Capitalism with Chinese Characteristics

The Zhejiang model, 20 years later

In 2008, Yasheng Huang published a book entitled Capitalism with Chinese Characteristics: Entrepreneurship and the State, based on research he had done in the early 2000s—which is ancient history in a country like China. In this post, I’ll review the model and update its relevance for today. Here’s Huang, from a Financial Times essay published in 2006:

During his recent trip to China, Hank Paulson, the US Treasury secretary, made his first stop in Hangzhou, capital of Zhejiang province. This carefully choreographed trip was thought to signal where Mr Paulson thinks the country’s future lies.

This is a long overdue approach. Unlike his predecessors, who liked to tour the skyscrapers in Shanghai, Mr Paulson understands the China miracle – that its impressive development came from the same dynamics that create growth and wealth elsewhere, namely bottom-up entrepreneurship and a market-based financial environment. It is time to get the China story right and understanding the rise of Zhejiang is the way to do it.

In the 1970s, Zhejiang was ranked in the middle of the country in terms of per capita gross domestic product; today it is number four, after Beijing, Tianjin and Shanghai. To some extent, this is an unfair comparison. The three regions above Zhejiang are cities and do not have an agricultural sector. ­Zhejiang, while heavily industrialised, still has a substantial rural population. In a like-for-like comparison, Zhejiang is the richest province in China.

But even this GDP comparison understates the achievement of Zhejiang because GDP may not reflect accurately the wealth of a country or a region. Many of the economic practices in China, such as forcible demolitions of residential houses to make way for government projects, can temporarily increase GDP growth but have a devastating effect on wealth creation. Because it is more market-driven, ­Zhejiang has avoided some of the most egregious mistakes of this kind.

Let us look at some other indicators of wealth creation. In 2004, according to data released by the Chinese government, urban residents in Zhejiang earned an interest income that was 4.5 times that of Shanghai and a dividend income that was 5.3 times. Why is there this difference between Zhejiang and Shanghai despite the fact that Shanghai has a higher per capita GDP and many more skyscrapers so admired by foreigners? The answer is that many more people own and operate successful small businesses in ­Zhejiang. According to the same survey data, Zhejiang has an entrepreneurial population 3.4 times that of Shanghai on a per household basis.

(Reading this makes me nostalgic for the time when the US government wasn’t trying to destroy China’s economy.)

If you visit Hangzhou, be sure to check out the beautiful West Lake area:

The following is from a much longer blog post that I wrote back in 2009:

My favorite Chinese economist is Yasheng Huang at MIT, who did a fascinating study of the provinces that border Shanghai; Jiangsu to the north, and Zhejiang to the south. He observed that both had similar histories of being relatively prosperous and open to trade. When the economic reforms started in 1978 Jiangsu had the 3rd highest per capita GDP (excluding urban provinces like Shanghai), and Zhejiang was 7th. In the 1980s, however, the provincial leaders in Zhejiang province were much more encouraging of private business. Although we think of the economic reforms starting in 1978, a huge ocean liner turns very slowly. The government of China does not just wave a magic wand and order changes, rather change often bubbles up from the bottom. So the leaders of Zhejiang province, and even more so the early entrepreneurial pioneers in business, were risking their lives. Just imagine if China had decided to abandon the economic reforms and go back to the Cultural Revolution.

BTW, a brief digression that libertarian readers might find inspiring. The rural reforms began in late 1978 in a single village in Anhui province. Each family in the commune was assigned their own plot of land. This decision was incredibly risky, so everyone took a blood oath to secrecy. Gradually other villages started to copy them. When the government saw that the reforms were successful, they eventually gave them their blessing. But it was not the sort of top-down change that is often portrayed in the West. It was the Chinese people that took the lead, and the leaders followed. In an earlier post I called this agricultural reform the single best thing that has ever happened in world history.

Yasheng Huang points out that the 1980s have been widely misunderstood. The industrial revolution occurred mainly in the countryside, where free enterprise was encouraged. (He points out that the name “township collective” was misleading, and fooled Westerners into thinking they were public, not private enterprises.) These reforms actually led to a reduction in income inequality in the 1980s, not the increase many Westerners assume occurred. Why? Because the growth was fastest in rural areas that had been much poorer than the cities. Of course since 1990 the cities have grown faster, and income inequality has indeed worsened. Huang argues that that is because government policy favored the cities after 1990.

