China's Troubling Lurch Back to Socialism
Friedrich von Hayek described in his legendary book The Road to Serfdom how economic and political freedoms go hand in hand. Socialism leads to totalitarianism. Capitalism leads to democracy. For decades, the Chinese government has acted as if it is immune to Hayek's logic, pursuing capitalism, while maintaining a totalitarian state. But the recent slowdown in the economy finally led the Chinese government to devalue the yuan by two percent on Tuesday, the largest depreciation since 1994. Just last month, the plunge in China's stock market sparked a massive round of government intervention, with the government poised to buy up 12 percent of all free-floating shares in the Shanghai and Shenzhen Stock Exchanges. This lurch back toward socialism is a troubling sign that the Chinese model that has been so economically successful in the past few decades may finally be, as Hayek would have predicted, breaking down.
There is no question that, as the Chinese economy has delivered increasing prosperity to Chinese citizens, they have demanded more political freedoms. But since it is not a truly democratic society, the Chinese government's answer to this demand has been an increasing willingness to respond in an ad hoc manner to mass protests. By reducing public unrest one crisis at a time, and using rewards to quell the troubles, the government has sparked even more protests. In addition, the rewards themselves have often compromised economic freedom.
The Chinese Academy of Social Sciences, a government think tank, reports that "mass incidents" - protests involving 100 or more people - have become much more common. There were two such protests in 2000, but 209 in 2012. Moreover, about 80 percent of these protests were "organized" to some degree: planned ahead, advertised, or even encouraged by certain leaders.
More important, the government is responsive to the demands of protestors. Consider environmental protests for example: protests against pollution, polluting projects, etc. Since 2005, 31 environmental protests were recorded by China Digital Times, a website that aggregates news from the Chinese cyberspace. Out of these 31 protests, 13 were "successful," that is, the government's micro-response was to cancel the polluting projects, improve the production processes, and subsidize the affected residents.
This means that the economic intervention by the Chinese government goes beyond the foreign exchange and stock markets. Since 2000, the number of protests (see figure) has skyrocketed, while China has slipped further behind the rest of the world on the Index of Economic Freedom published by The Heritage Foundation and The Wall Street Journal. Despite the Communist Party's promise to let the market play a more "decisive" role in resource allocation, economic freedom is in retreat in China.
Last month's stock market intervention arrives as the latest in a series of macro-responses to public unrest. It is a troubling metric of how the Chinese attempt to navigate between economic and political freedoms has veered out of control. The government is clearly worried that retail investors (who account for 90 percent of daily stocks turnover) might react to their losses in the stock market by participating in mass protests, especially when they have borrowed money or sold their homes in order to invest. In 2010, driven by the complaints of residents without homes who could not afford to buy, the authorities attempted to curb the surge in home prices, by imposing limits on the number of homes each household could buy. In 2004, to head off potential unrest in rural areas, the government had introduced a program to prop up the prices of agricultural products by buying directly from farmers. The goal of this policy was to ensure that the incomes of farmers kept pace with the incomes of industrial workers.
China reminds us of what Hayek calls "The Fatal Conceit," the belief that the government is better than markets in setting prices, that it can manage a form of "Capitalism Light." But interventions such as these will surely be counterproductive, and will rightly concern both domestic and international investors who rely heavily on economic freedoms. This means that the economic damage from the Chinese government's piecemeal attempts to be more responsive to its citizenry will be significant. We should be glad that the Chinese people are enjoying greater freedom to express their views and influence public policy. However, piecemeal pacification is no substitute for genuine political freedom, and it is in clear conflict with China's transition to a market economy. Hayek would have predicted that the process can only end in two ways: either socialism with totalitarianism, or capitalism with democracy. From today's vantage point, that means we can expect far more turmoil in the Chinese economy in the coming months.