China and India-A Note on the Influence of Hierarchy vs. Polyarchy on Economic Growth

Beginning of article

1. Introduction

Communist countries seem to have an advantage in the early stages of development: they seem to be able to shake up their atrophied social structures and mobilize all resources and start upon a fast lane of growth. However, this strategy puts up inflexible structures and soon meets obstacles it cannot overcome. As a result the frontrunners are overtaken by the former laggards, the open market economies that were slower to take off. This, at least, was how post World War II European experience appeared, where Communist states have managed to sprint into development and growth faster than similarly placed democratic market economies: see Table 1. Yet all European communist economies arrived at a ceiling that stopped their growth and let the market economies overtake them and leave them far behind. (3) Most of them tried to change course and introduce more decentralization and flexibility into their economy without weakening their centralized political structures--but failed. They found it impossible to change their economic regime without ditching the communist party's centralized control. The question arises: can a communist economy leave its economic trajectory, open up and join the new fast lane, without giving up its political institutions? On the face of it the comparison of the paths taken by China and India would seem an ideal response to the riddle, with a resounding positive answer: Yes, the communist development model can be left at will at a convenient junction and transition to market-led growth may be costless. It seems that such a switch by a communist state is much easier than a policy change and an opening up in a democratic country, the largest one that exists, India. My aim in this note is to examine the role of system and policy in this story, where arguably the most important policy decision is the decision about system change. Clearly, the factors discussed below may add to existing explanations of the paths taken by these two countries, and cannot claim to comprehend the myriad of factors that have shaped their development.

China, as a communist state, the first to liberalize its economy without letting go of the tight political control, has become a role model for the few remaining socialist countries. Ever since the accession of Deng Xiaoping to China's leadership slow, hesitant yet consistent steps were taken to permit the entry of non-state entrepreneurship, and later even allowing the privatization of large chunks of its state-owned sector (Economist, 1996d, 1997a, 1997c, 2000; Boltho, 2009). The response of the economy has been remarkable, with an accelerated and enviable rate of growth. A comparison with India may lead to the idea that its success can be credited to the centralized control of the Communist Party of China that may have given it advantages that India lacks because of its democratic and federal structure.

India among the non-communist states is also an exception. It did not follow the development paths of the group of Asian states to its east. India's original growth model relied on import substitution in a closed economy and on an effort to preserve traditional sectors and technologies, while some of its neighbors, the Asian tigers, opened their economies and darted forward. (4) These countries, much smaller than the Indian elephant, managed to sprint ahead to arrive at relatively high levels of affluence during recent decades, while India was lagging behind. Its growth started late and has been accelerating only in the last few years. Was this due to policy choices or to system changes, namely the modification of economic institutions?

My aim in this paper is to examine this question from the point of view of an economic comparativist, and to look at the systemic and policy differences and similarities between these two giant countries and how they affected their development. To point out, in particular, those elements of the systemic institutions of India and China that shape the incentive of entrepreneurs, both inside and outside of the countries, and lead them to take very different choices in each country. It will use some elements of the Koopmans and Montias seminal model of economic systems (1971) and two versions of the hierarchy vs. polyarchy model by Sah and Stiglitz (1986, S&S below). The original model, denoted S&S-M where the M stands for market, it is claimed below, is a good representation of different forms of market organization, while S&S-G, where G stands for government, can represent some characteristics of governmental organization that may effect very different paths of development. In its focus will be the governmental institutions of these countries. Section deals with this theoretical introduction.

The economic histories of India and China, countries that were endowed with their present political regime at almost the same time--1947 and 1949 respectively, is too well known to require detailed presentation. All that will be presented here is a brief set of stylized historical facts, a very concise picture of the history of the institutions of India in Section and those of China in Section . Section applies the modified Sah & Stiglitz model to China, the hierarchy, and India, the polyarchy. Section concludes with some comments on the relevance of the analysis to the study of economic systems.

2. The system as a polyarchy or a hierarchy

Let me recap the simple notation introduced by Koopmans and Montias in their seminal paper (1971):

o = f (e,s, [p.sub.s]),

where e is the environment, s the system, and p the policy, and where the outcome vector o depends on the interaction between the three sets of arguments. We can think of the environment and the system as the state variables, and on system-dependent policies as control variables that affect the system's equations of motion. The latter, besides impinging on the simultaneous outcomes, also affect the environment. Investment and education change the amount of capital and production depletes resources. The system is changed by legislation. But not only: the manner in which rules are enforced may also be a system-changing factor, when enforcement does not conform to the principles that lie at the basis of the formal rules. Thus bribes to corrupt officials enable a party to thwart their enforcement. The perception of the outcomes of given policies, rather than the outcomes themselves, may also affect policies and the development of the system. These dynamic aspects can be put as follows:

[??] = de/dt = g (e, s, [p.sub.s]),

and

[??] = ds/dt = h (o, e, s, [p.sub.s]).

That is, given the environment and the ruling system, policies determine, inter alia, the change in resources and system. Figure 1 depicts the Koopmans-Montias model.

The system is a set of interrelated institutions. We have learnt in the past few decades that the institutions that protect property are arguably the most relevant to our topic. They are the rules of the game that determine the relation between an actor's decisions and her payoff. Assured property rights and the ability to enforce contracts promise the entrepreneur that the fruits of her efforts and the risks she is taking will accrue to her and not to others who might without such protection gain control of her property.

[FIGURE 1 OMITTED]

It is noteworthy that Koopmans and Montias tried to get away from property and ownership as primary system elements. They put the stress on custody instead, i.e., on the relationship of direct control of a resource rather than on its ownership. What we have learned, observing both the continuous attempts at meaningful reforms in communist countries (all of which, essentially, came to naught) and the process of transition in the Soviet sphere, is that ownership and its security are of primary importance. Reforms foundered because bonuses, which were to simulate profits, did not stimulate managers to behave entrepreneurially, and transformation required assured possession before it led to real change in behavior (Keren, 1992). In other words, the importance of the incentives which a system establishes has gained prominence since the pathbreaking work of Koopmans and Montias.

The definition and protection of property is the remit of governmental institutions, and these are the set of institutions that will be at the focus of this paper. They differ greatly between …