009).

Economic development needs Schumpeterian institutions. This answers the above second question. Schumpeterian institutions are concerned with the importance of innovation in generating new knowledge and modes of production, which helps move the economic activities to the next ‘stage’ or ‘paradigm’ (Reinert 2000: 11). Schumpeterian institutions focus on production, and this stands in sharp contrast to the view of institutions adopted by mainstream economics, which focuses on the free market and trade and favours export-led and FDI-driven economic growth (Reinert 2006: 2-3). Further, Schumpeterian institutions differ from the world bank’s conception of ‘good institutions’ including those for ‘building market institutions that promote growth and reduce poverty’ (World Bank 2002: III).

Professor Vries also highlighted the difference between ‘growth-promoting institutions’ (I use development-promoting institution below for consistency with Schumpeterian economic development) and ‘good institutions’ as preconditions for growth as understood by the World Bank. Economic growth existed before the formation of ‘good institutions’. He argued:

Many institutions [,,,] which in mainstream institutional economics are regarded as necessary preconditions for growth actually only emerged when the economy already was growing and a certain wealth already existed: they, in brief, often were effect or symptom rather than cause (Vries 2013: 377-378; italics original; see also Chang 2002: Chapter 3)

We now need to think about the third question of how a country can develop. It is important to recognise the process of economic development as ‘creative destruction’: ‘[a] process of industrial mutation…that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one’ (Schumpeter 1943/2010: 73, italics original).  Combined with the answer to the second question, economic development as a process of ‘creative destruction’ can be elaborated as in table 1.

Table 1: Economic development as a process of ‘creative destruction’

Double arrow line indicates a co-evolution process. ‘Institutions and economic activities clearly co-evolve – the arrows of causality necessarily move in both directions’ (Reinert 2006: 10). Single arrow line indicates a causal evolutionary process.

Further, whether due to ‘improvisation and luck’ (Vries 2013: 378) or through purposeful activities, the ‘development state’ plays a crucial in promoting innovation laying the foundational elements for escaping poverty, that is, diversity, competition, and emulation (Reinert 1999; see also Vries 2013: 376). Professor Reinert argued:

[…] the antagonism between state and market, which has characterised the twentieth century, is a relatively new phenomenon. Since the Renaissance one very important task of the state has been to create well-functioning markets by providing a legal framework, standards, credit, physical infrastructure and if necessary – to function temporarily as an entrepreneur of last resort. Early economists were acutely aware that national markets did not occur spontaneously, and they used “modern” ideas like synergies, increasing returns, and innovation theory when arguing for the right kind of government policy (Reinert 1999: 268).

Table 2: The relationship between the state and market

The single line and question mark indicate a non-causal relationship. Double arrow line indicates a co-evolution process. The single line and question mark indicate a non-causal relationship.

The importance of the development state and the mutual relationship between state and market are reflected in China’s development policy. For example, Wen Jiabao (the sixth Premier of the State Council of the PRC 2003-2013) made a speech at the World Bank Global Poverty Alleviation Conference on 26 May 2004, emphasising:

[China should] continue “development-oriented poverty deduction” and enhance the capacity of the poor to escape poverty and become rich […] [We should] adhere to [the policy] that the state plays the leading role, make full use of market mechanisms, and improve the level of self-accumulation and self-development in poor areas by improving infrastructure construction, adjusting economic structure, and developing local resources.

Since how to develop is the central issue or problem of China’s escape from poverty in China’s national policy, it has become a key contemporary research topic. A quick search via the National Library of China using key words such as ‘poverty traps in China’ and ‘escaping poverty traps’ gives at least hundreds of research outputs. Every scholar who studies poverty alleviation in China or China’s escape from poverty would like to give their own answers. I think whether China will continue its past success to develop depends on two key issues: first, whether it continues expanding the ‘market’ to allow exploring, testing and experimenting with different ideas and policies; second, whether the state will continue to promote diversity, competition, and emulation. This will be the subject of my next blog posts.

