Useful Chinese lessons for the world's economists

In contrast, the so-called market reforms of the US and UK financial systems in the 1980s and 1990s sharply cut the savings rates. Just as bad, they directed capital primarily to monopolistic firms, which earned high profits for their owners but were not best for society.

A fundamental problem is that pure markets lead to less investment than would be optimal.

It is crucial to distinguish between return to capital and return to capital owners. Return to capital owners does not equate to the total value of capital investment for society as a whole. Without government intervention, capital owners will systematically underinvest and, also, will direct their investment toward companies or industries with monopolistic returns.

First, the most profitable investment is into monopolistic companies. Any business school strategy course focuses on ways a company can achieve bargaining power, which is just another term for monopolistic profits. Warren Buffett's statement that he invests only in companies with a "moat" also emphasizes the importance of monopoly positions to capital owners.

Monopolist firms make profits, but they charge higher prices to consumers and they underinvest. Maybe worst of all, they take capital away from the everyday industries in competitive markets that are the backbone of the economy.

The second reason that markets lead to underinvestment is that new equipment and factories benefit society and other companies. These positive externalities will not be considered by capital owners.

Research by Bradford DeLong and Larry Summers calculated that positive externalities are 25-35 percent of the total return on investment. China's many industrial clusters are perfect examples of this.

Investment in plant and equipment makes it possible for workers to find jobs and build human capital in new industries. As the companies invest more, workers "learn by doing" and are thus able to prepare for new, higher value positions. This positive loop is key to the kind of national search for new types of comparative advantage emphasized by Peking University economist Justin Lin.

Another key factor in development is having a government focused on economic growth. Until recently, local government officials in China were judged primarily on their success in pushing business in their areas. Of course, this led to some malinvestment and ecological damage, but it must be credited with greatly improving the lives of Chinese people.

In contrast, Morton Horowitz' well-known book, The Transformation of American Law, 1870-1960, documents how the US legal system moved its focus away from economic development. This may have led to some social improvements, but it reduced the total growth of the US.

We have also learned that the institutional "reform" part of China's development strategy is as important as the opening-up part.

When I was in graduate school, most economists believed that opening up the economy to market forces would be transformative by itself. There were institutional economists, mostly following the work of Nobel-prize winner Douglass North, who argued that legal and political institutions matter, but they mostly argued that institutions leading to growth had to be based on some version of English common law. But, China's gradual and more organic reforms have created a system that works.

Contrast this with the disastrous "shock therapy" recommended by American economists and implemented in Russia in 1992-93.

Even the much-maligned State-owned enterprises contributed to development. Many are in upstream industries that provide the basic materials entrepreneurs need to build their businesses. Plus, in my experience, they are more efficient than monopolistic firms in the US. I've received much better service from China Mobile than from any of the wireless or broadband oligopolies in the US.

In the future, the Chinese SOEs, which are seen as providing a public service critical for future growth, are much more likely to implement 5G quickly nationwide than the American firms.

The decision to keep out the global tech monopolists, especially Google and Facebook, allowed China to develop an independent tech industry.

Now, we are in the midst of another iteration of the Chinese economic model. The higher wages make it essential that Chinese manufacturers move to higher value-added industry. Plus, China's infrastructure is now world-class over most of the country, so further infrastructure investments will not be as useful or essential as they have been over the last 20 years.

A recent study by the Development Research Center of the State Council, China's Cabinet, predicts a sharp fall in investment as a percentage of GDP in the coming decade.

Consumption will continue to grow rapidly. Already, half of manufacturing investment is going into technological transformation, according to the study.

Upgrading labor skills and independent technological development will be key to the next stage. And, government officials are now being graded on quality of life, including environmental protection, not just raw GDP growth.

Following the 70th anniversary of the founding of the PRC I'm looking forward to seeing the next stage of reform and development as the country moves to homegrown technology and higher quality growth.