Back to Zhejiang. After the party leaders adopted a business-friendly policy, economic development in Zhejiang province took off. Since 1978 Zhejiang has gone from 7th to 1st in per capita provincial GDP, while Jiangsu, which has also grown fast, stayed at 3rd. But the most interesting part of Huang’s argument concerned foreign investment. Which province do you think attracted the most foreign investment? Surprisingly it was Jiangsu, the slower growing province. The reason was that after the economic reforms began the central government provided secure property rights for foreign investors in all of China’s provinces. In contrast, property rights for local business was much more iffy. So much so that many of the most famous “Chinese” corporations are actually incorporated in Hong Kong, which although part of China has a very different legal system.

Then Professor Huang applied a Ricardian comparative advantage model in a very ingenious way. He noted that if Zhejiang province was very private business-friendly, and both provinces were equally welcoming to foreign investors, then Jiangsu province would have a comparative advantage in attracting foreign business. But since Zhejiang province welcomed all types of business, it had a more efficient economic policy regime and would be expected to grow faster. And that is exactly what happened. Jiangsu attracted much more foreign investment, but Zhejiang grew faster.

I recently did some research with a Chinese PhD student named Tanyue Sun. She built a panel data set for 6 cities in the two provinces, and we found that the difference between Jiangsu and Zhejiang was even more dramatic if you looked at personal income, rather than GDP per capita. In relatively market-oriented cities in Zhejiang province, such as Wenzhou, the firms are mostly owned by locals, and GDP per person is only slightly higher than the personal income per person. In contrast, in a Jiangsu city like Suzhou, much of the industry is foreign-owned and GDP per person is roughly 3 times higher than personal income per person. The people in Suzhou produce a lot of output, but much of the income flows out of the country to the owners of the foreign enterprises. So even in two seemingly similar coastal provinces, there are vast differences in the economic structure. However in recent years these differences have narrowed, as Jiangsu province has also become more welcoming to domestic entrepreneurs.

Today, Jiangsu province (just north of Shanghai) has a higher GDP per capita than Zhejiang province (just south of Shanghai). But GDP per capita is a misleading indicator for areas with lots of multinational investment (unless you wish to believe that Ireland is the richest country in the world.) So I checked Wikipedia for data on disposable income per capita in Chinese provinces. Here are the top ten:

Notice that by a wide margin Zhejiang is still the richest of Chinese provinces that contain substantial urban and rural areas. But that’s not all, here’s a recent story in Sixth Tone:

Move over Alibaba and Tencent, China has a new set of tech champions. Often referred to as the “six little dragons,” they’re DeepSeek, the Black Myth developer Game Science, robotics firms Unitree and DeepRobotics, Neuralink challenger BrainCo, and spatial intelligence firm ManyCore. And while they may still pale in size relative to their more established peers, they’ve breathed new life into China’s tech sector over the past month. . . .

That this cluster would take shape in Hangzhou is no accident. Startups, especially in tech, tend to be located in the most economically developed, talent-rich, and densely populated regions of a country. Hangzhou is located in the Yangtze River Delta, not far from Shanghai. It boasts one of China’s top universities, Zhejiang University, and it’s surrounded by a region known for its entrepreneurial spirit, as well as strong norms around things like contracts. It’s also a hub for Chinese tech, home to firms like Alibaba that attract talent from across China.

Equally important is the city’s business environment. Hangzhou — and the surrounding province of Zhejiang more broadly — are known in China for their business-friendly policies and officials, an approach summed up by the catchphrase “non-interference when unnecessary, fast response when needed.” Hangzhou has also set up a number of funds to attract and incubate new tech firms. For example, its Yichuang Town neighborhood, where Game Science is based, offers full rent subsidies or exemptions for promising digital content enterprises, including gaming companies, which helped Feng Ji’s firm survive its first few years.