References

Banerjee, Abhijit and Duflo, Esther (2011) Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty. Public Affairs.

Central Committee of the Communist Party of China and the State Council (1984) ‘Notice on Helping Impoverished Areas As Soon As Possible (Guanyu bangzhu pinkun diqu jinkuai gaibian mianmao de tongzhi), the Gazette of the State Council of the People’s Republic of China, 1984,No. 25.

Chang, Ha-Joon (2002) Kicking Away the Ladder: Development Strategy in Historical Perspective. Anthem Press.

Elliott, John E. (2012) ‘Introduction’ to Joseph Schumpeter, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle, 16th edn. Transaction Publishers, vii-lix.

Hubbard, R. Glenn and Duggan, William (2009) The Aid Trap: Hard Truths About Ending Poverty. Columbia Business School Publishing.

Landes, S. David (1998) The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor. W. W. Norton & Company.

Moyo, Dambisa (2009) Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa. Farrar, Straus & Giroux.

Reinert, Erik S. (1999) ‘The Role of the State in Economic Growth’, 26 Journal of Economic Studies 4/5: 268-326.

Reinert, Erik S. (2000) ‘Karl Bücher and the Geographical Dimensions of Techno-Economic Change: Production-Based Economic Theory and the Stages of Economic Development’ in Jürgen Backhaus (ed), Karl Bücher: Theory-History-Anthropology-Non Market Economies. Metropolis-Verlag, 177–222.

Reinert, Erik. S. (2006) ‘Institutionalism Ancient, Old and New: A Historical Perspective on Institutions and Uneven Development’, UNU-WIDER (World Institute for Development Economics Research), Research Paper No. 2006/77.

Reinert, Erik S. (2007) How Rich Countries Got Rich…and Why Poor Countries Stay Poor. Carroll & Graf Publishers.

Reinert, Erik S. (2009) ‘The Terrible Simplifiers: Common Origins of Financial Crises and Persistent Poverty in Economic Theory and the New “1848 Movement”, DESA Working Paper No. 88.

Reinert, Erik S. & Xu Ting (2013). ‘Declining Diversity and Declining Societies: China, the West, and the Future of the Global Economy’, the Uno Newsletter Working Paper Series2(13), 1-21.

Schumpeter, Joseph (1934/2012) The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (16th ed). Transaction Publishers.

Schumpeter, Joseph (1943/2010) Capitalism, Socialism and Democracy. London and New York: Routledge.

Serra, Antonio (1613), A Short Treatise on the Wealth and Poverty of Nations, edited by Sophus A. Reinert. Anthem, 2009.

Vries, Peer (2013) Escaping Poverty: The Origins of Modern Economic Growth. V&R unipress GmbH.

Wen Jiabao (2014) speech at the World Bank Global Poverty Alleviation Conference on 26 May 2004.

World Bank (2002) World Development Report 2002: Building Institutions for Markets. Oxford University Press.

Ting Xu is Professor of Law at the School of Law, University of Essex. Her research focuses on comparative property law; Chinese law; law, governance and development; and political economy. She tweets at @TingXu7.

Photo by Denys Nevozhai.

5 thoughts on “Institutions, Economic Development, and China’s Development Policy for Escaping Poverty

  1. I think we need more illustrative examples of “Development- promoting’ institutions’ from China. How do they differ from ‘good institutions’ of world bank variety? Then we can ask how such institutions could make an impact in other poor countries. Are they unique to China?

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  2. […] This interesting post by Professor Ting Xu from the Developing Economics blog reflects on the realities of development as a process of Schumpeterian creative destruction, and the institutions which can promote this process, with an emphasis on the relationship between the market and the developmental state. Historically, successful developmental institutions have tended to be different to those considered in mainstream economics discussions. The post also discusses how these ideas apply to the experience of China and its policy aim of escaping poverty. […]

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