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Capitalism versus capitalism

US should encourage market forces in China rather than battle the power of the state

| North America
Missing in the popular debate about the U.S.-China trade conflict is the deep philosophical difference between Western and Asian capitalist models.   © Reuters

Popular wisdom says that escalating trade tensions between the U.S. and China are driven by sheer national interest. But what is lost in this debate is a profound philosophical cleavage between East and West. Viewed from this angle, current trade conflicts are about more than tariffs, but a clash between Western and Asian capitalist models.

On one side is the U.S., where there is deep-rooted agreement that the market economy should prevail. In trade policy, there should be a level playing field across borders -- with as little distortion as possible. The U.S. has long-standing demands that its trading partners, and in particular China, forego state intervention in the economy.

On the other side, the Chinese government seems to be hesitant to give way to the market fully, let alone rapidly. China sees its tremendous economic progress as a result of strong state guidance in key industries and sees the prevalence and imperfections of the market as a potential source of volatility and instability.

In this context, and in order to understand how trade disputes might be resolved, we have to understand the extent to which Asian capitalism -- while still encompassing wide variations depending upon the degree of the state's role -- has diverged from Western capitalism.

In the West, the original drivers of the market economy were capitalist merchants, with the state playing a secondary role especially in the most advanced economies of northwest Europe, including Britain and in the U.S.

In Asia, while capitalist merchants also played a big role in preindustrial times, the state played a much larger role in the industrial age as successive governments decided that catching up with the West could not be left to the vagaries of the market. Also, with the economic path to development having been sketched by early movers, it was easier for the state to see what needed to be done.

The history in the emergence of capitalism in Japan, Korea and China attests to this diverging path from the West. In Japan, it can be traced to the Meiji era, which heralded the beginning of the country's cultural and societal modernization in the 1860s, prompted by the dismantling of 700 years of bakufu regimes (essentially feudal military government) and the start of trade with the West. Underlying this rapid transformation was the important role of the centralized government, which in turn built an enabling environment for the development of the private sector along with the modern banking system and with it, widespread industrialization.

The roots of capitalism in Korea originated in land reform movements in the 19th century. However, it spread rapidly, if controversially, under the Japanese occupation starting in 1910. In this period, private property rights and personal autonomy started to be legally protected and the modern classes of capital owners and wage workers began to form. Without this seed of capitalism being sowed, the so-called "miracle on the Han River" might have been difficult to materialize later, after the Korean War. The state's strong role and influence over economic development intensified substantially under the authoritarian regime in the 1970s.

In China, the emergence of modern capitalism only kickstarted with the opening and gradual reform of the economy in the 1970s under Deng Xiaoping. Although officially the PRC remains a socialist market economy, at its core lies the recognition of private ownership of wealth and factors of production, including land, through long-term contractual arrangements by the state.

In all of these examples, the Asian model of capitalism is based on the state's active role -- stronger in the countries with socialist traditions, such as China, and less so in others. In this sense, equating capitalism with a traditional market economy may not be appropriate in the Asian context. Rather the key feature underpinning the bedrock of capitalism should be the "private ownership" of wealth and means of production, since without private ownership, there is no incentive to accumulate capital. Asian history has shown that capitalism can thrive under state control, even without full-fledged functioning of Adam Smith's "invisible hand."

The role of a wise state that can minimize inefficiency and reduce waste stemming from market failure has proved to be an effective substitute for market capitalism in Asia.

Certainly, the recent evolution of Asian capitalism in the cases of Japan and Korea testifies that state's role tends to recede gradually as the market becomes mature and well-functioning over time. Also, once the economic catch-up phase of development is over, it is not so clear for a single actor, however powerful, to chart the right course. Rather, bottom-up innovation becomes a critical factor in sustaining the growth and development momentum.

For China to preserve its dynamism, the state will also eventually have to give way to the market. As China's economy expands, the state's capacity will struggle to keep pace with an ever more sophisticated and complex economy. Only the market will be capable of handling the organic task of solving multiple equations at the same time.

Given the inevitability of China's transition toward a market economy, perhaps the most effective way of applying pressure for change is to help foster the role of the market rather than demanding an immediate withdrawal of the state.

Indeed, it is crucial to find ways to incentivize the liberalization of capital and financial markets and foreign investment, instead of penalizing state intervention through trade remedies and retaliatory measures. Bringing the country under the multilateral regulatory framework and implementing international trade and investment agreements will be as important as pushing for irreversible policy reforms to expedite the path for market orientation.

Given the possibility of exploiting loopholes in trade sanctions, such as shipping goods around between different countries in response to anti-dumping threats, it may not be wise to force China to reduce the role of the state in the economy unilaterally. Usually, the Beijing authorities have more alternatives in their toolbox than can be imagined, notably in an array of administrative measures. Once entrenched, these practices, deeply embedded in the domestic economy, are harder to spot and reverse than highly visible trade policies.

More often than not, we tend to commit a mistake by focusing on the tip of the iceberg without recognizing the bigger picture under the surface. Only when we understand the historic and social background of capitalism across regions and countries and its evolving patterns can we truly fathom the underlying source of the current trade tensions and find constructive ways of addressing looming trade conflicts.

Jong Woo Kang is a principal economist at the Asian Development Bank where he studies regional integration, inclusive growth, macroeconomic and trade policies, and aid effectiveness.

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