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Support innovation by institutional reforms, CIFAR Fellows advise Chinese leaders

by Lindsay Jolivet Feb 3 / 14

Three CIFAR Senior Fellows told Chinese leaders they may have to undertake institutional reforms to help move the country’s economy away from manufacturing cheap products, and introduce better social supports for citizens in order to spark innovation and avoid stagnating economic growth.

Senior Fellows Daron Acemoglu (1st on left), Philippe Aghion (1st on right), and IOG Senior Fellow Torsten Persson (2nd on right) standing with Chinese Premier Li Keqiang (3rd from right). Also pictured: John Hassler and Per Krusell. Photo courtesy of Torsten Persson

Institutions, Organizations and Growth program members Torsten Persson, Daron Acemoglu and Philippe Aghion had meetings with Chinese Premier Li Keqiang and with the head of China’s central bank, Zhou Xiaochuan, during a visit in December. The researchers told the leaders that China’s economic growth may be unsustainable unless the country makes its institutions more inclusive.

Persson, an economist based at Stockholm University, says China knows it must reorient its economy to avoid the “middle income trap,” whereby its growth becomes frozen because it cannot compete with countries that support new ideas and patents.

“Chinese leadership has been aware of these risks and they have been talking in various official documents about the need to reorient China from the world’s factory of cheap products to a more innovation-based economy,” Persson says.

He says his decade as part of the IOG program has been “instrumental” to his research on institutions.

“What we’ve been trying to do is to think about the systemic issues in a way that incorporates not only economic institutions, but also political and judicial governance,” Persson explains.

From that perspective, Persson, Acemoglu and Aghion told Chinese leaders that giving entrepreneurs and investors the confidence to pursue and finance innovations may require a range of reforms – from introducing new forms of social insurance to supporting intellectual property rights with courts that are truly independent from the Communist party.

In the words of Persson, “People are probably more willing to take risks if they feel that they are protected from ruin if things fail.”

However, an innovation-driven economy creates winners and losers, and the possibility of greater inequality as new industries become more profitable than old ones.

“Once inequality becomes too large, losers in this process might try and seek compensation in various ways — to push for radically different policies in the street, increasing the risk for riots, which the Chinese leaders are very worried about today.”

Persson says China must take better care of its population to avoid wide income gaps and conflict, by restructuring systems to bring in social supports and make local officials more responsive to their citizens’ needs.

“The leaders at top levels are not accountable to the population in their province, prefecture or county, they are accountable to the next level up in the Communist party.”

Tie into these issues the fact that China is facing a “mounting environmental disaster” from irresponsible handling of natural resources and air and water pollution, Persson says, and the list of changes needed is long and complex.

“The difficult equation that they have to face is how to reform without doing away with the Communist party’s own power base. It’s like a cat going around hot porridge, as we say in Sweden. That question is, of course, always there.”