Astro International Interview | Woo.Says Episode 5: “Think You Know How China Got Here?”

Awani International, the global affairs division of Malaysia’s leading news network Astro Awani, continues its signature series Woo.Says, a weekly dialogue between Professor Wing Thye Woo (University Chair Professor at Liaoning University and Distinguished Professor Emeritus at UC Davis) and Melisa Idris (Senior News Editor at Awani International).

China’s rise has been one of the most extraordinary economic stories of our time, but it’s also one of the most misunderstood. In the fifth episode, “How Did China Really Get Here?”, Professor Woo dissects the strategy behind China’s extraordinary economic rise.

Melissa Idris: Why is China’s industrial policy such a key topic in global economics?

Prof. Woo: Because China's experience offers valuable lessons for other developing countries trying to improve their economic welfare. Economic growth comes in two types: "catch-up growth", where poorer countries strive to master the most advanced technologies available to reach the prosperity level of rich nations like the US, Japan, and Western Europe, and "frontier growth," where advanced countries increase their productivity through technological innovations.

To implement catch-up growth, China used a method I call “intelligent copying" which is learning through close observation. China paid close action to the economic policies of successful countries, figured out the economic logic behind these policies, and modified them to be effective under Chinese conditions. "Intelligent copying" has to be differentiated from blind copying, which is replicating what one sees without understanding why something works and what circumstances would not allow it to work. What enabled China to succeed in intelligent copying was an adequately educated populace and a highly capable bureaucracy in 1978, thanks to the vast investment in mass education since 1949.

China has been investing heavily in research universities since 2000. China now possesses world-class capability in many fields in the natural sciences, a feature that has not been achieved by any other developing country. China is now transitioning rapidly from "intelligent copying" to "dynamic indigenous innovations".

Melissa Idris: When you say "copying", is this a good thing? Or, is it a bad thing? How should we think about it?

Prof. Woo: At the micro level, the act of copying may appear to be a zero-sum game between individuals, what one gains, the other loses. However, from the perspective of society at large and at the global level, it is in fact a win–win outcome. Being the cleverest person in the room certainly offers individual advantage. But if everyone else is also clever, I benefit even more, because the others can help me refine and extend my ideas. In general, increasing the proportion of well-educated people by spreading knowledge freely is always a good thing. For example, with more well-educated people around, my children would have more choices in good marriage partners. Ultimately, collective advancement is a synergistic mechanism that benefits all.

Turning to the case of China, the key point is that the country understood the nature of catch-up growth correctly after studying carefully the experiences of its neighbours closely. From Northeast Asia, namely Japan and South Korea, China learned that the private enterprises served as the principal engine of growth not state enterprises. Looking southward, China observed that Southeast Asia, which was significantly wealthier than China in 1978, had benefited greatly from foreign direct investment (FDI) as a catalyst for growth. From these nearby growth experiences, China implemented a series of fundamental policy adjustments.

The first fundamental policy change was to end the domination of state enterprises in most economic sectors by legalizing the establishment of private firms in most sectors and allowing them to grow in accordance with market opportunities. Moreover, the state also set up legal institutions that reduced transaction costs e.g. commercial courts to adjudicate contractual disputes objectively and bankruptcy courts to reorganise failed businesses quickly.

The second major policy adjustment was in administrative procedures. A large amount of economic decision-making powers was delegated to provincial governments. No longer was the central planning agency in Beijing that determined what types of factories would be built in Sichuan or Guangzhou. Instead, provincial governments were entrusted with the authority to make such decisions based on local conditions. More importantly, there was also fiscal decentralization whereby provincial governments had their own sources of revenues beside receiving an allocation from the federal budget. Fiscal decentralization enabled the local governments to have the means to implement the local development plans that they had formulated.

Universities have also benefited from this administrative decentralisation, which increased their operational flexibility. If a university wished to establish departments that mirrored Western institutions in structure or content, it was allowed to do so. This administrative reform created a more responsive and innovative educational system.

The third major policy adjustment was in China’s approach to economic planning. China's deep understanding of the catch-up growth strategies of its Asian neighbours meant that the quantitative targets at the endpoint of the planning period were based on the standard of living enjoyed by Western Europeans, Japanese, Koreans, and Americans. The key adjustment is that these targets would be achieved by market-compatible policies and not by command-and-control methods that suppress the market.

The task of economic planning was to work backward from those targets to the current position to identify the necessary steps required to deliver the desired outcome in a market economy. This development approach of market-based reverse engineering allowed China to formulate a market-compatible package of mutually-reinforcing strategies in areas like industrial development, education expansion, financial sector reform, spatial distribution of urbanization, and technological upgrading.

Melissa Idris: What have been commonly misunderstood about China's development path?

Prof. Woo: The major misconception, particularly in Western analyses in the 1984-2000 period, is the erroneous belief that certain new economic institutions that emerged in China represented new permanent or essential features of the Chinese economy. These features were in fact temporary responses to specific political and economic conditions and were later phased out when those conditions changed. A good example of mistaking some of the transitional institutional forms in the 1978-1994 period as permanent institutional forms is the early economics literature on China’s dual-track pricing system, a hallmark of its gradual reform strategy.

