Zhejiang Province: A Free-Market Success Story

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Probably the most famous product of the Zhejiang model is Wenzhou, a city in southern Zhejiang province that today accounts for a disproportionate share of rich entrepreneurs, asset owners, and China's manufacturing prowess.

Although Wenzhou and Zhejiang represent the triumph of laissez-faire, broad-based, entrepreneurial capitalism, many outside analysts fail to appreciate why China should adopt free-market economics rather than retaining state-owned monopolies and state interventionism. Western observers and many inside the Chinese government focus on a narrow set of economic indicators. Specifically, they track economic performance by GDP data. In terms of GDP performance, the differences between Zhejiang's economy and the more statist economies of Jiangsu and Shanghai seem to be minor. Zhejiang outperformed these two regions in GDP performance but not by a large margin. So does it matter that China failed to embark upon "the other path?"

Breaking Down the Numbers

Economics, John Stuart Mill famously stated, is the study of "the sources and conditions of wealth and material prosperity for aggregate bodies of human beings." "Aggregate" is the key operating word here because it gets to the heart of why economic growth matters. Growth is important because it improves the welfare of the majority of the population. It is not sufficient that growth only benefits a few elitist members of the society. Here's where the difference between a bottom-up, entrepreneurial economy and a statist economy looms large.

Let me contrast Zhejiang with Shanghai. Shanghai has some exalted GDP numbers. For example, in 2004, Shanghai's GDP per capita was 55,037 yuan (about $6,880). This was 5.2 times China's GDP per capita. These data, however, are extraordinarily tricky. GDP per capita is often loosely referred to as income per capita. That phrase leaves the impression that an average Shanghai resident earns an income close to its GDP per capita, i.e., 55,037 yuan. Many foreign firms, for example, use GDP per capita data to design sales strategies in their regional marketing plans. But this assumption is deeply flawed.

There are two ways to disaggregate GDP data. One is the expenditure approach, under which GDP is disaggregated into consumption, investment, government spending, and net exports. The expenditure approach is the most common method by which GDP data are reported for China and for other countries. The alternative approach is the income approach, under which GDP is divided into the following components: labor income (wages and benefits); capital income (business profits, interest, and rent); depreciation; and taxes (income to the government). Depreciation is otherwise known as consumption of fixed capital, and it refers to the amount that businesses set aside to replace worn-out structures and equipment. Calculations of the income components of GDP often require removing the depreciation amount from GDP. GDP minus depreciation becomes the net national product.

The other three components of GDP represent income accruals to the three main players in an economy—labor, capital owners, and government. This decomposition of GDP immediately illustrates the fallacy of the common assumption: GDP per capita of 55,037 yuan in 2004 does not at all mean that an average Shanghai resident earned 55,037 yuan. The 55,037 yuan was shared among labor, capital owners, and government. Importantly, it matters how the GDP is shared among them.

In 2002 (the latest year for which such data are available), employee compensation comprised 41% of Shanghai's net national product. This is a remarkably low ratio. In the U.S., the labor income and proprietors' income together typically exceed 70% of the net national product. Employee compensation comprised 53% of the net national product in Zhejiang, a full 12% higher than in Shanghai. The two regions have almost identical shares of corporate profits, about 30%, which implies that the key difference between the two is the income accruing to the government. For Shanghai, the ratio is 28.9%; for Zhejiang, it's 17.4%.