Western governments have offered protections for incumbent firms at the expense of new market entrants and productivity growth. With China realising the value of fair & free competition, the West needs to change course or get left behind

Western governments have offered protections for incumbent firms at the expense of new market entrants and productivity growth. With China realising the value of fair & free competition, the West needs to change course or get left behind

By Edmund Phelps*

From the early nineteenth century to the early twentieth century, Western countries attributed their economic growth to the discoveries of “scientists and navigators.” A country needed only the “zeal” to develop “obvious” commercial applications, and build the facilities to meet demand for new products.

Until recently, the Chinese believed the same thing. But now, Chinese business people and entrepreneurs are increasingly showing not only the entrepreneurial drive to adapt to new opportunities, but also the desire and capacity to innovate for themselves, rather than simply copying what’s already out there.

Indeed, more and more Chinese companies are realizing that they must innovate in order to get – and stay – ahead in the global economy. Several companies – notably Alibaba, Baidu, and Tencent – made breakthroughs, by offering digital-age infrastructure that facilitates innovative activity. And industrial firms have recently moved into robots and artificial intelligence.

For its part, China’s government is evidently supportive of Chinese businesses developing a capacity to produce indigenous innovations. It no doubt recognizes that such innovations are all the more valuable when innovation remains weak in the West, where growth in total factor productivity (TFP) has continued its long slowdown.

In recent years, China’s government has introduced initiatives aimed at increasing both entrepreneurship and innovation. It has shortened dramatically the process for forming a new company. It has built a vast number of schools, where Chinese children learn more about the world they will face. And it recently facilitated the entry of foreign experts to work on new projects in the business sector.

The authorities have also recognized the importance of allowing more competition in the economy. Individuals should be freed up to start new companies, and existing companies should be freed up to enter new industries. Competition solves a lot of problems – a point that is increasingly lost on the West.

At the World Economic Forum’s annual meeting in Davos, Switzerland, in January, Chinese officials discussed basic reforms that the government introduced two years ago to increase competition. Under the new policy, excess capacity now signals that supply should be allowed to contract and prompt redundant firms to exit the market. Of course, excess demand signals that supply should be allowed to increase, leading to the entry of new firms.

The key insight is that when existing enterprises are protected from new market entrants bearing new ideas, the result will be less innovation and less “adaptation” to a changing world, to use Friedrich Hayek’sterm.

Another argument can be made. In any modern economy, virtually every industry operates in the face of a largely unknowable future. The more companies an industry has thinking about a problem, the more likely a solution is to be found. A company that has been kept out of an industry might know something that all the companies in the industry do not. Or some unique experience may have furnished an individual with “personal knowledge” that is impossible to transmit to others who have not had the same experience. Whatever the case, society benefits – through lower prices, more jobs, better products and services, and so forth – when outsiders with something to add are free to do so.

All of this was known to the great theorists of the 1920s and 1930s: HayekFrank Knight, and John Maynard Keynes. And now it is known to the Chinese, who understand that a country benefits when companies – each with its own thinking and knowledge – are free to compete.

The West seems to have forgotten this. Since the 1930s, most Western governments have seen it as their duty to protect established enterprises from competition, even when it comes from new firms offering new adaptations or innovations. These protections, which come in myriad forms, have almost certainly discouraged many entrepreneurs from coming forward with new and better ideas.

History is rife with evidence of the value of competition. In post-war Britain, into the 1970s, industries were controlled by exclusive clubs within the Confederation of British Industry, which barred new entrants. By the time Margaret Thatcher became prime minister in 1979, TFP had stagnated. But Thatcher put a stop to the Confederation’s anti-competitive practices, and Britain’s TFP was growing again by the mid-1980s.

We are now seeing something similar in China. By 2016, China’s TFP growth rate had been slowing for a number of years. But since the reforms that year, it has been increasing.

The West must address its great TFP slowdown, which has lasted since the late 1960s. Ending protection of incumbents from new entrants possessing ideas for new adaptions and innovations is a good place to start.


Edmund Phelps, the 2006 Nobel Laureate in Economics, is Director of the Center on Capitalism and Society at Columbia University and the author of Mass Flourishing. Copyright: Project Syndicate, 2018, and published here with permission.

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The West seems to have forgotten this. Since the 1930s, most Western governments have seen it as their duty to protect established enterprises from competition, even when it comes from new firms offering new adaptations or innovations. These protections, which come in myriad forms, have almost certainly discouraged many entrepreneurs from coming forward with new and better ideas.

I think it's beyond governments ascribing to economic theory of protection. Regulatory capture seems most likely - as per American lobbyists and the correlation between donations and votes. Many Americans lament this regulatory capture and its negative effects on everyday Americans, including stifling of domestic competition.

I remember reading an article (NewScientist), which highlighted the increase in Chinese related scientific/scholarly being published. This bodes well for future advancements & full credit for the improvement in education (and the economic strategies) that has developed this.

However, I call out that part of the reason for China's grow much like Japan after WW2 is that it is coming off a low base. Catching up (though legal or illegal means), to others is somewhat easier than the incremental gains that happen when you are at the forefront of the Economic or Scientific community.