While subsidies are common nationwide, the rise of Hangzhou’s six little dragons has sparked a nationwide conversation on how cities can better attract and support their own business clusters.

For example, Xinhua Daily, a state-backed newspaper in the neighboring and economically prosperous province of Jiangsu, recently ran a number of articles asking why DeepSeek and its peers emerged in Zhejiang, rather than its province. And local media in the eastern city of Jinan — the capital of Shandong province — recently published an article titled “What Can Jinan Learn from Hangzhou’s ‘Six Little Dragons?’”

Many Westerners talk about “China” as if it’s a single entity, like Denmark or Austria. In fact, it’s a huge and diverse continent-sized country. The phrase “entrepreneurial spirit, as well as strong norms around things like contracts” suggests the importance of Zhejiang’s culture. The phrase “non-interference when unnecessary, fast response when needed” suggests the value of what Tyler Cowen calls state capacity libertarianism. Of course, even Zhejiang is light years from being a libertarian paradise, but it’s well ahead of the rest of China.

A few years ago, Xi Jinping cracked down on the high tech sector. Today, the Chinese government is trying to patch things up, as they realize that high tech is their best hope in competition with the US. Here’s Dean Ball, discussing the new AI program Manus:

As I have written many times, the existence of an innovation is only the beginning; technology changes the world by being integrated into products and services that improve productivity or otherwise perform useful work. With novel technologies—especially general-purpose technologies—the work of integration is unglamorous, nontrivial, and utterly essential for realizing the benefits of innovation.

[George Washington University scholar Jeffrey] Ding describes how, in the 19^th century, Europe led the world in scientific innovation. The best research universities in the world were there. Aspiring researchers from all over the world—especially America—would travel to Europe to learn in their top-tier research institutions. But Europe did not use their innovations to their maximum advantage; instead, that honor went to America—the hungry, less sophisticated upstart. Europe led in innovation, but America led in diffusion (and eventually innovation also, but this took time). . . .

This pattern has repeated itself with the United States and China today—except this time, America is in Europe’s position. The United States led much of the innovation on lithium-ion batteries, solar panels, and electric cars, yet it is China that has exploited those technologies to their fullest advantage. Manus is evidence that something similar could happen in AI.

It's not the only evidence either. Compared to the US, China has focused much more heavily on open-source frontier AI, which I and others have argued benefits technology diffusion. Manus itself relies heavily on open-source tools and models (with the exception of Claude). Polls indicate that Chinese consumers are much more excited about AI than Americans, who in general seem much warier of the technology. The Chinese government has made accelerating practical, industrial applications of AI a major priority.

I can confirm that the Chinese seem especially receptive to new technology. For instance, their payment system is far more high tech than ours. In my most recent trip to China, I’d stop at Luckin Coffee in the morning. I felt like a barbarian trying to pay the old-fashioned way. They actually had to go to a neighboring store to make change for me. Meanwhile a steady stream of young Chinese people would enter the business, and leave about 5 seconds later with hot coffee in hand. They simply swiped their phone, and then picked up a bag with their number on the counter, which had been pre-ordered electronically. The busy staff didn’t even monitor this; it was on the honor system that you picked up the right item.

This 20 minute Youtube video is from Shenzhen, which is not in Zhejiang province. Nonetheless, it’s a very informative look at how tech is transforming one part of China.

BTW, please don’t take nominal Chinese GDP data seriously. PPP estimates from places like the IMF Bank are a joke, as they have Taiwan supposedly being much cheaper than Mainland China! (The reverse is true.)

PS. In America, some right wingers (not me) fall all over themselves praising El Salvador for a dramatic fall its the murder rate achieved by locking up thousands of men without a trial. China achieved a steep reduction in its crime rate with widespread security cameras (like in the UK) and facial recognition technology (like at our airports) and got nothing but scorn for that accomplishment from the West. I’m not a fan of security cameras either, but I can sort of understand why both El Salvadorians and Chinese are willing to accept the trade-off. And given a choice, I’d prefer the security cameras to prison with no trial. Today, of course, it’s not acceptable for a Western intellectual to say anything good about China.

Here’s West Lake, with the Hangzhou skyline in the distance: