Global Economic Commentaries

David Husband
China: Mass Innovation for Greater Prosperity
April 27, 2015

Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and Change,
by Edmund Phelps
Princeton University Press, 2013
392 pages, $23.51

President Xi Jinping’s Chinese Dream foresees national rejuvenation and building of a prosperous society. The Dream has many dimensions, including inclusive and sustainable growth free of the dangerous pollution so pervasive in China’s major cities, and a stable and unified society free of severe poverty and unjust income disparities. The big question is how the dream can be realized?

In the quest for answers, China would do well to study the findings of Professor Edmund Phelps, the 2006 Nobel Laureate in economics. His recent book, Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and Change, traces the basis for explosive growth in productivity and living standards in the United States and Europe from the 1830s to the 1960s. Despite a revival in population and economic growth during the three hundred year period between the 1500s to the early 1800s, there had been virtually no increase in per capita incomes and overall living standards. Suddenly, however, the United States and Western Europe began to surge. What caused this?

Mass innovation depends on innovative people with expertise and experience to conceptualize new products or methods, to judge whether to attempt to develop the new product or method, to determine whether it is worth financing and whether it is worth trying to market the product or apply the new method. In turn, these attributes depend importantly on the prevailing cultural system – political, economic and social. The economic culture of a nation consists of prevailing attitudes, norms, and assumptions about business, work and other aspects of the economy – impacting participant’s motives and incentives.

As noted by Professor Phelps, China’s economic reformation in 1978 succeeded thanks to a well-entrenched culture tracing back to the 1500s. Yet while China would seem to have a highly dynamic economy, it is still far from being a generally prosperous society (per capita income is about US $6,000). To progress up the income ladder, it will have to do more than copy innovations from other countries. China has been able to acquire and adopt a vast amount of production knowledge from overseas but, as illustrated by Indonesia, Thailand and other relatively slowly progressing middle-income countries, to reach upper income status will require greatly deepening and widening the domestic knowledge and entrepreneurial base. Chinese authorities recognize this and are searching for factors or measures that will promote and facilitate indigenous innovation.

For mass flourishing of indigenous innovation, people have to be motivated and encouraged to innovate – to use their imaginations and knowledge to venture into new ways. Aspiration, curiosity and self-discovery are vital attributes – reflected in the home environment, the educational system, the business world and the political system. A dynamic combination of these attributes unleashes creativity and vision and harnesses it. Potentially countering this, the well-connected in China, those already rich from exploiting imitation, may themselves be slow to encourage indigenous innovation out of fear of domestic competition.

Just as the United States and Western Europe shot to upper income status as a result of mass flourishing of indigenous innovation, so too China (and other developing countries) could benefit in a similar fashion. Professor Phelps draws attention to factors critical for this. A supportive economic culture and institutions need to be in place, including a regulatory and policy framework that promotes and facilitates entrepreneurship. The freedom to own property, to open new companies, to accumulate income earned from a newly successful product and other basic “freedoms” are important. Certain rights are fundamental, including to education (limited under the hukou household permit system), intellectual property protection, business incorporation, access to financing, and political representation (e.g., pushing the public sector to break up domestic monopolies and to support small and medium-sized business interests). The rule of law is fundamental, including contract, limited liability and bankruptcy laws, and protection against fraud. Population density and domestic integration promote and facilitate knowledge generation and sharing, in turn stimulating innovation. Importantly, workers and other resources must have the wage and price signals to prompt their most efficient employment.

In March 2010, former Prime Minister Wen Jiabao stated “The socialist system’s advantages enable us to make decisions efficiently, organize effectively and concentrate resources to accomplish large undertakings.” Professor Phelps reviews and contrasts the three principal state models of the business sector: market capitalism, socialism and corporatism (state direction of the private sector rather than state ownership). China appears to be endeavoring to blend the three. It has invested heavily, notably through its state enterprises, to steer its scientists and engineers to new products (e.g., solar energy and other green initiatives). In Professor Phelps’ words, presumably this reflects the belief that scientists equipped with the tools of their science more effectively advance the flowering of new products and methods than do the diffuse and often misdirected initiatives taken in a free enterprise economy. Economists are generally skeptical of this view. Dismantling the barriers to entry of new firms is one of the key institutional steps for promoting and facilitating indigenous innovation. More generally, a culture of problem-solving, curiosity, experiment, exploration and novelty is more conducive to mass innovation and dynamism.

Professor Phelps concludes that the United States has undermined its innovative leadership through counterproductive public policies in the name of social justice, but at the expense of private investment and incentive. Indigenous innovation in the United States has slowed sharply since the 1970s, together with growth in total factor productivity. He claims that a resurgence in both is critical to inclusive growth and regaining American confidence. While the later chapters of Professor Phelps’ book are perhaps contentious, the book as a whole provides much food for thought. Indeed, Chinese officials would do well to invite Professor Phelps to help them better appreciate his findings.