Under the original centrally planned economy, all producers were allowed to buy fixed quotas of various inputs at state-set prices in order to produce an assigned quota of output that was sold to the government at a predetermined price. One straightforward way to marketize an economy is to abolish both the system of state-set quotas for inputs and outputs and the system of fixed state-set prices for inputs and ouputs, and let the suppliers of each commodity sell their products at freely-floating market prices. This method of instant total marketization of the economy has often been called "big bang reform" and, sometimes as, "shock therapy". This quick comprehensive marketization of the economy was exactly what the Polish government did on January 1, 1990, and what the Russian government did on January 2, 1992.

However, China chose a dual-track pricing approach to slowly marketize the agricultural sector in 1978, and to slowly marketize the industrial beginning in 1984. The state retained its quota system: a factory continued to procure its input quota at low state-set prices from the state store but it was permitted to procure additional inputs at market prices. Likewise, the firm had to continue to deliver an assigned quota of its output at low state-set prices to the state store but its above-quota output could be sold for a higher price in the free market. This created a dual price structure, a set of low state-set prices for input and output quotas sold at state stores, and a set of higher market prices for above-quota purchases of inputs and above-quota sales of output.

This dual price structure was maintained by the ration coupon system. The amount of ration coupons for each good equaled the size of the national quota for the same good. The state store would sell the good at the low state-price only when the buyer also submits a ration coupon for unit of that good. For example, each household might be allowed to buy two kilograms of rice per month at the low price at the state store. Any additional consumption had to be purchased from the free market at a higher price. In this way, poor households were protected, while wealthier families could buy more through market channels. This dual price system allowed the state to maintain some price stability while offering incentives for increased production.

This dual price arrangement has been seen by many scholars as a key Chinese innovation for avoiding the dislocation and chaos that accompanied "shock therapy" reforms in other post-communist economies like Poland and Russia. The problem with this interpretation is that it creates the puzzle of why the Poles and the Russians did not adopt the dual price approach in 1990 and 1992 respectively. After all, many Polish and Russian economies had studied the Chinese experience of the 1980s very closely after the impressive 10% growth of post-1978 China. It is facetious to dismiss this puzzle by claiming that the Chinese are just cleverer than the Poles and the Russians.

Melissa Idris: You seem to suggest that a critical part of China’s economic success story has been underappreciated or misunderstood. Could you elaborate?

Prof. Woo: Yes. It is important to note that despite the great praises that many scholars have heaped upon the dual price system, the dual price system had practically ceased to exist after 1994. The dual price system is potentially socially-destabilizing with prolonged use because it incentivizes corruption. A well-connected individual could be tempted to use his status to gain preferential access to the rational coupons, and re-sell the rationed units in the free market at the higher price. The dual price system was a transitional phenomenon because while it is economically stabilizing in the short to medium run, it is socially destabilizing in the long run.

There are several reasons why the dual price method of marketization was not chosen by Poland and Russia in the early 1990s. One important reason is that there is a big difference between the socio-political conditions in China in 1978 and those in Poland and Russia in 1990-1992. The Chinese bureaucracy was functioning normally in 1978 and it could be relied upon for the proper implementation of the dual price system. Poland and Russia had total changes in their government in 1989 and 1991 respectively after a prolonged period of economic decline, and the political longevity of the new governments was very uncertain. Their civilian bureaucracies were barely functioning because the new governments did not have the resources to fund normal government operations amidst the political turmoil and economic collapse. Unlike the Chinese state in the 1980s, Poland and Russia just did not have the administrative capacity in the early 1990s to implement a dual price system effectively.

Another reason why Poland and Russia did not follow China's dual price approach is because the great differences in economic structure between China and these two countries meant that the dual price mechanism could not have prevented the output collapses in the latter. Poland and Russia were already urbanized and industrialized societies in 1990. Their economic flaw was that central planning had made the heavy industrial sector too big and the light industrial sector and service sector too small, making everyday life very inconvenient.

Marketization of Poland and Russia led to structural adjustment which forced labor and capital to move out of heavy industries into light and service industries, going through a phase of high unemployment to effect the labor reallocation. This structural adjustment produced an immediate negative-sum outcome in GDP which changed to a zero-sum process in the short-run, before finally producing GDP growth in the medium run.

China on the other hand was a subsistence peasant economy in 1978. The marketization and internationalization of the Chinese economy led to economic development whereby underemployed, low-productivity agricultural labor moved to high-productivity jobs in the industrial sector – thereby ensuring an immediate jump in GDP – repeating the export-led industrialization experiences of Japan in the 1950s and of South Korea in the 1960s.

Melissa Idris: Would you say that a large part of China’s success lies in its willingness to adopt international norms?

Prof. Woo: Absolutely. Before 1978, China maintained more than an arm-length distance from the global economy. China followed the Soviet practice of being as self-sufficient as possible, and importing only items when it could not make domestically. In the 1978-1988 period, China studied the export-oriented growth paths of Japan and South Korea, noting that they had reinvested export earnings into technological upgrading. The lesson from Southeast Asian industrialization was that multinational firms would bring their technology and capital into countries with cheap labor and political stability, provided that they were welcomed.

