China has once again reached a crossroads on its journey toward inclusive, sustainable prosperity. At the Chinese Communist Party’s congress in November, the new leadership was tasked with plotting the country’s path for the next ten years, which entails modernizing China’s social, political, and economic systems within the constraints of its history and changing geopolitical context.
By any standards, the reform agenda is ambitious – especially given a fragile and unaccommodating external environment. Within the next decade, China’s leaders must design and implement reforms to combat corruption; support migration to cities (such as liberalizing the house-registration system); promote technological innovation; rebalance sources of economic growth; raise environmental and labor standards; and build the country’s social-welfare system, including health care, education, and social security.To ensure a system’s sustainability, its design must account for what Nassim N. Taleb called rare “black swan” events – which, as the global economic crisis demonstrated, do occur, with devastating consequences. But measures to make systems more “resilient” or “robust” would be incomplete. They should not only be able to withstand volatility; they should be primed to profit from stress and chaos.
Recently, Taleb coined the term “antifragile” to describe a system that benefits from inherent uncertainty, volatility, and disorder. He pointed out that, while rigid systems may seem more stable, they are not equipped to cope with unexpected shocks, making them fragile in the long run. By contrast, frequent exposure to localized, temporary volatility forces systems to become more dynamic and flexible, enhancing their capacity to thrive under pressure.
Given this, rather than allowing demands for maximum efficiency to push structures to their limits, redundancies (equivalent capabilities implemented in multiple ways) should be built into systems. These low-cost measures nurture long-term antifragility, while capturing future upside gains that could compensate for black swan events.
Antifragility is crucial in large economies like China, where administration is largely centralized, but activities are dispersed among families, civil society, markets, and the various levels of government. China’s greatest challenge lies in balancing its decentralized, family-based traditions with its centralized governance, thereby developing in its institutions the kind of antifragility that is already present in its culture.
China has been struggling to balance centralization and fragmentation – that is, control and uncertainty – throughout its long history of rising and falling dynasties, domestic decay, and foreign invasion. While the open, meritocratic selection of “scholar-officials” helped to sustain China’s closed dynastic governance structure for more than 2,000 years, it could not offset the system’s growing fragility under the Qing Dynasty, as territorial gains increased the empire’s population from 150 million to 450 million. Rampant corruption, rising social unrest, and the inability to resist modern Western powers ultimately caused the dynasty, and the world’s longest-lasting bureaucracy, to crumble in 1912.
The nationalist government that followed, which established the Republic of China, also failed to address the tension between centralization and fragmentation – what the macro-historian Ray Huang called China’s “mathematical unmanageability.” Indeed, it never developed the property-rights infrastructure or the monetary and fiscal policies needed in a family-dominated agrarian economy with an elite-run government.
By effectively enforcing property rights and implementing national policy, the Chinese Communist Party became the institutional mechanism that bridged the divide between the elites (the Party) and the masses. But, in 1958-1961, excessive central planning to support the Great Leap Forward (Mao Zedong’s intensive campaign to industrialize and collectivize China’s economy) generated systemic fragility.
The situation began to improve in 1978, when Deng Xiaoping began to implement market-oriented reforms and open up the economy, giving China access to new opportunities for economic growth and employment. Through the so-called Four Modernizations, the crucial sectors of agriculture, industry, national defense, and science and technology were strengthened.
At the same time, China was slow to open up its financial system – even as other East Asian economies pursued efficiency by liberalizing their capital accounts in the 1990’s. As a result, when the Asian financial crisis struck in 1997, China was insulated from the volatility that ravaged its fragile neighbors. In fact, the crisis became an opportunity, prompting China to join the World Trade Organization, implement reforms of its financial system and state-owned enterprises (SOEs), list major banks publicly, and privatize civil-service housing.
But many of China’s antifragile measures have been piecemeal and incomplete. The need to overhaul SOEs, for example, remains on the agenda, owing to the power of vested interests that oppose further privatization and market-based reforms.
China’s leaders now must identify the specific areas in which to build antifragility, and approach the required reforms prudently. While they must ensure that reforms are comprehensive, they also must avoid attempting too much too fast, which could trigger resistance from deeply entrenched players or unintentionally trigger dangerous chain reactions.
Fortunately, China’s relatively strong fiscal and foreign-exchange positions can cushion the economy against short-term shocks. And, notwithstanding corruption-induced fragility, the bureaucracy’s capacity to implement policy is sound.
A major challenge will be delineating the roles and responsibilities of the Party, the state, the market, and civil society. Given the government’s proven capacity to intervene, the default option during a crisis has been to rely on administrative measures rather than on market forces. To allow disorderly self-correction by markets would require confidence at all levels of governance, from the central government to village administrations, and among SOEs.
Moreover, China’s leaders must build sufficient institutional power within the judiciary, civil society, and the media to implement the rule of law and enhance long-term antifragility. This entails preventing administrative abuses, establishing a level playing field for SOEs and other companies, and divorcing regulators from regulated entities.
As they undertake structural reforms across multiple sectors, China’s leaders have the opportunity to bolster their country’s long-term prosperity. But success will require striking a balance between maintaining systemic stability and allowing the country’s massive economy to adapt and grow – a challenge with which China has struggled for centuries.
Andrew Sheng, President of the Fung Global Institute, is a former chairman of the Hong Kong Securities and Futures Commission and is currently an adjunct professor at Tsinghua University in Beijing. Xiao Geng is Director of Research at the Fung Global Institute.
Copyright: Project Syndicate, 2013.