I also question the paragraph
"And now it is known to the Chinese, who understand that a country benefits when companies – each with its own thinking and knowledge – are free to compete."
The experience of Many Many Western corporate investing into China (IP infringement / Political Restrictions for Board & force JV's / What look like Pump & Dump strategies in Commodities), do not suggest a free to compete environment.

"I remember reading an article (NewScientist), which highlighted the increase in Chinese related scientific/scholarly being published"

Do you recall reading about the rampant fraud and fake peer reviews in Chinese 'research' papers too?

https://www.nytimes.com/2017/10/13/world/asia/china-science-fraud-scanda...

Yeah.

https://www.economist.com/news/china/21586845-flawed-system-judging-rese...
https://www.ft.com/content/680ea354-5251-11e7-bfb8-997009366969

I do wonder at the relationship between philosophy and culture, and innovation. How does it work being told to question everything in one sphere, and question nothing in another? (We certainly have examples of innovation under totalitarian regimes...but did they have existing bases of philosophy and innovation prior to the totalitarianism?)

Certainly. There was no shortage of innovation and engineering prowess in Nazi Germany, because there was no shortage of innovation and engineering prowess prior to it.

Question: Will China out-innovate the West?
Answer: Yes.

I would disagree and what's holding china back is the CCP's obsessive power control over its own people that restricts innovation and creativity. The 3 companies that this article cites is no more than rip off of amazon, google and the likes of Facebook/messenger and so on. If anything china is good at is reverse engineering, because after all why spend hugh investment into innovation when you can rip off others hard work in an environment with very little copyright protection??? As long as CCP is in power and dictates rules as it suits them with no regards for the rule of law china will always be a 2nd tier nation no matter how materially wealthy they may seem.

I'm at least as anti-China as you. And the crowning of Emperor Xi frightens me. Obviously I think innovation needs Maths and Science and doesn't need democracy. That is why China will succeed - they push kids into science at a young age and keep the pressure on whereas the west is forgetting science and our few mathematicians go into banks and finance companies and avoid the creative research jobs because the pay is bad.

I don't think is just about democracy though is vital because democracy ensures to a certain extent that no one or few can have absolute power over what others can or can't do. I am with you on the point that china lacks not mathematician and scientist but that will not raise innovation if they can only do what their are told to do which is what CCP is enforcing. Let's say some genius Chinese person developed a technology that can transfer/communicate to another person instantly just by thought alone and now everyone linked to that system can talk to each other anywhere anytime.... sounds neat and will have many useful application for this advancement.....BUT CCP will never allow such a thing to exist without their absolute control over it.. because all they can think of is will the people use this for uprising and revolts. Innovation comes from a system where people are allowed to do what they wanted to do which under CCP can never happen. Again you think about what happened to a certain AI technology that got axed by CCP because it spoke its mind by saying CCP is corrupt and not worth loving... So much for technological advances if you do not worship CCP

Exactly the wrong atmosphere for innovators and innovation to thrive. For all the innovations that succeed are many failed attempts, something dictatorships are not overly willing to tolerate. I think you are wrong.

The most naive comment that I have not seen for a long time.

I would have thought migration has been a driver of innovation success of the Anglo American sphere. People from East, Africa, South have all been attracted to the great Western Democracies. They have brought there there business and intellectual energy. And their children and childrens children are the "innovators", Jewish, Italians, Germans, going to America over the past 150 200 years.

No wants to go live in China. Therefore isn't open to a key source of intellectual generational productivity.

China won't take any one a step beyond the Digital Age. They don't have the inflow of minds.

Correct... and don't let the CCP worshippers and spies make you think otherwise. The reality is people under CCP dictatorship wants to leave when ever they get a chance and is never the reverse. This is so obvious that you just need to say why so many high ranking CCP's officials children have USA or UK passport if they love their motherland so much???? Why send their kids overseas never to return?? If anyone thinks New Zealand will be better with more CCP influence or ties then just think Hong Kong... it only took CCP 20 years to go back on their promise to HK and dismantle their "rule of law" and "human rights" that the Brits setup that ensured stability and wealth for the people of HK that turned HK from a fishing village to a city like no other, the pearl of the east!!! This can never happen under CCP and the now backwards HK is the evidence of CCP ruling. Never trust the communist!!!

I'm a rather proud ex-Brit and we did invent many things: railways, most sports, etc but if you take the last 2000 years then the Chinese are the only country that confidently claim to have invented more - compass, gunpowder, papermaking, printing etc. The history of Science in China is a thick 12 volume book. When Marco Polo arrived he visited Chinese cities many times bigger than the biggest European cities and met businessmen many times wealthier than the richest European princes. So taking the long view what has been consistent in China: Innovation (except for a blip from about 1700-2000), total lack of diversity (everyone Chinese), authoritarian rule (emperor Xi for life).

Ha, you lost me at "With China realising the value of fair & free competition". Shyeah.

Here is something that may interest you guys. Live on Canada's east coast and work as a contractor and have been in manufacturing for the last 45 years, most of that time was working in North American aerospace part manufacturing. Original from Wellington.
http://honoringhomer.net/wp-content/uploads/2014/08/wood.pdf