Their experiences persuaded China that international trade and market mechanisms were not only beneficial, but also essential for sustained development. China gradually expanded openness to foreign direct investment (FDI), enabling international capital and expertise to participate in its domestic development. It also initiated institutional reforms in state-owned enterprises (SOEs), transforming many into modern corporate entities, some of which were listed on domestic or international stock exchanges. Market valuation and disclosure requirements helped improve transparency and efficiency in enterprise governance.

China systematically adopted and adapted best international practices to be consistent with its institutional setting. This pragmatic approach of balancing state guidance with market dynamics has become a hallmark of China's economic transformation.

Melissa Idris: What does it take for an industry to move from "learning how to make something" to "mastery over the making of that thing"? And how should governments support the process of infant industries becoming global champions?

Prof. Woo: In order to learn how to produce something efficiently and at a lower cost, you first have to produce enough of it. This is the principle of learning by doing, which only works when production level is above a certain minimum threshold. Making only one car each year would not teach a firm how to make cars competitively. But once a firm produces a large enough volume annually, it accumulates practical experience to discover ways to boost efficiency. In short, a successful case of learning-by-doing creates economies of scale.

So, how should a government help producers to learn how to produce cheaper? The usual method is to impose tariffs on imported goods. This raises the domestic price artificially, allowing local producers to earn higher profits and thereby justifying expansion. But this protectionist strategy limits producers to the domestic market, which might be too small for them to reach the necessary scale to learn how to increase productivity significantly. This is precisely the dilemma faced by industries like automobiles or steel in smaller economies such as Malaysia. Without sufficient domestic demand, these industries could not reach the scale needed for learning to occur, and the growth of the industries thus stalls.

One way to address this small country problem is to incentivize production for both domestic and foreign markets. While local producers can charge higher prices domestically under tariff protection, they must compete at world prices when exporting. Since their initial production costs are higher than those of established global players, their governments should provide targeted production subsidies. They do not have to be direct cash transfers, they can take the form of low-interest working capital loans for exporters, and financial support for marketing abroad. The key is to ensure that profitability does not depend on whether goods are sold at home or abroad. With production not constrained by the small size of the domestic markets, firms are encouraged to produce more overall, speeding up their learning process.

Melissa Idris: And what if, after all efforts, an industry still fails to learn to produce more efficiently?

Prof. Woo: This is a situation which many governments mismanage badly. In learning how to produce at the lower cost of foreign producers, two factors are crucial: sufficient quantity of production and sufficient time to learn successfully. A firm might say, “I’m not profitable yet, but give me five more years.” This is a reasonable request as long as there is a clear deadline and a transparent performance criteria.

The real challenge to handling a failed infant industry is political. If the politician who had sponsored the firm were to admit that the firm should be closed, this is a public confession of bad judgement, a potential career-ending admission. Worse still, the industry might start bribing politicians to stay afloat, turning state subsidies into a source of corruption. The politician uses public funds to support the firm, and the firm, in return, finances the politician’s survival.

China, like South Korea, has shown willingness to terminate underperforming sectors. Once the trial period has passed and there is no evidence of learning, policy support is withdrawn. This capacity to make enforce hard budget constraints is what sets ultimately successful countries apart from the unsuccessful ones. But even then, firm closures can only be justified if there are other examples of success to point to, so the government does not appear to be universally hostile to industry.

Melissa Idris: So industrial policy needs not just protection from foreign competition but also a supportive ecosystem?

Prof. Woo: Exactly. Tariffs alone are not enough. You also have to reduce the structural costs of production. Workers need reliable public transportation to reach factories on time, and affordable healthcare to reduce the number of sick days.

Most importantly, the education system must equip them with the right technical skills, and with the ability to acquire new knowledge. A good education system is possibly the most critical long-term investment for successful industrialization and dynamic innovation. The United States has 26 universities ranked among the world’s top 100 universities, China has 5, and tiny Singapore has 2.

Malaysia, in contrast, has only one university in the top 100. In addition to not investing effectively in education, Malaysia also suffers from brain drain. The World Bank reports that within five years after graduation, 20% of Malaysian graduates are no longer in the country. Intellectual synergy within a country is the equivalent of economies of scale in manufacturing. Intellectual synergy is created when there is a a dense concentration of highly educated people who push and help each other toward innovation. In car design, for example, you need electrical engineers, mechanical engineers, industrial designers, and others working closely together. Without that team-based problem-solving capacity, a country cannot compete globally

Melissa Idris: So China’s openness to foreign talent plays a part as well?

Prof. Woo: Yes, absolutely. China has increased its openness to foreigners, not only for capital but also for talent, because it understands a fundamental truth: intelligence is randomly distributed within the global population. If it’s not available domestically, you need to attract it from abroad. Look at the United States, many of its Nobel laureates were not American-born. That’s a lesson worth learning.

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